What’s At Stake For Apple Stock As Epic Case Goes To Trial?

Apple’s (NASDAQ:AAPL) highly lucrative services business faces its biggest legal challenge yet, as the Epic Games lawsuit against Apple and its AppStore went to trial on Monday. Epic alleges that Apple’s AppStore is an anti-competitive marketplace, that locks in customers and diminishes the earnings of mobile app developers. The game developer sued Apple back in August 2020 after its popular Fortnite game was removed from the AppStore shortly after Epic let players bypass Apple’s in-app purchase system, avoiding the 30% commission on sales. So what’s really at stake for Apple and its services business?

Apple has been increasingly counting on selling digital services to drive profitability and stabilize its revenues, which have been somewhat volatile in recent years. Services accounted for about 19% of Apple’s total revenues and about 31% of gross profits over its most recent quarter (Q2 FY’21). Apple has also launched a slew of new service offerings in recent years, ranging from fitness tutorials, paid podcasts, and streaming video. However, we believe that the AppStore and the commissions from third-party subscriptions, both key targets of the Epic lawsuit, still account for a bulk of its services earnings, since they primarily comprise commissions (typically 15% to 30% of purchase value). We estimate that the two services revenue streams together accounted for about $23 billion of Apple’s roughly $54 billion in services sales last year. While we wouldn’t speculate on the possible outcome of the case, it’s clear that Apple’s earnings would see a meaningful impact if it were forced to reduce commissions considerably or allow app developers to bypass its store.

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.

[8/17/2020] Epic Lawsuit Hits Apple’s Stock Where It Hurts

Last week, Epic Games sued Apple (NASDAQ:AAPL) for antitrust violations, after its popular Fortnite game was removed from the AppStore shortly after Epic let players bypass Apple’s in-app purchase system, avoiding the 30% commission on sales. Although Apple has had spats with developers in the past, the Epic lawsuit is noteworthy for a couple of reasons. Firstly, the Epic lawsuit comes at a time when tech giants, including Apple, have been facing increasing scrutiny from regulators regarding their market power. Secondly, Apple is more dependent on its Services business than ever before, with hardware growth slowing (profits from Services grew 5x as fast as hardware profits over the first three-quarters of FY’20), and Epic’s lawsuit targets Apple’s commissions, which we estimate are Apple’s single most profitable revenue stream.

Apple made roughly about $360 million in commissions from Fortnite over the last two years per Sensor Tower –  a relative drop in the bucket for Apple which pulled in $260 billion-plus in revenues last year. ^[1] However, if Epic sees a favorable judgment, and if Apple is forced to reduce its commissions or change the terms of its AppStore, this is very likely to set a precedent, causing other developers to demand similar terms.

So what could be the financial impact of Apple reducing commissions across the board? Apple takes a 30% cut on App sales and subscriptions (15% from the second year of subscriptions) and we estimate that total commission revenues stood at almost $20 billion in FY’19 (out of a total of about $46 billion in Services Revenue).  If Apple reduced commissions to say 20% from 30%, it would reduced total commissions by about $7 billion to roughly $13 billion. Although the revenue impact would be limited for Apple (under 3% of Apple’s Total Revenue) the impact on profits would be more pronounced given that commissions are likely to be almost entirely profit. We estimate that Apple’s Operating Income would be about 10% lower if commissions were reduced, considering Apple posted about $64 billion in Operating Income in FY’19.

Now commissions of 30% are actually pretty standard across the industry – Alphabet’s (NASDAQ:GOOG) Google, which also faces a similar lawsuit from Epic, as well as Microsoft and Amazon, charge roughly the same fees on app sales on their respective market places. However, Apple has the most to lose from this given the sheer scale of its business. AppStore revenues are roughly twice as large as Google’s Playstore.

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1. Apple made $360 million from ‘Fortnite, Business Insider, August 2020 [↩]