Is Apple TV a Viable Replacement?

As of the end of last year, roughly 132 million DVD players have been sold in the United States since the device's debut in the late 1990s. Over 10 million of these players were sold in 2007 alone, notwithstanding the advent of the Blu-Ray and HD-DVD formats. At its height in 2003, DVD sales reached close to 22 million units annually (U.S.). If Apple (AAPL) is able to dominate the video market with the Apple TV, as it conquered the digital music market with the iPod, Apple could potentially add an additional $2 to $4 billion a year in "surreptitious" revenue from sales in the United States alone.

Apple has been, and continues to be, quite secretive regarding the number of Apple TVs that are in circulation. Apple neither discloses a total unit sales figure for the device, nor does it announce the amount of revenue it receives from Apple TV sales. All we know is that Apple currently uses the subscription method of accounting for Apple TV revenue, much like it does with the iPhone.

But instead of allocating a separate line item for the Apple TV on its financial statement, Apple simply records the revenue under one line item called "iPhone and Apple TV"—leaving the relevant observer completely ignorant as to both the monetary and market impact of the device. This has led many Wall Street pundits, investors and financial analysts to fully understate the potential influence the Apple TV might have on the video market.

Investors should view this as a positive for more than one reason. First, by leaving the financial public in the dark, Apple has all but eliminated potential headline risk commonly associated with the inauguration of a new digital product. Both sell-side analysts, and the financial press, thrive in writing negative fluff pieces focused on the understandable and unavoidable set-backs that occur whenever a new device is introduced into the market place. The Apple TV, like the iPhone and the iPod, probably started off with relatively low sales figures. If Apple reported those figures, then the headlines, instead of focusing on blow out earnings, might have read: "Apple drops 5 points in after hours on lower than expected Apple TV sales." By leaving everyone in the dark, neither Apple nor its investors have to deal with such nonsense.

Secondly, if the Apple TV does begin to dominate the market place, Apple will find itself in the advantageous position of being able to frequently post upside surprises to its revenue. While the Apple financial community focuses on iPod, iPhone and Mac sales, the Apple TV would continue to fly under the radar as it posts stealthy but significant sales revenue to the largely ignored deferred revenue category. Additionally, by being secretive regarding the Apple TV, management gives Jobs & Co. the option of blindsiding the market during one of its MacWorld or WWDC conferences by announcing staggering sales figures of which the market might have otherwise been aware.

For all we know, the Apple TV could be making considerable ground even as I write this article. Last week, Apple announced that iTunes has become the world's most popular online movie store as it sells and rents over 50,000 movies per day or a little over 18 million movies per year. That's with a catalogue of only 2,000 movies. With a huge customer install base for movie downloads already set in place, the Apple TV 2.0 can already be taking off.

Yet, while Apple has made significant inroads in its campaign for occupancy of the living room with its Apple TV Take 2, the Apple TV still has a long ways to go from being the perfect alternative to DVD players.

There is a lengthy laundry list of easily fixable issues that Apple needs to address before the Apple TV can be considered a viable replacement. Some issues touch on practical considerations, while others focus on the convenience of the end user. Knowing the genius of Steve Jobs, Apple is probably working on most, if not all of them:

