The iPad Revolution: Naysayers Miss the Big Picture

Apr.15.10 | About: Apple Inc. (AAPL)

About a decade ago, in the quest for a convergence device that could do email, browse the internet, manage task lists, etc., I decided to check out the smartphone offerings from Verizon (NYSE:VZ) in Oregon. Besides the fact that most phones offered by Verizon back then were unappealing in general, the only device I could find was a Kyocera (NYSE:KYO) smartphone that felt like a brick, cost more than $500 and was as attractive as a pack mule (no disrespect intended towards pack mule lovers).

Research in Motion (RIMM) took the lion's share of the smartphone market with its Blackberry line of smartpphones by getting email right and building durable phones that did not crash. However even though I was a power Blackberry user, as soon as the iPhone (NASDAQ:AAPL) released, I knew this was the convergence device I had been waiting for.

While the Blackberry models circa 2007, like the 8700 and the Curve, could do email well, the selection of apps was limited, the process of getting an external app cumbersome and the Blackberry browser felt like something from the Stone Age after trying out Safari on the iPhone. Research In Motion has been playing catch up since the release of the iPhone.

Amazon’s (NASDAQ:AMZN) Kindle device is going to experience a similar fate following the release of the iPad. When considering gift ideas for my nephew whom I was going to meet after nearly 8 years, I strongly considered getting him a Kindle given his passion for reading but ended up picking up an iPad instead. The iPad is a convergence device that successfully combines the best of an E-book reader and a Netbook. Not only can you access books on the iPad through the iBooks application, an app called Free Books given you access to over 23,000 free books. The FreeBooks app itself costs $1.99 for the iPhone and iPod Touch but is free for the iPad.

Apple sold 300,000 iPads on the day it was released. This was well below analyst estimates that had touted sales as high as 600,000 to 700,000. As you can read from the article titled “Apple Analyst Pulled 700,000-iPads-Sold Number Out Of His Ass”, those analyst estimates were little more than conjecture. You are not alone if you find it ironic that Wall Street’s disgraced internet poster boy Henry Blodget is taking a shot at another analyst.

The Monday following the release of the iPad, I was surprised to see Michael Bigger of Bigger Capital short the stock of Apple. I respect Michael’s investing acumen given his decision to pick up Amazon.com following the 2001-2003 recession and more recently footwear company Crocs (NASDAQ:CROX) after most people had given up on the company for dead. He has the rare ability to not only go against the crowd but also has the patience to hold on to his investments for years.

His approach brings the words of the great speculator Jesse Livermore to mind. In the book Reminiscences of a Stock Operator by Edwin Lefèvre, Jesse is quoted as saying

It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets. I’ve known many men who were right at exactly the right time, and began buying or selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine–that is, they made no real money out of it. Men who can both be right and sit tight are uncommon.

Michael’s coverage of Crocs was published in the March 2010 edition of SINLetter and the stock is up more than 45% since that newsletter was published. I can see why Michael and a number of other people would dismiss the iPad as a fad but I felt that he was missing the bigger picture here (yes Michael, this is a pun on the name of your investment firm).

The similarly priced iPhone sold 270,000 units when it was first released but eventually went on to sell more than 25 million units in 2009 (3.8 million in fiscal Q2, 5.2 million in fiscal Q3, 7.4 million in fiscal Q4, 8.7 million in fiscal Q1 2010) and now has every smartphone company from Palm (PALM) to Research in Motion playing catch up. After testing the water shorting Apple, Michael decided the momentum was too strong and covered his short position in Apple for a small profit.

The Apple sales associate who helped me with my iPad purchase used an iPod Touch to accept my credit card payment right on the floor of the Apple store without requiring a visit to a long checkout lane. You can currently use the iPhone and the iPad to unlock your car and start it remotely using the Viper SmartStart app should you desire a warm and toasty car on those chilly winter mornings. I can easily fathom someone developing an app that would allow restaurants to accept orders using iPads from tables and displaying these orders on a large screen for the chef along with the timestamp of the order.

With over 3,000 apps specifically designed for the iPad and the ability to use a majority of the 180,000 iPhone apps, the number of ways you could use this device is almost limitless. Zynga’s word game Scramble 2, which is actually an iPhone app and not a native iPad app was fun to play on the iPad even after I expanded the app to make it fit the iPad screen. According to tech review site Engadget,

To say Apple is about to put a major dent in Kindleworld is an understatement. The iBooks app is one of the most beautiful and thoughtful uses of the iPad screen real estate on the device.

Amazon.com’s Kindle reader is available in 130 countries and Amazon sells 6 Kindle books for every 10 physical books sold. Despite this first mover advantage, the iPad is a clear and present danger to Amazon’s Kindle device. Amazon would do well to take a page out of Google’s Android book and focus its attention towards using the Kindle software as a delivery device for its customers irrespective of the actual hardware used.

When the editor of Wired magazine, Chris Anderson, released his book Free: How Today’s Smartest Businesses Profit by Giving Something for Nothing on the Kindle for the grand price of $0 (the hardcover version cost more than $20 at the time of release), I decided to give the Kindle app for the iPhone a whirl and read nearly a third of the book on my iPhone. An iPad version of the Kindle app was released on April 7, less than a week after the iPad’s April 3, 2010 launch.

Amazon is a very well run company with their G&A expenses falling 25 basis points to 14.5% in Q4 2009 even as revenue grew 42% to $9.52 billion. Return on invested capital (NASDAQ:ROIC) was an eye-popping 66%. In the fourth quarter of 2009, third party sellers accounted for 28% of overall worldwide revenue for the company.

Amazon simply acts as a middle man for this revenue stream and it is highly profitable for the company. Amazon Prime, a service that offers 2 day free shipping for an annual subscription fee, is reaching maturity in international markets. As an Amazon Prime customer I can see how it could help enhance international growth in the months to come.

However if your investment thesis regarding Amazon depends on Kindle fueled growth, this might be a good time to reassess that thesis. The iPad is going to change the landscape for every E-reader in the market including Kindle, Barnes & Noble’s nook and Sony’s Reader just like its little brother the iPhone did a couple of years ago.

On an unrelated note, I wrote most of this blog entry on a Virgin America (@virginamerica) flight from Washington DC to San Francisco. This was my first time flying Virgin America and the experience was as good as some of the best international airlines I have flown like Singapore Airlines and Emirates. In flight Wi-Fi and a personal entertainment console that can be used to watch movies, play games, order food and drinks by adding them to a shopping cart, listen to music by creating a custom playlist with artists ranging from Moby to Bob Dylan and even the ability to chat with others on the plane made the hours melt away. An upgrade to Main Cabin Select allowed me to check in bags, watch on demand movies and order as much food, snacks or drinks as I wanted without paying a dime more.

The only thing that was not included was Wi-Fi, which was an additional $10 charge from a third party provider. I would highly recommend checking Virgin America out for domestic flights even if they cost a few dollars more than incumbents like United Airlines (UAUA) and keeping an eye out for an upgrade to Main Cabin Select (I only had to pay about $40 more).