iPad 12.9-Inch Version May Deliver Strong Gross Margins For Apple

| About: Apple Inc. (AAPL)


Apple continues to enlarge devices across its ecosystem.

A 12.9-inch variation of the iPad is expected to launch early 2015.

By comparing bill of materials I estimate that gross margins for the 12.9-inch iPad will be in the range of 42% to 50%.

Apple (NASDAQ:AAPL) finally decides to enlarge everything. Bigger iPhone, bigger iPad, and heck at this rate they might as well create a 42" Macintosh and a 20" MacBook. Everything is getting bigger in California, of course with the exception of California itself (land mass erosion anybody, anybody?).

According to Bloomberg:

The new iPad will have a screen measuring 12.9 inches diagonally, said the people, who asked not to be identified because the details aren't public. Apple currently produces iPads with 9.7-inch and 7.9-inch displays. The Cupertino, California,-based company has been working with suppliers for at least a year to develop a new range of larger touch-screen devices, said the people.

So, according to Bloomberg there's going to be a 12.9" iPad device that will be released sometime in the beginning of 2015. This is another welcomed addition to the iPad product lineup, as it helps to address the cannibalization issue that I brought up earlier in the year. But before I delve any deeper into the analysis, let's refer back to what I had said earlier.

A bigger iPhone will cannibalize iPad Mini demand:

Furthermore, just because a consumer buys the larger 5.5-inch display device doesn't mean that the same consumer will not buy a tablet. In fact, it may encourage consumers to buy the larger tablet (iPad Air), therefore I believe that Apple's upcoming product mix will have a positive impact on net income, and phablet cannibalization will positively impact gross margins.

I think the bigger iPad is in response to bigger iPhone devices. I think that the 12.9-inch iPad will be a price competitive product that significantly encroaches upon the $600-$800 laptop/Ultrabook category of the PC market. The pricing of the MacBook air starts at $900, so Apple is filling the holes, and is broadening its market at the same exact time.

Currently the iPad Air's pricing starts at $500, so I'm anticipating the 12.9-inch iPad to be priced somewhere between $700-$800. At this price point, it will appeal to those who want a laptop/Ultrabook-like experience using iOS. I think iOS is a more popular operating system than Mac OS X 10.6, and assuming the iPad 12.9-inch model uses ARM based components, the company will generate a significant rate of profitability.

The incremental cost of a larger screen will be minimal, but unlike previous generation iPad devices, there's the ongoing speculation of a sapphire laminate that will drive up costs a little more from previous generations. However, from a bill-of-material perspective, the incremental cost from a smaller to larger iPad tablet device is offset through higher pricing. According to a Bill of Material figure for the iPad Air, the display alone costs $90. However, when you compare the Bill of Material figure for the display for MacBook Pro at 15.4 inches, the cost could go up to $160 for the screen.

Therefore, the impact of a slightly larger screen could drive the incremental unit cost up by $50-$100. Assuming the cost of sapphire is too prohibitive, it may not even be used in the iPad lineup. If sapphire is used, the cost of the screen may come in slightly higher than the range that I'm working with as a bigger screen will use more sapphire, which will carry significant cost.

Most likely, the cost of the screen won't increase by as much, and it will most likely be offset by at least a $200 price differential, which will result in higher profitability when compared to the iPad mini and iPad Air. The bill of materials for the base iPad Air model is currently, $304 and add in $50 in cost from a bigger screen, paired with a selling price of $700, and perhaps gross margins for the 12.9 inch model is approximately 49.4%. However, if the 12.9 screen costs increase by $100, the gross margin figure should be 42%. Therefore, gross margins should be in the range of 42% to 50% for the 12.9 inch model.

The 12.9 inch model offsets cannibalization from phablets, improves the ASP of the iPad segment, and improves gross margins of the whole entire segment. I think MacBook Air sales will get cannibalized. However, the higher profitability offsets the decline in sales that will most likely occur.

I think a bigger iPad should be interpreted positively. I reiterate my buy rating and $120 price target for 2015.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.