After a flurry of speculation last month, the Apple (NASDAQ:AAPL) car hype has started to recede. That said, there are still a few nuggets of speculation emerging, and lots of investors are excited about the possibility of Apple disrupting the auto industry.
There's no way to know whether or not Apple will build a car. In all likelihood, even Tim Cook doesn't know at this point whether or not Apple will build a car! Even if Apple is working on an auto project, anything beyond the existing CarPlay system is still in the early stages of development.
What does seem clear, though, is that investors need to curb their enthusiasm about the supposed Apple car. Even reputable investment banks have offered some wildly optimistic projections of Apple's auto opportunity, but Apple investors should take these analyses with a big grain of salt.
Big money in the car
One notable example of overly optimistic Apple car speculation is a joint report by Morgan Stanley's tech and auto analysts that was issued last month.
The analysts pointed to the size of the global auto industry ($1.6 trillion in annual revenue today), noting that it is about 4 times the size of the global smartphone market. They see this as a market that could solve Apple's need for growth beyond the iPhone: "If AAPL were to corner just 25% of the value of the car, it would be equivalent to the entire smartphone industry today."
To be fair, the Morgan Stanley analysts do not claim that Apple is on the verge of building its own car, nor that such a vehicle would sell in big numbers. But they do think that Apple can get a foothold in the auto value chain through infotainment and then quickly expand into other parts of the car initially as a supplier to other automakers. Eventually, this could pave the way to a full-blown "Apple Car."
How big is this opportunity?
Morgan Stanley's market analysis relies upon the supposition that autonomous cars will hit the market around 2020 and become more common over time. The analysts claim that 60% of the value of autonomous cars will come from software, compared to 10% for cars today.
But if that's true, then autonomous cars will be quite expensive. The average transaction price of a vehicle in the U.S. today is more than $30,000. Auto profit margins are quite low, so the average cost of building a typical vehicle is probably more than $25,000.
Furthermore, the cost to build vehicles is rising, as automakers add technology and work to boost fuel economy to meet federal regulations. (If Apple builds a fully electric car, then that would further increase costs.) Thus, if the content of a present-day vehicle represents less than half of the value of a future autonomous car -- with the remainder being software -- then autonomous cars will need to cost more than twice as much as today's vehicles.
As a result, if Apple builds a car -- or if it provides extensive software and other technology for an existing automaker's car -- the average selling price would have to be a Tesla-like $100,000 or so for Apple to earn its normal profit margin.
Apple could probably expand the market for $100,000 cars quite a bit -- just as it vastly expanded the market for pricey smartphones. But it's still not going to sell millions of cars a year at that price.
Alternatively, if Apple provides infotainment and a few other software-based systems for $500-$1,000 it could snag much more of the auto market. However, with that business model it would only capture a small part of the auto value chain. Either way, Apple wouldn't be able to corner anything close to "25% of the value of the car."
The car is not a growth panacea
Perhaps Apple can revolutionize the car. I wouldn't bet against it -- Apple has demonstrated a remarkable ability to upend a wide range of product markets.
However, cars are already so expensive that even Apple probably can't convince a large proportion of consumers to spend twice as much on one. As a result, if Apple enters the auto market, it will probably have to choose between accepting a small position at the high end of the market or capturing a small part of the value chain in the high-volume mass market.
Instead, many investors and analysts seem to think that Apple can avoid this trade-off and enjoy high unit volumes in the auto market at an astronomical average selling price. This vision is the product of wishful thinking. Apple may find success in the car, but it isn't likely to be another iPhone-like $100 billion-plus business.
Adam Levine-Weinberg is long January 2016 $80 calls on Apple, short January 2016 $120 calls on Apple, and short January 2016 $140 calls on Apple. The Motley Fool recommends Apple and Tesla Motors. The Motley Fool owns shares of Apple and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.