1. Where's the TV Tuner and HD-DVR? One of the most complained about issues regarding the Apple TV is its lack of a basic TV Tuner and an HD-DVR. By adding a TV Tuner and a DVR, the Apple TV will probably become the best alternative to any current set-top box on the market today. It will allow the end user to interface the Apple TV software conveniently with his or her television programming. By offering Cable TV shows, such as HBO, through iTunes, the DVR + TV Tuner might even obviate the need for a subscription to Cable for some users. Yet, it will be really crucial for Apple to successfully interface its Apple TV software with its tuner capabilities. This might require a complete revamp of Apple TV's current software. A big annoyance with the Apple TV is having to switch to "video 2" every time I want to watch a downloaded TV show or movie. Having a TV Tuner and a DVR would create the maximum convenience for the end user. It will allow the user to channel surf, record a TV program and download a movie from a large catalogue in iTunes all through the same set top box. This is very key. If Apple could get over the legal hurdles to do so, it would also be vital to allow users to sync its DVR recorded content with his or her iPod/iPhone.
2. Wireless Syncing and Streaming with the iPod Touch & the iPhone. As a practical matter, I could always take a DVD I rented from Blockbuster (BBI) or Netflix (NFLX) to a friend's house to watch on his or her DVD player. But with downloaded content, this is not so easily accomplished. I would have to copy the iTunes movie onto an external hard-drive from my computer, add the video to my friend's iTunes account on her computer, authorize her iTunes to be able to play my content, and then she would have to have an Apple TV to play the movie on her television set. After watching the movie, my friend would have to delete the digital copy, and I would have to unauthorize her computer from playing my content. Clearly, this system causes major headaches for even the technologically inclined, not to mention for those individuals who have a hard enough time understanding how to load their iPods with music. An obvious and clever solution to this problem is to allow wireless streaming between the end-user's iPhone/iPod Touch and any Apple TV. That way, one could load his or her movies on his or her iPhone and take them to a buddy's house to watch on the telly. This would also further solidify the Apple ecosystem of the iPod-iTunes-Apple TV. Moreover, one is more likely to be carrying his or her iPhone than a DVD, thus allowing the end user to be able to spontaneously watch their downloaded content at a friend's house. Wireless syncing would also be a huge plus, but it is not as necessary as being able to stream content. It would be great to be able to download a movie through Apple TV and wirelessly sync that movie to one's iPhone. Yet, more importantly, it would do Apple well to allow users to plug in their iPods/iPhone to their Apple TV to pull content directly off of the set-top box. That way, if one has DVR recorded content, he or she would be able to download it onto his or her portable device.
3.  iTunes Expansion, DVD Extras, Subscription Services and HD Content. Apple TV's potential for success is only as good as the catalogue of movies and TV shows offered in iTunes. The Apple TV cannot be considered a viable replacement of the DVD player without the full catalogue of movies. Yet, in all fairness, Apple is slowly, but surely, building its iTunes catalogue with movies and TV shows daily. Still, iTunes movies currently contain no DVD extras, which severely limit the content available to the end user. Apple needs to make all of their movies available for both purchase and rent in HD quality, insert the extras found in DVDs and increase the storage capacity on the Apple TV. Moreover, the Apple TV would be even more attractive if Apple offered its users a wider range of service by creating a Netflix-like subscription service along with its a la carte offerings it already sustains.
4. Maybe a Blu-Ray Player? Another idea that I have come across is the notion of adding a Blu-Ray player to the Apple TV. I remain skeptical about Apple going in this direction for a number of reasons. First, while the inclusion of a Blu-Ray player might help make the Apple TV an attractive option with the HD crowd, the idea of including a Blu-Ray player defeats the fundamental purpose behind the Apple TV—making video content available to the end user in the quickest most convenient way. The whole concept behind the Apple TV is an attempt to put an end to the physical medium for music, television and movie content. Secondly, Apple's HD medium should try to compete with Blu-Ray. By adding a Blu-Ray player, Apple is helping itself defeat its own HD format.
5. Allow DVD Ripping in a DRM Protected Format. Once again, if Apple could get over the legal hurdles of permitting its customers to do so, Apple should allow the end user to rip their DVD catalogue in DRM-protected files so as to allow the end user to make a quick and easy transition to the Apple TV. For those who have huge DVD catalogues, there is a high incentive to stick with the physical medium. Blu-Ray would have a difficult time surviving if its players were not compatible with DVDs. In the same way, it would behoove Apple to take steps in the direction of helping their customers make a smooth transition to virtual content. One way or another, the Apple TV will be better off if iTunes customers do not have to pay twice for the same content.
6. Better Remote Control. For anyone who has an Apple TV, this is self-explanatory. Apple needs to develop a much better remote control for the Apple TV, especially if it decides to add an HD-DVR and TV Tuner. A touch screen one perhaps?

