(By
Michael Corty, CFA) Before
the iPad achieved its current popularity, magazine publishers pointed
to digital tablets as a possible knight in shining armor, a way to
offset inevitable declines in print advertising. As it turns out, the
knight emerged wearing a black turtleneck and jeans. Under the direction
of Steve Jobs, Apple's (
AAPL) iPad,
by some estimates, accounts for more than 80% of the nascent tablet
computing market. Early versions of magazines on the iPad are visually
impressive and allow for an enhanced experience with embedded video and
interactive advertising. At the moment, a major roadblock for magazine
publishers is moving beyond single edition versions available and
transitioning into a formidable digital subscription business.
The current dominance of the iPad (after just over one year on the
market) essentially forces publishers to work with Apple for a
subscription model through its application storefront. It has been
widely reported that Apple wants to retain 30% of the subscription
price, as well as most of the customer data, which is crucial to
magazine publishers and the heart of their sales pitch to advertisers.
Magazines typically sell a certain demographic to advertisers, with
categories like average age and household income among the more basic
buckets. Magazines have relied on this customer information throughout
their history and are looking for the same access with digital
subscriptions. We don't blame the magazine publishers from balking at
the terms from Apple, as the obvious risk is that Apple becomes the
dominant middleman for digital subscriptions and uses the leverage to
gradually extract better economics.
Magazine subscriptions would be a very minor part of the iTunes
business, so Apple retains the upper hand in this relationship. The
publishers need a subscription model on the iPad more than Apple needs
this business. However, we think there are limits to how far Apple will
push the magazine publishers, and within the past month, Apple has
softened some of its rules for publishers looking to sell subscriptions.
Part of the appeal of Apple's hardware is the vast amount and variety
of entertainment options within its closed ecosystem. Also, while we
believe the iPad is very likely to dominate the tablet market, it is
possible that an Android-based competitor could eventually emerge as a
viable number-two player that would allow publishers more favorable
terms.
We expect the publishers and Apple to eventually come to terms for a
viable subscription model. However, tablet penetration remains low, so
it will take several years for any material digital revenue to
materialize.