Seeking Alpha

Andrew Sheehy's  Instablog

Andrew Sheehy
Send Message
Mr Sheehy is one of the founders of Generator Research. Before Generator he was a partner in a management consultancy which focussed primarily on venture-funded technology companies in the telecoms, media and digital space. Including over 20 years operational experience in the technology sector,... More
My company:
Generator Research
View Andrew Sheehy's Instablogs on:
  • Why Apple Needs 22% Of The Worldwide TV Business

    The TV set business: approaching the abyss

    With the news that Toshiba will close its TV set manufacturing plants in 2014 and Panasonic will cease manufacturing plasma TV sets in 2014, it seems that the global TV set business has taken another step towards the abyss.

    And in spite of assurances to the market that better times are ahead, Sony's TV set business continues to operate at a loss - as has been the case for the last 8 years.

    With industry gross margins in the region of 12%, it is vital to be able to sell enough volume to at least be able to cover the fixed costs of running a TV set manufacturing business and this explains why Samsung's TV set business is profitable: Samsung's share of worldwide TV set shipments is on an upwards curve: with every percentage gain in market share Samsung achieves a 'double whammy' benefit: increased profitability for its own business, thereby better allowing further investment in new products, while rivals are forced further into losses, thereby reducing their ability to invest in R&D to maintain their competitiveness.

    The market is now locked into a state where it is almost a 'winner takes all' scenario: the further the pendulum swings in favour of Samsung, the harder it will be for rivals to pull it back.

    It is clear to me that the worldwide TV set business is in a phase where the baton is being handed over from the Japanese to the South Koreans, although Sony will do everything it can to prevent this from happening.

    Apple: How to keep the motor running

    So how does Apple perceive what is happening in the TV set business - a market where the company has no products and market share?

    Apple is dealing with a high class problem: how to keep the world's largest cash machine running at full speed.

    We carried out a bottom-up valuation of Apple in August because we wanted to understand what the market was assuming about sales of the company key products.

    According to Bloomberg and Yahoo Finance, Apple's market capitalisation on 26 August 2013 was USD 455 billion - I was interested to know what this valuation means in terms of actual sales of the company's products, namely the iPhone, the iPad, the iPod Touch, iTunes, and Mac computers.

    It turns out that unless you make completely crazy assumptions about how fast sales of the iPhone and iPad will rise (such as assuming that Apple's share of the worldwide smartphone market will climb to over 90% - which is clearly not going to happen), then the only way you can get to a valuation that is close to the company's market capitalisation is to assume that Apple will launch new products - products that do not exist.

    The most obvious products that have the potential to close the revenue gap are an Apple Smart Watch and an Apple TV set - both of which we know the company is working on.

    You then need to make some pretty aggressive projections about the revenues that Apple will derive from these two new products: I have projected that Apple's TV set business will grow from zero in 2014 to be worth USD 81 billion in 2023, by which time it will represent nearly 22% of the company's entire revenues (which will at that time be worth USD 372 billion, up from USD 186 billion in 2013 (this is my view of the company's likely revenues in advance of the company's year-end announcement which will be due later in October 2013).

    Here is my analysis for what Apple's future TV set business will look like in terms of unit shipments:

    (click to enlarge)
    View Metadata

    Apple: Is it credible that Apple would enter the TV set business?

    With the worldwide TV set in such a mess, why would Apple want to enter the market at all? If Apple does decide to enter, then here is what the company will be facing:

    • A mature, slow-growth market characterised by high capital costs if you want to get into the manufacturing business;
    • Low gross margins - as in 12% - which means that simply operating the business on a cost-covered basis will be a challenge, let alone running a growing, profitable business;
    • A market landscape that is littered with mortally wounded players most of whom will price their products at any level - even below cost - just to keep going;
    • A major competitor - Samsung - which is gaining strength day by day and which is Apple's major competitor in Apple's own core markets. Samsung is an extremely determined rival which will do anything necessary to defend its markets.
    • Apple's current market share is zero.

    There are two ways Apple could look at this:

    • The TV industry is a train wreck: there is no opportunity for Apple;
    • The TV industry is a train wreck: there is a huge opportunity for Apple.

    I think that Apple has taken the latter view and is now totally committed to making a success out of a future TV set business.

