All roads lead to Rome! That is always true in a metaphorical way, but I think that the right phrase for now is that all roads lead to the long overdue introduction of a phablet! This is a smart, ingenious new gadget that according to IHS iSuppli, will double or even triple its market share in 2013, reaching a shipment of ~ 60 million units - an amazing growth of 136%. I believe that phablets can do even better. I will position my thesis by supporting the proposition that the introduction of phablets is akin to the introduction of the Apple (AAPL) iPhone. And you guessed it - Apple is in a position to capture this market here and now.
You may have already heard about phablets, or you may have even acquired one. If not, the chances are that you are going to hear about them and that you are probably going to buy one soon. Apple and Google (GOOG) are working hard (at least from what I hear and read) to enter the business of making futuristic watches and glasses (with a high dose of irony here)... They are not going to compete with Rolex and Gucci (at least for now), but they are entering a relatively new business area with many pitfalls. Even if this new endeavor is a success, both Apple and Google (and potentially several others), must seriously educate consumers to realize possible applications and benefits associated with these new products.
The process of educating consumers can be long and full of mishaps. Unfortunately, education is not the only hurdle towards success here. Tight or well-provisioned budgets could be another one. More precisely, consumers will have to make provisions and be forced to use their accounting skills before endorsing these new products. This is particularly true since these new articles do not necessarily replace existing products but leave the current repertoire of gadgets unaffected, if not expanded.
A phablet, however, is different. It is not an entirely new product. Consumers don't need extra education, extravagant marketing campaigns, or even additional financial provisions in order to consider purchasing one. When their existing phone contract expires, instead of opting for a phone, they will just go for a phablet.
A phablet fills the gap between a phone and a tablet. The Apple mini iPad, for example, or any other 7" - 8" tablet is not a phablet. It is not difficult to define what is a phablet, but before doing so, let's find out more about the dimensions of existing products.
The following lists contain what I believe to be the most popular tablet and phone products:
Kindle Fire HD
Galaxy Tab 2 7.0
Motorola XOOM 2 Media
Xperia Tablet S
Motorola XOOM 2
Galaxy Tab 2 10.1
Nokia Lumia 920
Motorola RAZR HD
Galaxy S III
Galaxy Note II
Data from manufacturers. Dimensions in centimeters. Both tables are sorted by Height (in ascending order).
A phablet is, essentially, a smartphone with a screen bigger than a phone, but not as big as a tablet. Based on the above definition, I would classify a phablet as anything that has dimensions between (H x W): (14 - 16) x (7 - 9) cm. Obviously these are not territorial boundaries and, therefore, some flexibility should be assumed. Roughly speaking, 5" could be the median size of a phablet.
Only Galaxy Note II fits very well in the phablet category for now. All the other providers offer clear cut phones or tablets only. According to Samsung, Galaxy Note II has sold 5 million units globally during the first three months after its introduction (September 2012).
The phablet category will be a battlefield in the next months and quarters. The availability is absolutely non-existent and I believe that a great number of phone users will swap their existing phones for a phablet without any hesitation. This is the second iPhone commercial revolution and it will spread like fire.
Samsung has lost the opportunity to create this storm and create a phablet market. Current shipment of 5 million units and a projection of 20 million units of Galaxy Note II for 2013 is a big number, but is not a market. I believe Apple will offer a captivating product that will amaze the market. Sure, Google, Microsoft (MSFT), Nokia (NOK) or even Samsung can do that. But I doubt it, and I believe that only Apple has the experience to create a market. The creation of the phablet market is an undertaking for Apple and only Apple.
A phablet offers:
- More real estate than a phone, allowing a user to perform tasks that are cumbersome in a normal mobile phone (e.g. watching a movie).
- More physical volume to facilitate substantial spec upgrade (e.g. processor power increase) without the associated high cost and the restrictions of squeezing everything in a tiny amount of space.
- More breadth to enhance productivity (e.g. typing).
All the aforementioned characteristics, simply described, are size / volume related and can be easily achieved by opting for a tablet. That's absolutely true. A tablet, however, has a number of drawbacks:
- A tablet cannot act as a phone. It is possible to use phone-like services and make a call, but I guess carriers (at the moment at least) try to raise as many hurdles as possible to prevent a tablet being used as a phone.
