Apple Isn't Frittering Away Its Growth Opportunities

 Apple (AAPL) generated $65 billion in revenue in fiscal 2010, and it is only natural for investors to wonder how much bigger the company can get. We think that over the next three years revenue could double and that over the next five years Apple could add another $100 billion to its top line. If Apple were a one-product company, we'd be uncomfortable throwing around those kinds of numbers, but Apple isn't just the iPhone/iPad company. In fact, with the exception of the iPod, every single one of Apple's product lines is contributing to double-digit revenue growth.

The iPad: An Entirely New Product Category
The newest of Apple's product lines, and essentially an entirely new product category, the iPad has been a stunning success. As Apple is still selling the second iteration of the iPad as quickly as they can be manufactured, we think that momentum will continue through 2011 and 2012 at the very least.

That said, estimating the eventual size of the tablet market is difficult, as today it isn't so much of a "tablet market" as an "iPad market." Although PC manufacturers have been taking stabs at producing a mass-market tablet computer, Apple was the first company to succeed. (We suspect that this is because the company already had a massive base of iPhone users that were essentially using a miniature version of a tablet.) It is possible, in our view, that the iPad will remain the standard for the tablet market--similarly to how the iPod quickly became (and has remained to this day) the dominant personal media player. Our view is that, after explosive growth in 2011 (during which we expect Apple to sell about 40 million iPads), unit sales grow at an average of 55% per year, with Apple selling 80 million iPads in 2015.

However, given that the tablet market and the iPad are still in their infancy, it is possible that the tablet market turns out to be just a fad. It is also possible that another tablet maker can knock Apple from its perch. In the eventuality that Apple does not sell another iPad after 2012, our fair value estimate would fall from its current $475 into the high $300s.

We Think the iPhone's Days of Explosive Growth Are Nearing an End
We expect the iPhone to continue to gain market share in 2011 and 2012, but after that we think it will have become a mature product and that growth will slow accordingly. At the end of our five-year forecast period, we expect Apple will have a market share of approximately 15%, only slightly higher than it stands today.

For the next two years, we think Apple will continue to benefit from the launch of the iPhone on the  Verizon (VZ) network (and if the proposed  AT&T (T) acquisition of T-Mobile happens, the availability of the iPhone to former T-Mobile customers). The initial launch did not make headlines in the same manner as the iPad launch, but we think adoption of the iPhone by Verizon customers will be largely driven by the timing of subsidized phone upgrades.

 

Sales of Apple's Desktops and Notebooks Still Growing
After going into a precipitous decline in the 1990s under the previous management team, Apple's PC business began steadily gaining market share in the early 2000s. We think these gains are attributable to several interlocking factors: the success of the iPod, the rollout of Apple's retail stores, and Apple's hardware and software design.

High interest in the iPod helped drive traffic to Apple's stores, which allowed Apple to show off its products (both hardware and software) in a way that wasn't previously possible. As iTunes for Windows didn't launch until more than 2.5 years after iTunes for the Mac, the iPod helped jump-start demand for the Mac among 20-somethings--a group that has yet to hit peak earnings power. Although newer products like the iPhone and iPad worked with iTunes on Windows from the start, we still think these products continue to drive new users to the Mac platform.

We think the launch of the Mac Application Store (patterned after the iTunes Application Store) could help Apple maintain or accelerate its pace of market share gains. Historically, one of the biggest knocks against the Mac platform has been the relative scarcity of third-party applications. The smaller developer base (relative to the Windows third-party developer base) was exacerbated by the poor distribution of the Mac software that was developed. We think the Mac Application Store could help mitigate this disadvantage and eliminate one potential concern a new customer might have about switching to the platform.

iPad, iPhone, and PCs Drive Growth of Other Products and Services
We expect growth of Apple's hardware platforms to continue to drive growth of Apple's sales of peripherals, software, and media/applications through the iTunes store. Interestingly, from 2005 to 2008, sales growth rates of those two product categories were roughly equal. And while the highly successful launches of the iPhone and iPad threw that relationship off, we think that over time the relationship will be restored and therefore that the peripherals/media/software category will grow roughly in line with Apple's corporate average over our five-year forecast period. Sales of Macs will drive sales of displays, Mac software, and AirPort base stations. Sales of iPads and iPhones will drive sales of media and applications through the iTunes store.

Growth Will Slow in 2012, Unless Apple Has Another Trick Up Its Sleeve
Altogether, we think Apple will hit $100 billion in annual revenue sometime in 2011 but expect growth to hit an inflection point near the end of 2012 as the iPhone and iPad platforms become more mature. However, we aren't building in any expectation of new, announced products into our growth estimates. Looking at the graph below, it is worth noting that the top two layers of the graph (the ones that represent more than half of total revenue) didn't exist as late as 2007. We would therefore not take the bet that Apple will stop innovating anytime soon.

Our best guess is that Apple will continue its push into the living room as it further refines its AirPlay wireless streaming technology, and as third-party home electronics vendors begin embedding AirPlay (and perhaps even the iTunes Store) into their hardware. Pioneer has already announced home stereo receivers that can stream music directly from Macs, iPads, and iPhones via AirPlay, and over time we could see that functionality being a de facto standard. We see incorporation of AirPlay into car stereos as another logical step.