    Here are the reasons why:

    • High-impact potential: An Apple TV set would be a large ticket item selling for, say, USD 1,500 (or more) into a market that is shipping 300 million units per year. Should Apple be successful in winning a significant share of the market, then an Apple TV set would contribute very significantly to the company's top line: I project USD 81 billion by 2023;
    • Manufacturing & distribution OK: Apple has enough manufacturing assets and experience to be able to pull off a TV set: the iPhone and iPad and Apple Mac products cover all the required bases;
    • Product strategy: Looking ahead, the company's product portfolio is not complete without a smart TV set: Samsung is already developing features that allow users to experience content and services across PC, smartphone, tablet and smart TV. Apple simply cannot 'opt out' of the Smart TV market;
    • Competitive rivalry: Samsung, which is Apple's most direct competitor has not yet shown the sort of innovative flair that Apple has (admittedly this is a subjective assessment - but I think is a safe one when one looks at Apple's entire history). This should provide Apple with enough of an opportunity to develop a differentiated product that can shake up the TV set industry to a similar extent that what the company achieved the iPod, iPhone and iPad;
    • Could sell at a sensible margin: Following on from the above point, I think that Apple's future TV set will be priced at a premium level - just like how the company has managed to sustain a price premium in its existing markets - and in spite of initial market reaction that the company has priced too high. This will not mean that the gross margin on an Apple TV set will be 40%, but it will certainly not be 12% either;
    • Existence theorem - have done it before: The TV business is clearly very different to music devices, mobile devices and portable computers. But that is the point: all these markets are different and, somehow, Apple has managed innovate in all. It is entirely possible that Apple could do the same thing again with TV sets;
    • Resources: Apple has the capital, brand and marketing ability to make a success out of an Apple TV set.

    To my mind there are two major uncertainties:

    1. Tim Cook is not Steve Jobs: There is a growing question over whether Apple, under CEO Cook, has lost its ability to innovate. Maybe the company is now just too big. Perhaps Cook is too detached from the details of the product design to force the company to produce something that resonates with the market;

    2. Content: I would not just expect to see an an improved version of iTunes (optimised for use on a TV set) but a range of new content as well. This would require Apple to close a range of new content licensing deals with studios and TV networks - to an extent that would catapult the company ahead of key rivals, such as Netflix and Hulu.

    What would an Apple TV set offer be like?

    Apple would not simply launch a TV set as a standalone product.

    In order for it to have the best chance of success, an Apple TV set would need to combine 4 key ingredients:

    • expanded, exclusive content compared with Apple TV;
    • a superb hardware platform, probably with innovation in regards to screen resolution etc.;
    • integration with PC/Mac, iPhone and iPad;
    • improved version of iTunes (optimised for use on a TV set).

    Apple TV by the numbers

    This analysis assumes that Apple will launch a TV set product along the lines of that described in the previous section in 2015.

    Unit sales in 2015 would be around 2 million units, representing a share of total worldwide flat panel TV set shipments of 0.7%

    Shipments would then grow to reach 15 million in 2017 (4.9% market share) and 72 million units in 2023 (22.2% market share):

    (click to enlarge)
    View Metadata

    Achieving a market share of 22.2% in 2023 is actually less than what the company has already managed with the iPhone, as can been seen from this chart where we have compared the worldwide market shares for the iPhone (actual) with a future Apple TV set (projected):

    (click to enlarge)
    View Metadata

    In terms of revenues, a properly-executed Apple TV set has the potential to generate USD 81.1 billion in revenue in 2023, which would then make the Apple TV set the company's second largest product, after the iPhone, which will be responsible for revenues of USD 115 billion in 2023.


    View Metadata

    Andrew Sheehy
    Chief Analyst

    --------------------------------
    Generator Research, Ltd.
    Petitor House
    Nicholson Road
    Torquay, TQ2 7TD
    United Kingdom

    --------------------------------
    +44 (0)208 144 7073 (Direct)
    +44 (0)7866 387 715 (Cell)

    +44 (0)208 711 3065 (Fax)

    aaapps (Skype)www.generatorresearch.com

    Twitter: http://www.twitter.com/sheehy_andrew
    LinkedIn: http://www.linkedin.com/pub/andrew-sheehy/0/a34/603

    Oct 25 12:39 PM | Link | Comment!
Full index of posts »
Posts by Themes
Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.