Disclosure: I own long term 2009 and 2010 call options in Apple. The information contained in this blog is not to be taken as either an investment or trading recommendation, and serious traders or investors should consult with their own professional financial advisors before acting on any thoughts expressed in this publication.

Comments

[User 216900:]

TV "Turner"??? Are you f'in kidding me? It's a TUNER.

2008 Jun 26 08:37 AM

[Wbestdeal:]

Great article, but needs a bit more TLC then just spell checker. Think you mean "Tuner", not "Turner"?

"Where's the TV Turner and HD-DVR? One of the most complained about issues regarding the Apple TV is its lack of a basic TV Turner and an HD-DVR. By adding a TV Turner and a DVR, the Apple TV will probably become the best "

2008 Jun 26 08:42 AM

[Vox Rationalis:]

First off, it's "tuner," not "turner."

I don't believe that Apple TV sales are comparable to iPod and iPhone sales, nor do I think either of those products had initial sales that were disappointing in any way. Certainly iPhone sales were not disappointing. iPod sales way back in 2001 were just 125k in its first two months (at $400 for a 5GB HDD), but this was a big number, trumpeted in AAPL's quarterly earnings report. There was never ANY attempt to disguise sales numbers for either product.

Also, consider the hype surrounding both the iPhone and iPod. Both had benefited from much larger marketing campaigns than Apple TV. iPhone has been a focus of the media covering the cell phone market like no other device I can recall. Apple bought lots of ad time for the iPod - how many ads have you seen for Apple TV?

I like the Apple TV. It's a nice device, a cut above competing products, and the potential is clear. But I trust Apple to manage the marketing efforts for the product, and clearly Apple doesn't think the market's there for a big push.

2008 Jun 26 09:16 AM

[Zoltan L. K...:]

AAPL is taking the "TV-Business" very seriously, but I think we will see some more iterations to the Product/Market-solutio... I still cannot figure out, how the business will look like with Apple TV as a stand-alone product.

2008 Jun 26 10:38 AM

[mollytjm:]

Good take on Apple TV. Apple TV may seem like a slow starter,but there are probably a lot of people waiting to end phone contracts and buy the iphone, then consider buying the Apple TV. With so many wonderful products, it's hard for a lot of people to budget these purchases. i bought a MacBook this year, my husband bought an Imac, and we bought the external hard drives for TimeMachine and now are thinking about going wireless with that. We have NetFlix with a kazillion movies, but i'm emptying my list and will cancel that. Next... after the iphone purchase at end of summer and going wireless, then we'll get Apple TV, which will by that time, have a bigger movie selection. See, the problem here isn't with Apple TV..it's that Apple makes so many wonderful innovative products.

2008 Jun 26 10:42 AM

[Gears of War:]

Loved your last article about the iPhone.
Question about the "iPhone and AppleTV" category Apple uses-aren't analysts pretty confident about the numbers for the iPhone? Can't someone with better math skills than me just extrapolate the actual revenue from the AppleTV?

2008 Jun 26 12:09 PM

[KenC:]

1) TV tuner/DVR-So you want a STB replacement. Well, unless you have a cablecard built into the ATV, it won't happen. And, given how problematic cablecards have been, I doubt it will happen, so the STB stays, and you'll just keep having to hit "video 2".

As an alternative you could setup an EyeTV that records in HD, and has "streamer" software to stream your shows/movies. I think it also automates the process of getting your shows into the ATV.

2) iPhone/Touch portability-Well, you are not going to be able to stream a show, without plugging it in. Why not just buy the $50 set of cables and connect it to your friend's TV? The only advantage to connecting an iPhone/Touch to the ATV is to get the HD content, but you can't move the HD content, so there's no advantage to connecting directly to the ATV. Connecting to your Mac, allows you to move all your non-HD content easily. I just moved the "Untouchables" which I got for 99 cents from my Mac to my iPhone. I can now hook up the $50 set of cables and watch in on someone else's TV.