- A tablet does not fit into your pocket, which means that even if you are able to make a call, carrying a tablet all the time, would be too geeky!
- A tablet is usually an outright purchase and not linked to a contract with a carrier.
A phablet is the answer and it has several clear cut advantages:
- It is a phone.
- It can be bought with a carrier contract to spread the cost.
- It fits into a pocket.
- It has all the advantages of a tablet.
- It appeals to both phone and tablet users.
- It is a product that is highly anticipated (particularly by existing iPhone users).
- It is not necessarily a technical innovation, but a cultural one.
But what is the likely scenario for the near-to-medium term future regarding phablets?
I will make the case for an Apple phablet. I believe that a watch or glasses is a bit "beam me up, Scotty" at this point. Success for these products could be round the corner, but that corner might be many many years down the road. A phablet, however, is an investment for here and now. I believe the phablet space will be filled with plenty of new devices within the next 12 to 18 months. Consumer acceptance will be high due to the limited education needed, the obvious market gap and the high affordability factor associated with a phablet.
Apart from the iSuppli forecast, other analysts are even more optimistic. Business Insider calls the phablet the gadget of 2013 and claims that phablet shipments will surge by nearly nine-fold to 228 million units within the next three years. According to Barclays, phablet volume will reach 143 million this year.
My analysis is not as optimistic as Barclays or as pessimistic as iSuppli. I believe that iPhone and phablets will follow a very similar growth path and I will base my thesis on that. I will use iPhone revenue numbers (see table below) as a proxy, to derive a phablet CAGR and, then, 2012 smartphone shipments (722 million; IDC.com) to re-engineer a likely consumption of phablets for a period of 60 months, following the introduction of a major branded phablet (apart from the Galaxy Note II, which is already in circulation).
iPhone Revenue ($M)
Data from Apple.com.
The above iPhone sales provide a CAGR of ~75% (assuming constant quarterly sales for 2013). By using ~ 75% CAGR and sales of 722M units (achieved after 5 years), this type of analysis gives us a value of 77 million phablets after 12 months.
Projected Phablet Shipments (units million)
77 million units (if achieved) is a big number and the possible consequences for all players can be substantial:
- Apple most likely will be the first to introduce a captivating new product and secure 40%-60% (~30 - 45 million units) of this new market in the blink of the eye. This is exactly what Apple did with the introduction of iPad (~ 25 million iPads sold within the first 12 months of its introduction) and iPhone. I believe Apple can do it again.
- Global smartphone shipments will not be cannibalized due to continuing smartphone market expansion.
- Smartphone shipments in U.S. and Europe will be slightly affected since the penetration of smartphones is already high.
- Small size tables will be affected the most, since consumers will have the option to select a subsidized phablet (with contract).
- Kindle, Nexus and other $200 or less devices should face increased competition from a free (with contract) phablet.
- Amazon (AMZN) should be motivated to introduce a Kindle phablet in order to preserve and expand market share.
- It is also possible that Amazon will start giving away certain Kindle models for free.
I expect Apple to deliver an insanely magical product and grasp the lion's share. The introduction of a phablet will happen within the next 6 to 9 months or earlier. This might be the big iPhone or a brand new product. It is difficult to know, since Apple maintains absolute secrecy.
By introducing a phablet, Apple should achieve the desired diversification - i.e. to reduce reliance on iPhone sales. This diversification should help push PE to 10-12x or higher and increase EPS by ~ $5 - $7.5 (assuming 40% - 60% market share, maintenance of existing margins and no cannibalization of iPhone sales). The corresponding price increase, due to the introduction of a phablet, could be ~ $50 - $90. This represents a 10% - 20% price increase.
Phablets are coming and their impact will be big. Existing players will not have any hesitation to introduce a new device since consumer acceptance is expected to be high. Apple can be the real winner here, by introducing an amazing new device. The phablet space is almost empty now (only Galaxy Note II acts as a phablet). But the potential growth is substantial and most likely will resemble the growth of the iPhone.
Disclosure: I am long AAPL.