The year-over-year unit sales declines in iPad that began in calendar Q1 of 2014 have continued relentlessly up to calendar 2015 Q3, when unit sales suffered a 20% y/y decline. For the December quarter, the limited availability of iPad Pro probably means no return to growth for the iPad line. However, Apple (NASDAQ:AAPL) is clearly positioning the Pro and future offshoots as its personal computing platform of the future.
It would be easy to look at the sales trajectory of the iPad and conclude that Peak iPad occurred in calendar 2013 Q4.
Undoubtedly, what has happened to iPad sales serves as the model for the assertion of Peak iPhone now being espoused by Apple bears. While the bears gloat about the iPad sales decline, pro-Apple pundits retreat into denial. Daniel Eran Dilger's take on the sales decline is that it's due to cannibalization by the iPhone 6 Plus phablet because, of course, the sales decline couldn't possibly be the result of competitive pressure.
The problem with this rationalization is that the y/y declines in iPad unit sales started in calendar Q1 of 2014, well before the iPhone 6 Plus was released. The onset of the iPad sales decline beginning in 2014 coincides with the beginning of Intel's (NASDAQ:INTC) contra revenue subsidized tablet processor sales in 2014.
Intel had set for itself the goal of selling at least 10 million tablet processors per quarter. By the end of 2014, Intel had shipped 46 million tablet processors and lost about $4 billion doing so. Intel virtually gave away the 46 million processors, which was 1/5th of the total tablets shipped globally in 2014, according to IDC.
Yet somehow, Apple pundits like to ignore what Intel did, and continued to do in 2015, pretending that flooding the market with nearly free Intel processors somehow had no impact. Contra revenue continued throughout 2015, despite Intel's assurances that it was being cut back.
As I pointed out in my recent article on Intel's 2015 Q4 earnings, Intel appears to have reverted back to full contra-revenue subsidies in order to achieve 9 million tablet processor sales for the quarter. For the year, tablet processor sales totaled 34 million units.
Although pressure from artificially low-priced tablet processors (Intel Atom series) let up somewhat in 2015, the pressure from more capable tablets and 2-in-1 notebooks running Intel Skylake processors increased. These were exemplified by the Microsoft (NASDAQ:MSFT) Surface Pro 4 and the Surface Book.
These were a much higher class of tablet. Whereas Android tablets often feel like mere upscaled smartphones, the Microsoft Surface Pro 4 and Surface Book run full versions of Windows 10. And while the Atom tablets often feel underpowered, Microsoft's devices were powered by full-fledged Core-series processors. The competition offered by the Microsoft devices (and similar devices by HP (NYSE:HPQ), Dell, Lenovo (OTCPK:LNVGY), etc.) was all the more potent for not being cheap, low-end devices.
So iPad has been taking hits from both the top and the bottom of the tablet market. In addition, Windows 10 devices have forced an evolution of the tablet market. Win10 has successfully blurred the line between the tablet and notebook and made a good case for being a better value than the iPad.
The value proposition for the Wintel tablet or 2-in-1 is fairly compelling, especially if you're a Windows user. A Wintel 2-in-1 equipped with an Intel Core processor can run legacy Windows software, serve as a respectable tablet, often with a pen accessory, and also provide a keyboard and track pad when needed. Given that these were priced about the same as iPad Air 2, the value proposition was fairly compelling for anyone who needed to run software such as Adobe Creative Cloud, which isn't available for iOS.
The Apple Response
To some extent, Apple's position on convergence seems pedantic and inflexible. Sure, Win10 is a compromise that never really achieves a pure tablet experience. The user is constantly forced back into desktop mode so that keyboard and trackpad/mouse become necessities. But it's a compromise that works, and you can do things with a Win10 tablet that you can't do with any Apple device, such as use the pen and touchscreen with Adobe Creative Cloud apps.
Apple's position on convergence may have more to do with its long-term product plans than the Steve Jobs dogma that touch screens don't work on the desktop. Apple may simply not want to invest the time and money necessary to endow Mac OS X with touch capability. Most importantly, Apple doesn't want to set up Mac OS X as a competitor to iOS. iOS is by far the more lucrative operating system.
The imperative to not compete with iOS is probably what's driving Apple's decision making. It's in this context that the iPad Pro is best understood. If Apple's only goal was to build a touch capable device that would be able to run desktop apps, then a touch capable MacBook would have been the right answer.
Instead, Apple has chosen to create the Productivity iPad. As such, the iPad Pro is only partially successful, but where the Pro succeeds, it points the way to the future of the iPad, and I think, tablet computing in general.