3) All in due time.

4) Apple would sooner include a DVD player than a BD. BD is still a niche product.

5) Legal DVD Ripping? Studios will never allow it. Just let the in-the-know users do it.

6) Remote - Expect one for the iPhone/Touch once the App Store is up and running.

Other than integrating an EyeTV device, I'm not seeing too much here.

2008 Jun 26 01:32 PM

[cherf:]

Good point about Apple TV being a stealth product, but I'm not certain you're really looking in the right place.

While Apple TV looks like the company's first foray into the set top box, it really isn't. Pretty much everything you've suggested Apple do with the product is already available with a Mac Mini, the exception being the Blu Ray drive. The Mini has a standard def DVD drive.

If you take a Mini, hang 4 terabytes of storage off of it (1394 preferred), hook it up to a gigabit LAN and a widescreen TV you can not only archive your complete DVD and CD collections you can use the thing as a server to stream video to every computer in your home. I put in an Airport Extreme along with a few Airport Express remotes around my house near audio amplifiers and now I can watch my entire DVD collection or listen to my complete iTunes Library from any laptop I own, on any monitor I have connected to a Mac, from any amplifier I have connected to an Express.

It's pretty cool. I agree they need to do something about Front Row; it's painfully slow sometimes.

It isn't $229 though. You aren't going to find a system that can drive 5 displays and 8 speaker systems all over your house for $229. A gigabit ethernet switch alone will cost you more than that. However if your house is already wired for CAT 5, all you need are a few eBay Minis, a switch and some storage. Life will be good.

2008 Jun 26 01:54 PM

[Mike E:]

Anyone who's followed Apple can tell you that if the numbers for the AppleTV were good, we'd be hearing about them. Since Apple's not bragging, the number are not good. It's that simple.

I own an AppleTV, but seldom use it. It's a pretty good music player, but for video It is too limited and geared primarily towards buying or renting content from Apple, which I don't do.

2008 Jun 26 03:01 PM

[BobF4321:]

This should be on the list: 1080i/p HD resolution movies and hardware. This would go a long way to reduce the need for Blu-Ray support.

2008 Jun 26 03:41 PM

[roz:]

These area all great suggestions. I would like the Apple TV to be the only box connected to my tv - or even better - built into the tv. So it needs to be able to handle broadcast and cable tv in some way, ideally with support for a Tru2Way card and a DVR. If the AppleTV had tuner/dvr and blueray disk, I can't see why I would need to have any other device in the living room. That would make things much more easy.

Even though it conflicts with the download concept I really think having a BlueRay drive would be great for consumers and even for Apple. Not all AppleTvs should have BD but there should be a unit with it. A lot of people are going to be thinking about getting a BlueRay soon and one thing I think is true is that people want better integration. In the same way they want their iPod in their phone they would rather not have more and more devices in the living room. I want to insert a disk and have it play automatically. I don't want to have to change any inputs on my TV or receiver.

2008 Jun 26 07:05 PM

[Puggsly:]

2 out of 6's not bad!

Item one is just stupid and with out it item 6 makes not sense. Look at your premiss, AppleTV as a DVD replacement. I've never seen a DVD with a tuner in it. It is not necessary and ultimately almost contrary to apple's long term strategy as adding Blu-Ray.

Item 2, if somewhat long winded, is a good idea but has nothing to do wtih AppleTV. iPod and iPhones should allow for iTunes sharing just like a computer and this is solved.

Item 3 is being done as fast as possible, with the exception of subscription and extras. I'd love to see a low cost subscription service for back catalog, but I doubt it will ever happen. Extras could be offered but are more of a niche market anyway and not critical yet if ever.

Item 4 you already argued against! Why would you want Blu-Ray if you could purchase and rent HD movies direct from Apple.

