Apple Services Revenue Mix
Apple’s services business is becoming a big part of the thesis behind buying the stock as the smartphone market is saturated and there’s probably a limit to how much Apple can raise the prices of its iPhones. There was some pushback from the consumer after the $999 iPhone X came out. It doesn’t seem like the firm will be able to raise prices that much each year. Raising prices goes against every other consumer-tech hardware product’s price trajectory. Apple doesn’t breakdown its services business which makes the chart below, which utilizes a few data points Apple releases to get a mix of the revenue from each business line in the services category, very valuable. I find it shocking that the Apple Pay division has less than $1 billion in revenues which represents 0% of total services revenue.
Apple Pay & iCloud
Some claim Apple Pay drives services growth which isn’t true. On the one hand, this means there’s room for growth, but on the other hand there needs to be a game changer to make it relevant. In the latest iPhone software updates, the settings app gives users an alert to set up their Apple Pay and iCloud accounts. To me this wreaks of desperation as the firm tries to nickel and dime consumers opposed to the past where growth stemmed from consumers desperate to buy the latest products such as iPhone, MacBook, and iPad. On the bright side, it’s not as if Apple Pay and iCloud are bad services. Apple Pay is a convenient way to make purchases and iCloud allows a more permanent place to save your videos, photos, documents, etc. Both services are for Apple device users which limits their addressable market, but acts as a benefit of buying Apple devices.
Apple Versus Amazon
Apple is in a difficult situation as it keeps needing to beat out amazing years of earnings results. Apple made more money last quarter than Amazon made in its entire existence. To be fair, Amazon has a different business strategy to Apple in that it invests its earnings into new products at a high rate, showing little profits. This allows the company to pay less taxes and grow quickly. It has worked for the company.
Apple cares more about achieving profits than market share. That’s a great strategy which has worked well as it has a relatively small market share in the smartphone category but makes almost all the profits. On the positive side, Apple doesn’t rely on ads which exploit users’ privacy. This strategy is coming under intense scrutiny as regulators clamp down on Alphabet and Facebook. The negative is Apple appears to be behind Amazon and Alphabet in AI which makes Siri weak and versus Alexa and Google. This causes Apple to struggle in the smart speaker category.
Gross Margins
The biggest division in the services category is digital content which also happens to have the lowest gross margins as you can see from the chart below. Licensing is an obvious winner for gross margins because Apple simply gets a cut of the pie for distribution. There are little costs in most licensing businesses. The App Store is 35% of the services business and iTunes and Apple Music represent almost as much as the App Store. It makes strategic sense for Apple to keep boosting the storage in their devices. Storage is cheap and the potential cost of lost iCloud users is minuscule compared to the potential revenue from downloading apps and digital content. There is room for expansion in spending on apps as many people, who still have 16 GB devices from a few years ago, will soon be upgrading to devices with more storage.
Japan’s GDP Falls For The First Time In 2 Years
One of the biggest economic stories on Wednesday was that Japan’s GDP growth was negative for the first time in 8 quarters. Annualized growth fell to -0.6% because capital investment fell 0.1% and private consumption was flat. Japan’s slow growth potential makes it easy for bad weather to push growth to the negatives. Growth had actually been above potential in the past year. Wage growth is only expected to be 1% in 2018 despite the 2.5% unemployment rate, so it’s not a big surprise that consumption growth is flat.
The wage growth is being suppressed by a weak unions, women entering the workforce with lower wages, lifetime contracts, low productivity growth, and a lack of investment by private corporations. Japanese workers spend an average of 12 years with the same company which is much greater than the 4.2 year average in America. Job switchers have much higher wage growth than job stayers as the worker’s negotiating power grows when he/she threatens to leave. When workers do leave, they are obviously going for either better pay or an improved work environment.
Q2 Japanese growth is expected to increase from the Q1 decline, but 2018 growth is supposed to slow from last year. 2018 GDP growth is expected to be 1.3% which is below 2017’s growth of 1.7%. It’s interesting to see that the growth re-acceleration in Q2 is expected to come because of optimism about global growth and Japanese industrial production. I figured the ‘global synchronized growth’ story was long gone with the underpeformance in Europe and emerging markets, but the IMF expects 3.9% global growth in 2018 which is the highest point since 2011. Industrial production is expected to grow 3.1% in April and fall 1.6% in May. The point I’m making is the Q2 estimates might be too high for Japan as the global backdrop is weaker than expected.
U.S. Exports Hawkish Policy
If Japan, Europe, and emerging markets are all faltering, this makes American growth even more interesting. Will America actually see 3.6% GDP growth or will it follow in the footsteps of the other economies? Emerging markets are acting poorly because of the strengthening dollar and the Fed’s rate hike cycle. The chart below shows the historical GDP growth responses to previous rate hike cycles. In this case, the U.S. is exporting its hawkish policy. The good news for Europe is if its economic weakness pushes back the ECB’s normalization process, the euro can weaken versus the dollar which will help its economy.
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