Google Antitrust Suit Could Upend Apple’s Services Business

[Updated 10/26/2020] How The Google Antitrust Case Threatens Apple

The U.S. Justice Department’s antitrust lawsuit against Internet behemoth Google could have major repercussions for Apple. Google is estimated to pay Apple between $8 billion to $12 billion a year to be the default search engine on Apple’s iDevices. While the deal is nice for Google – which sees about 50% of its searches originate from Apple devices, it is much more lucrative for Apple considering that the payments are likely pure profit. The Services segment, under which Apple books these Revenues, is becoming crucial as hardware growth cools. For perspective, over the first three quarters of this fiscal year, Apple’s profits from Services grew 5x as fast as hardware profits.

While the case against Google could take years to conclude, how would Apple be impacted if the deal was forced to end? If we assume that licensing payments from Google stood at about $10 billion in FY’19 and Apple had to forgo the entire amount, Services Revenues would be lower by about 22% with Total Revenues lower by about 4%. The impact on Apple’s Profits would be much more pronounced as Apple likely incurs no costs to earn these Revenues. Specifically, Apple’s Operating Profits would be lower by a whopping 16%, with Operating Margins coming in 380 basis points lower at 20.7%. The impact of the cancellation of the deal on Apple stock could be more pronounced, considering that Services are Apple’s fastest-growing business and Google’s payments likely the most lucrative part of the Services segment.

Our dashboard Breaking Down Apple’s Services Revenue estimates the revenue figures for AppStore, Apple Music, Apple TV+, iCloud, Third-party Subscriptions, Licensing, Apple Care, and Apple Pay.

[Updated 10/14/2020] Do The New iPhones Meet Expectations?

On Tuesday, Apple (NASDAQ:AAPL) launched four new iPhones – the iPhone 12, iPhone 12 Mini, iPhone 12 Pro, and iPhone 12 Pro Max that operate on the next-generation 5G networks. Apple stock has rallied by about 60% year to date, fueled partly by anticipation surrounding the 5G devices, which investors are counting on to return Apple’s iPhone business to growth. So, do the new iPhones deliver? While the new devices represent a nice upgrade from last year’s models, with faster wireless tech, new processors, an improved camera, a slightly refreshed design, and new screen size options, we don’t think they will drive a “supercycle” on the lines of what Apple saw with the iPhone 6 in FY’15. Although 5G offers significantly higher data speeds versus 4G, there aren’t many compelling use cases for the technology on mobile devices just yet. Moreover, big upgrades to wireless tech haven’t really driven Apple’s sales in the past. (More details below) That said, wireless carriers – who’ve spent considerable amounts on 5G network upgrades – are going to be aggressive with promotions on the new devices as they look to sign up new customers and boost revenues. AT&T (NYSE:T), for instance, is effectively offering the iPhone 12 for free with a trade-in of an iPhone 8 or newer model.

[Updated 7/17/2020] A Reality Check On The 3 Stories Driving Apple Stock

Apple’s (NASDAQ:AAPL) market cap has almost doubled, from about $900 billion at the end of 2017 to about $1.7 trillion currently. Now looking solely at Apple’s fundamentals, the numbers don’t really add up. Apple’s revenues and net profits are up by less than 15% over this period, with revenues growing by roughly $30 billion and profits rising $7 billion. However, investors have valued Apple more richly, with its P/E expanding from about 18x at the end of 2017 to about 32x presently. There are three broad narratives driving Apple’s multiple expansion, namely, the pending launch of the 5G iPhone, strong services growth, and Apple’s position as a safe-haven stock. While these factors broadly make sense, there are some real risks that investors should be aware of.

Our dashboard What Factors Drove 135% Change In Apple Stock Between 2017 And Now? breaks down the key factors that drove Apple’s stock price appreciation.

The 5G iPhone: Investors are counting on the 5G iPhone, due this Fall, to jump-start iPhone shipments. However, has an upgrade in wireless technology really kick-started iPhone sales in the past? Not quite. We see that Apple’s iPhone shipment figures are more responsive to major design-overhauls and form-factor changes than big upgrades to wireless tech. For instance, looking back at FY’13, the year Apple launched the iPhone 5, its first 4G handset, shipments expanded by just 20% year-over-year, down from the previous year when shipments grew 73%. Apple saw iPhone shipments grow by a stronger 37% over FY’15 when the larger screen iPhone 6 was launched. Considering this, there’s every possibility that sales could remain muted over the 5G cycle as well, if the devices look and feel similar to the iPhone 11 series. Moreover, with the ongoing pandemic, people may see little reason to upgrade to pricey smartphones with the latest cameras and wireless standards as they spend more time at home.

Apple’s Services Business: Services have played a major role in the growth of Apple’s stock price, thanks to their thick margins and revenue growth. However, there are some key risks here as well. We estimate that about $28 billion of Apple’s total $46 billion in services revenues in FY’19 came via commissions – essentially taking a cut of app sales, subscriptions, and traffic acquisition payments from search engine providers such as Google. That’s a whopping 60% of services revenue. Why is this risky for Apple? Firstly, Apple could face anti-trust risks given its market power in this space. Secondly, digital services providers may also stop in-app subscriptions from Apple devices to bypass Apple’s cut, just as Netflix did in early 2019. Sure, Apple does have other services that are growing quickly, such as the Apple TV+ streaming video, but margins will be much lower compared to commissions – which are likely almost pure profit. Our dashboard Breaking Down Apple’s Services Revenue estimates the revenue figures for AppStore, Apple Music, Apple TV+, iCloud, Third-party Subscriptions, Licensing, Apple Care, and Apple Pay.

Apple As A Safe Haven: Investors are increasingly treating Apple stock as a safe haven through the current crisis, on account of its strong balance sheet and the sizable share buybacks that support its stock price. However, to be sure, Apple is far from a risk-free investment. On one hand, if the Covid-19 crisis gets worse, Apple’s sales and cash flows could come under pressure hurting its stock price. On the other hand, if Covid-19 is contained and the broader economy rebounds strongly, investors could start moving back to riskier assets, reducing demand for Apple’s stock.

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