Over the past week, rumors of an upcoming "iPad Mini" (a 7-8 inch version of the iPad at a lower price point) have multiplied like wildfire. A smaller iPad starting around a $299 price point could potentially expand Apple (AAPL) into a new demographic and would compete directly with Amazon's (AMZN) Kindle Fire and Google's (GOOG) Nexus 7 tablet. This news likely accounts for a large part of Apple's 7% gain over the past week. The concept of a cheaper 7 inch tablet has drawn largely positive analyst commentary.
However, it seems unlikely that an iPad Mini can provide more than a minor (less than $2) boost to Apple's annual EPS. For one thing there will inevitably be some cannibalization from people who purchase an iPad Mini instead of the full sized iPad. While this danger can be exaggerated, Pacific Crest analyst Andy Hargreaves estimates a 25% cannibalization rate, which seems quite plausible. Topeka Capital's Brian White (a long-time Apple bull), by contrast, thinks cannibalization could be as low as 10-20%.
To be relatively optimistic, let's assume that the iPad Mini sells 40 million units next fiscal year (above Hargreaves' estimate of 35 million units) with a cannibalization rate of only 20%. Most analysts estimate that Google will break even (roughly) on the hardware for the Nexus 7. Apple has significant supply chain advantages which can keep its costs lower, but will probably build a device with somewhat better specs to maintain its "premium" feel. At a $299 starting price point, it seems reasonable to assume roughly $100 in profit per device. With 40 million sales, that's $4 billion in pre-tax profit. However cannibalization of 8 million higher-profit iPads reduces that figure by roughly $2 billion. The net contribution to Apple's profit after tax in this scenario is a little over $1.5 billion (about $1.60-$1.80 per share). Even if profit per device is somewhat higher than $100, it's hard to get beyond a $2/share impact to the bottom line. This is certainly material, but not much of a catalyst for a company that's estimated to earn $47/share this year.
Apple's market opportunity with the iPad Mini pales in comparison to the prospects for growth in the iPhone business (which already provides the majority of Apple's profit). Apple sold 72 million iPhone units in the first two quarters of this fiscal year, at a higher profit per device than the full-sized iPad. The company managed this feat even though the iPhone 4S has the same form factor as its predecessor, albeit with upgraded technical specs and the addition of Siri (a feature that has disappointed many users, with some even suing on the grounds that it was mis-advertised).
Most analysts expect the iPhone 5 (or whatever it is called) to have a larger screen size and 4G LTE capability. Moreover, it is likely to be the first device offered by China Mobile, which is by far the largest wireless provider in the world. This will provide a significant boost to iPhone sales (my estimate is 30-50% gain over an FY12 total of 125-130 million units, assuming iPhone 5 launches in October). This should be sufficient to take Apple's earnings beyond $60/share in FY13, well ahead of average analyst estimates today.
If anything, the iPad Mini's value might be in the ability to draw new customers into the iOS ecosystem. At a lower price point than the current iPad or an unsubsidized iPhone, a sub-$300 iPad could get some users hooked on Apple products and result in more-profitable sales of Macs and iPhones in the future.
Disclosure: I am long AAPL.
