Apple Inc. Can Grow with Beats and an iWatch

Ever since the launch of the revolutionary iPod, Apple (AAPL -1.08%) has been experiencing success at every turn thanks to its constant innovation. However, the industry's performance and quality gap is decreasing. New high-end products are being launched and there are some concerns over Apple's innovation leadership. It is safe to assume that Apple will follow a "design-first" strategy and will be able to sustain its smartphone market share with new offerings.

The worrying factors for the company, however, are the performance of its iPad and MacBook Air, and threats from the Surface Pro 3 launched by Microsoft (MSFT -0.40%). Moreover, Apple is trying to counter shrinking iTunes revenue through the acquisition of Beats.

Industry outlook and Apple
Phone and tablet growth is slowing. Smartphone sales are expected to grow by around 19%, as compared to 39% growth in 2013. Tablet growth is expected to be capped at 19.4% this year, as compared to an impressive 51.3% last year. Most of this growth comes from emerging markets, and the average selling prices and margins are decreasing. The slowing growth, increasing competition, and commoditization of smartphones will impact the margins of any company operating in the industry.

As Apple generates more than 50% of its revenue from the iPhone, it should be considerably affected by this outlook. However, this may not be the case due to several reasons. First, Apple will be able to sustain its share in North America, where consumers trade in old phones for new ones more frequently as products refresh.

Second, consumers have developed a strong loyalty to the iPhone. The HTC One or the Samsung Galaxy S4 did not have any impact on iPhone sales in 2013 despite their larger screens and superior performance.

Apple has shown a rather unimpressive performance in the tablet and PC arena in the recent quarter, indicating that consumers may not place as much value on the iPad or MacBook Air as they do on the iPhone. Moreover, the recently launched Surface Pro 3 is directly competing with iPad Air and MacBook Air.

This will put additional pressure on sales going forward, but the refresh cycle of iPad and MacBook Air may neutralize the threat from Surface Pro 3. The increasing competition in the tablet space along with the decline of iTunes -- thanks to music-streaming services like Pandora and Spotify -- could affect the prospects of the company going forward.

Beats acquisition
The recent acquisition of Beats Electronics will help the company in boosting iTunes and entering the music-streaming market, which is currently the high-growth segment in the music industry.

Beats gives Apple access to a major music-streaming platform. This will allow the company to offset the revenue-per-user decline in the iTunes segment. Moreover, music producers Jimmy Iovine and Dr. Dre will help Apple negotiate deals for streaming music. In short, the Beats acquisition is likely to counter the iTunes problem.

Smartwatch
The launch of Apple's smart watch can neutralize the threat it is facing in the tablet and PC arena. Apple executive Eddy Cue believes that the company's upcoming product line is the best he has seen in the past 25 years. This is quite a bold statement and relates to a new product, most likely the iWatch, because mere upgrades cannot justify such a claim. The smart watch is expected to have a rectangular dial, and Apple is expected to ship up to 50 million units. This translates to $15 billion in revenue at an assumed $300 price tag. The iWatch is a promising product and has the potential to repeat the iPhone effect.

Bottom line
The smartphone industry may be heading toward maturity, but the iPhone is not likely to suffer due to strong consumer affiliation and Apple's design superiority. The headwinds being faced in the tablet and PC market will be countered by the launch of the iWatch later this year. Moreover, Apple is directly addressing its music content business by buying Beats and launching a radio service. These steps will ensure Apple's growth and it will continue to be the apple of the shareholder's eye.