Item 5 is also unnecessary. Few people have really large DVD collections and there are ways to easily rip those DVD's (handbrake). Apple is not going to change the law and should not try for fear of pissing off the Studios.

And I already said with out a DVR you don't need a different remote. That said, I agree that Apple may make the iPhone/iPod touch into killer remotes in the future.

AppleTV is missing only one thing.... Content! They need to get NBC back on board and they need to pressure the studios into HD Sales and better pricing. Steve should use his influence on Disney to get them to release a huge back catalog of their movies for $.99 or $1.99 HD. Newer or Bigger older titles should go $1.99 and $2.99HD with new releases $2.99 and $3.99HD. Similarly, TV shows should drop to $1.49 for 1 hour shows and $.99 30 minute shows for current seasons standard def with HD $.50 more/episode or free with season pass purchase (note: HD purchase should include a special iPod resolution version as well). Previous seasons could be discounted a bit more.

If they could pull this off there would be no need for a DVR as you could leave your cable behind and truly start watching your shows when ever and on what ever you want! Or that's how I see it!

2008 Jun 26 08:04 PM

[dorian:]

The ATV is simply meant to do what it does for the price it commands. Anything else, would put it in the MacMini category, where you can do EVERYTHING you asked for. That's what I have connected to the 65" LCD and it rocks.

2008 Jun 26 08:48 PM

[dorian:]

The ATV is simply meant to do what it does for the price it commands. Anything else, would put it in the MacMini category, where you can do EVERYTHING you asked for. That's what I have connected to the 65" LCD and it rocks.

2008 Jun 26 08:48 PM

[Gerg:]

In Australia, the TiVo is about to sell for US$680.

What would it cost to add HD PVR to an AppleTV?
(serious question!)

2008 Jun 27 04:40 AM

[Puggsly:]

The cost of adding a DVR is in more than just dollars. You would need more storage (much more storage) which means switching to 3.5 inch drives to keep it reasonable. This increases heat and minimum size as well. You would need a processor fast enough to encode analog video which again costs both money and heat which might sacrifice quiet. Finlly, because re-encoding analog signal sucks, you need to get cable card to work (which it doesn't) so you sacrifice making the thing just work!

Turn this on it's head. Apple increases it's back catalog (re-runs) and figures out how to get all new release content (NBC back on board and better buy in by the other majors). Now it becomes possible to have some people ditch cable TV and buy shows alacart. Volumes increase and prices decrease and more people can get on board.

Sounds crazy but it is nearly a break even at my house with only minor cost cutting (discounted gift cards and season passes). The up side is it is all commercial free! If you throw out re-runs, figure out how much new TV you watch each year. I'm betting at $1.50/episode your annual cost will be $800-$1200 which is going to be oddly close to the cost of your Cable bill which you pay for with commercials as well. I'm just saying, maybe there is a better way.

2008 Jun 27 09:10 AM

[JoeDoe:]

Seems like the author has little insight into Apple or this marketplace. The Religion of Apple (whether you drink the Koolaid or not) has a long track record here:

First of all, it must simply work, which means a simple user experience. So out of the gate Apple TV had few bells and whistles... but it is gradually improving (e.g. Rentals, HD)

Bluray drive? Hmmm... Apple TV is an Ipod for your tv right? I never saw a CD player integrated into any Ipod. Or an FM tuner for that matter. Don't you get it... Stevie J. wants to sell you your content. His Steveness is content to let BluRay sink under the inevitability of downloads...

Which is why even Sony sees the limited future of physical media and is moving towards downloading now.

2008 Jun 29 07:50 AM

[dragon10:]

To Puggsly.
When you read back cover of CD, how many names you can find, 20, 30 in the best and for 10 songs and you bought any of them for .99$. But any show have much longer list, much higher cost in every way, lights, cameras, stage, locations (every city sold space for movies or series) etc.. so episode for .99$ is impossible.

2008 Jun 30 11:19 PM