This was brought home to me in Anandtech's very good review of the iPad Pro. In addition to the obvious productivity enhancing features such as the larger 12.9-inch diagonal screen and multitasking provided by iOS 9, the review highlights other important features that point to the future.
The most important feature is the Apple A9X custom system on chip (SOC), which is a graphics-enhanced version of the processor in the iPhone 6s. Anandtech has performed perhaps the most comprehensive comparison of an Apple SOC with Intel's Core M series processors that I've seen published. The bottom line is that Apple's latest SOC still trails the CPU performance of the latest Skylake Core M3, but not by much, and it has much better graphics.
Overall, the processors are fairly comparable, and this has tremendous ramifications for Apple's product plans. Almost certainly, Apple's SOCs are less expensive than Intel's, even when all expenses such as design and engineering costs are taken into account. I've speculated in the past that this would motivate Apple to port Mac OS X to its ARM SOCs.
In fact, I doubt that Apple wants to manage such a transition, mainly because the Mac OS platform is not nearly as lucrative as iOS. Instead, what Apple wants to do is grow iOS to the point where it supplants Mac OS X for most usage scenarios. iPad Pro is an important step in this direction.
The next most important feature of the iPad Pro is Apple Pencil. Stylus capability is of course included in the Surface Pro, so Apple's adoption of it is not a breakthrough in itself. Apple Pencil is an example of Apple taking an existing idea and refining it to the point that it becomes a breakthrough in utility. The key improvements here are the extremely high screen resolution, the accuracy of positioning of the marks made by the Pencil, and the lack of discernible latency.
The Anandtech reviewer found that using Pencil was very much like using conventional paper and pencil, and he liked taking notes on the Pro better than on paper. So the pencil turned out to be not just a very useful drawing tool, but a legitimate alternative to keyboards for text entry. If Apple were to develop a set of handwriting recognition APIs for developers to use, Pencil would become that much more useful.
The advantage of Pencil for text entry is that it's much lighter and more compact than a physical keyboard. It's also more natural for use when the tablet is held in one hand. Apple Pencil is a productivity enhancement that doesn't compromise the fundamental iPad experience, and I predict that we'll see an expansion of its use to other iPads in the near future. The next likely candidate is the successor to the iPad Air 2.
The final innovation of the iPad Pro is the Smart Keyboard. Frankly, calling it smart is a complete misnomer. Copying the flimsy, plastic, detachable keyboard of the Surface was the last thing Apple should have done. It should just be a rule: NO PLASTIC. Ever. Keyboard, yes, definitely. Plastic keyboard, no. The keyboard should have had an aluminum frame like the keyboards of the MacBooks, and should have been attachable to the iPad Pro in such a way that the combination was rigid and could be used at a variety of screen angles.
Was Jony Ive on extended leave when they designed the Dumb Keyboard? I can't believe he had any design input. But, once again, this was a step in the right direction. Detachable keyboards are very useful additions to tablets.
All told, the iPad Pro is not the perfect productivity tool, or the tablet that will replace everyone's PC. It is, however, much more capable and probably can replace the PC for many users. Apple is simply going to keep enhancing the iPad and iOS to make using the PC (including Macs) less and less necessary.
The key takeaway for Apple investors is that iPad Pro is a transitional device, not a final destination. Apple is choosing not to compete directly with Microsoft in the PC-as-tablet market. Instead, it has created a device that affords more content creation without sacrificing the basic goodness of iOS. With iPad Pro, Apple has, at the very least, made drawing tablets like those from Wacom obsolete.
Because of the competitive pressures of Intel contra-revenue and Core series 2-in-1s, iPad Pro isn't going to work miracles for iPad sales this quarter. iPad sales also were hurt by the lack of an iPad Air refresh, which was probably necessitated by the short supply of A9 processors used in the iPhone 6s/6s Plus. I expect sales of non-Pro iPads to suffer a y/y decline of about 20% to approximately 17 million units. I expect sales of iPad Pro to be about 4 million units, for a total of 21 million. This represents a slight y/y decline of 2%.
I really don't expect iPad sales to resume growing until Intel gives up on contra revenue tablet subsidies. When that will finally happen is anyone's guess. As I pointed out, Intel seems to be capitulating in the mobile space after realizing that it can't be cost competitive with ARM processors. But we won't know for sure until Intel's financial data corroborates the curtailing of contra revenue subsidies.
Apple certainly has the financial wherewithal to weather this storm, no matter how long it takes. Consequently, I view the decline in iPad sales as a transitory effect. I remain bullish on Apple and recommend it as a buy.
Disclosure: I am/we are long AAPL.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.