Apple TV - Destined To Be Mediocre

| About: Apple Inc. (AAPL)

Given the recent development that Microsoft (NASDAQ:MSFT) has introduced its own "iPad killer," it becomes more important for Apple (NASDAQ:AAPL) shareholders, current or potential, to find more growth in Apple's business.

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When talking about Apple's potential, two things usually pop up in the conversation. The first is Apple's so-called "ecosystem," which I believe is far less important than people think. More important for Apple are things I've written about before: its ability to innovate and the potential factors that could hurt Apple's earnings. The second thing constantly mentioned by diehard Apple bulls is Apple TV. Proponents say that Apple TV has enormous potential, but I disagree with this judgment. Here are my reasons:

1. The market is too small.

During the first quarter of 2012, Apple sold 1.4 million units of Apple TVs, a great achievement if Apple was a small-cap startup company. This, however, converts to approximately $140 million in revenue, or only 0.36% of Apple's revenue in the same quarter. It has been five years since Apple introduced Apple TV into the market, and sales are still not picking up in absolute terms.

It is so insignificant for Apple that in the company's earnings report, Apple TV can only be categorized as "peripherals and other hardware." This is on the same scale as Apple's keyboard, monitor, or mouse sales.

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2. The market is not growing fast.

Percentage-wise, Apple TV sales seem to have been growing at a fast pace. But that has been largely driven by a tiny base number. The first Apple TV came out as a "DVD killer," but with very little consumer interest. Now that more and more consumers are streaming videos, with improved high-speed Internet access, the world is on its way to bypass the age of DVDs or even Blue-rays. That change, however, is an industry trend, not because of Apple TV. When examining absolute sales figures, the unit sales of Apple TV have been growing by an average of less than a million units a year. Given the rate of upgrading likely from Apple fans, it is doubtful that much of these sales were to new customers. Even if new customers start buying, it would take years to penetrate a decent percentage of U.S. households at this pace.

The slow-paced growth suggests there is an utter lack of interest in this product category, not only Apple TV.

3. The market is too crowded.

Not only that, the market for digital media players has clearly become very crowded. Apple TV is a fairly low-tech product from a hardware perspective. On the low end, Roku does pretty much the same thing Apple TV does. Since many TVs are now equipped with Internet capacity, Amazon's (NASDAQ:AMZN) streaming service doesn't even need to go through a digital media player. Google (NASDAQ:GOOG) has Google TV in the market. If, by chance, the market becomes lucrative enough, Microsoft can significantly boost the capacity of its Xbox to do the same thing equally well, if not better.

4. Apple owns no content.

The ultimate blow to the Apple TV dream is Apple doesn't own content. Apple is a device-selling driven business. Its major revenue sources are the iPhone, iPad, and Mac. Even today, content sales account for a very small share of Apple's profits. Since Apple doesn't own content and the outlets for content are plentiful (no monopoly power for Apple as a content distributor), Apple will almost never have a high profit margin from content-selling business. Content owners are the sole owners of the copyright, so they are the monopoly. They can always jack up the price to ensure Apple only has a thin margin from content distribution.

Therefore, Apple's profit from Apple TV will again be largely driven by hardware sales. Since the hardware is not selling in large quantities, Apple's profit from Apple TV has been mediocre and will likely stay that way for years to come. It could even be discontinued if it stays this non-substantial for Apple too long.

For this reason, I believe the prospects for Apple stock, up or down, don't depend on Apple TV. For the foreseeable future, it won't leave a trace in Apple's earnings records. Apple shareholders who put their hope on Apple TV to achieve a $1,000 stock price may be wishing for something with a very remote probability. When the reality sinks in that Apple TV is just another failed attempt by Apple, it could actually hurt Apple's stock since shareholders would realize that another potential growth prospect is gone.

In order for Apple for stay ahead of its competitors and keep growing in the post-Jobs era, CEO Tim Cook still needs to find the next big thing for Apple. It just isn't Apple TV.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.