Does the 'iPad 2.5' in 2011 Make Sense?

| About: Apple Inc. (AAPL)

Just days after The Wall Street Journal announced that Apple (AAPL) has begun production of the iPad 2, TechCrunch reported that Apple has plans to release the iPad 3 (or "iPad 2.5") in Fall 2011. Initially this seemed farfetched; but then again, this may happen. Here is why Apple releasing the iPad 2.5 in 2011 makes sense.

1. iPad 2 May Fail To Meet Lofty Expectations: It is appearing more likely that the iPad 2 will only be an incremental upgrade, similar to the upgrade from the iPhone 3G to iPhone 3GS. The 3GS was clearly better than the 3G but was not a very compelling upgrade for current users of the 3G. I suspect that a similar situation will occur with the iPad 2 in which current iPad owners will not rush out to upgrade for only a bump in speed and memory. I believe that much of this hinges on whether the retina display is part of the iPad 2.

2. Increased Competition Forcing Apple’s Hand: It seems that every week there is the announcement of the next "iPad Killer" whether it is from HP (HPQ), Dell (DELL), Samsung (SSNLF.PK), Motorola (MMI), Microsoft (MSFT), or Research in Motion (RIMM). There were over 100 tablets announced at the Consumer Electronics Show last month, and none could be called an iPad Killer yet but they are much better than previous offerings. According to Boy Genius Report, Apple’s market share of the global tablet market declined from 95% to 75% as Android tablets continue to enter the marketplace. While this is not a very significant statistic due to the fact that Apple practically created the market for tablets, it is still a notable decline. The emerging market is poised to grow so fast that many different tablet players can thrive, but Apple may not want to sacrifice its dominance. These competitors are widely targeting the summer for their new tablets, and therefore Apple cannot afford to wait until 2012 to react to these new offerings. The March/April 2011 iPad 2 will stem the tides while the iPad 2.5 would ensure Apple’s dominance.

3. Back-To-School Season: The iPad is increasing its penetration into the classroom as more and more schools and colleges are seeing the educational benefits of supporting the iPad. If Apple is able to move the release date of an iPad 2.5 to August or September 2011, it will have even greater market success with parents, students, school boards, and administrators. This could also provide Apple with the opportunity to "dump" its old inventory stock en masse. For example, iPad 2 prices could be lowered by $50 to $100, making it attractive to another market of customers. With the iPad selling like hotcakes at $500+, imagine the increased sales at a lower price.

4. Strengthens Relevance of Fall Announcement: With iPod sales virtually flat, Apple could use a high growth-high profile product launch in the Fall to capture media attention and prepare for the holidays. Apple has traditionally released its new iPods in September but the event has increasingly lost potency as the company’s iconic product line has declined in relevance. Moving the iPad launch to the Fall would supercharge the release cycle and provide Apple with even more coverage during the critical pre-holiday season. Lastly, if the iPad were to be released in March/April it could very well be overshadowed by the new iPhone which would be released mere months later.

5. The X Factor - Apple is Fearless: For virtually any other company the idea of cannibalizing other products, or even the same product line would be out of the question. At Apple, the focus is more on delivering quality (or as Steve Jobs would say, "magical") products to customers. Apple faced a very similar situation when it released the first iPhone and then quickly lowered the price a few months later. Early adopters were enraged; however, Apple quickly appeased them with a credit. I could see history repeating itself if there is enough public outcry. Early customers would benefit from a lower iPad 2 price and new customers would get the iPad 2.5 at around the same price as the original iPad.

So what does this mean for investors? It depends upon what company you are investing in. If you are hoping that RIMM’s/HP’s/etc.’s new tablet will be an "iPad Killer," the climb to the pinnacle could become more treacherous. If you invest in Apple you may be able to breathe a little easier knowing that the Apple product pipeline is secure.

Will my scenario happen? It could happen despite it being a notable change from Apple past marketing strategy, but I would not be shocked. Apple has proven to be very dynamic and "out of the box" thinking company which has helped in its success.

Author holds long positions AAPL (with Feb 19 360 Covered Calls written), MMI, and VZ.