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Apple's Biggest Growth Engine (Services) Coming of Age
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While iPhones returning to growth is good news of course, it’s evident that the business has lost momentum. Penetration levels have increased significantly with the scope for further innovation shrinking with each new product generation. So users not just in traditional markets but also in some emerging markets have less of a reason to upgrade.
Since Apple (AAPL - Free Report) sells a high-end product, its market is further limited. So a jump in the holiday sales doesn’t excite me as much as the fact that the number of iPhone users increased double-digits during the quarter. Because it is the installed base of over a billion active devices that Apple can count on to use its services and generate recurring revenue for the company.
What Services Did This Quarter
Apple’s service revenue grew 13.4% sequentially and 18.4% year over year to around $7.2 billion. Management said that growth would have been higher taking out the one-time receipt of $548 million in the year-ago quarter and adjusting for the extra week of sales in December. This is the fourth straight quarter that services grew strong double-digits and contributed an equal or greater share of revenue than both Macs and iPads, making it the second most significant segment behind iPhones.
At just 9% of revenue, Apple however has no legal compulsion to provide too much detail on what this business is about. It does offer interesting tidbits though such as the paid subscriptions number that was over 150 million in the last quarter.
Consequently, services include a motley crowd, the chief of which is the App Store. This business “broke all-time records during the holiday quarter, including $3 billion in purchases in December alone, making it the App Store's single best month ever,” in the words of CEO Tim Cook. Over 2.2 million developers are currently working on apps for the App Store and payments to developers have now topped $60 billion.
So it isn’t surprising that both the average revenue per customer account and the number of customer accounts grew strongly. Apple also quoted App Annie as saying that App Store revenue more than doubled Google Play revenue in calendar 2016. Another positive about this business is that it isn’t geographically limited, meaning that even a soft market like China is currently contributing to sales.
Apple Music grew for the third straight quarter as Apple enabled downloads in addition to the streaming business. It has had good luck with exclusive content to date and is currently looking at original content to further push things.
Apple Pay users tripled, transaction volumes jumped 500% running into the billions of dollars as the service expanded to Japan, Russia, New Zealand and Spain. Nearly 2 million small businesses are accepting payments through Apple Pay.
AppleCare is closely linked to the growth in the installed base, so it continues to grow strongly.
iCloud storage services are doing well, and that’s all that Apple will say about it.
Why’s This So Important?
It’s hard to overstate the importance of this segment as mobile computing devices race to their saturation point. Device sales overall are coming down and what little growth is there today will be gone tomorrow. Upgrades will be fewer and sales will depend on the ability to take market share.
The other reason is profitability. Management says very little about the margin profile and makes sure we understand that there are many parts to this business that don’t generate the same margins. But they also say that the segment carries higher margins than the rest of the business.
This makes perfect sense since hardware generally carries lower margins than software that is increasingly offered as a service these days. So as the mix of this business grows, it will fetch stronger margins for Apple.
Also, while Apple has successfully convinced customers its devices are worth the money, hardware innovation hasn’t been that great in recent times and could get more difficult going forward. So differentiation could be rooted in the software ecosystem more than it has been thus far.
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Apple's Biggest Growth Engine (Services) Coming of Age
While iPhones returning to growth is good news of course, it’s evident that the business has lost momentum. Penetration levels have increased significantly with the scope for further innovation shrinking with each new product generation. So users not just in traditional markets but also in some emerging markets have less of a reason to upgrade.
Since Apple (AAPL - Free Report) sells a high-end product, its market is further limited. So a jump in the holiday sales doesn’t excite me as much as the fact that the number of iPhone users increased double-digits during the quarter. Because it is the installed base of over a billion active devices that Apple can count on to use its services and generate recurring revenue for the company.
What Services Did This Quarter
Apple’s service revenue grew 13.4% sequentially and 18.4% year over year to around $7.2 billion. Management said that growth would have been higher taking out the one-time receipt of $548 million in the year-ago quarter and adjusting for the extra week of sales in December. This is the fourth straight quarter that services grew strong double-digits and contributed an equal or greater share of revenue than both Macs and iPads, making it the second most significant segment behind iPhones.
At just 9% of revenue, Apple however has no legal compulsion to provide too much detail on what this business is about. It does offer interesting tidbits though such as the paid subscriptions number that was over 150 million in the last quarter.
Consequently, services include a motley crowd, the chief of which is the App Store. This business “broke all-time records during the holiday quarter, including $3 billion in purchases in December alone, making it the App Store's single best month ever,” in the words of CEO Tim Cook. Over 2.2 million developers are currently working on apps for the App Store and payments to developers have now topped $60 billion.
So it isn’t surprising that both the average revenue per customer account and the number of customer accounts grew strongly. Apple also quoted App Annie as saying that App Store revenue more than doubled Google Play revenue in calendar 2016. Another positive about this business is that it isn’t geographically limited, meaning that even a soft market like China is currently contributing to sales.
Apple Music grew for the third straight quarter as Apple enabled downloads in addition to the streaming business. It has had good luck with exclusive content to date and is currently looking at original content to further push things.
Apple Pay users tripled, transaction volumes jumped 500% running into the billions of dollars as the service expanded to Japan, Russia, New Zealand and Spain. Nearly 2 million small businesses are accepting payments through Apple Pay.
AppleCare is closely linked to the growth in the installed base, so it continues to grow strongly.
iCloud storage services are doing well, and that’s all that Apple will say about it.
Why’s This So Important?
It’s hard to overstate the importance of this segment as mobile computing devices race to their saturation point. Device sales overall are coming down and what little growth is there today will be gone tomorrow. Upgrades will be fewer and sales will depend on the ability to take market share.
The other reason is profitability. Management says very little about the margin profile and makes sure we understand that there are many parts to this business that don’t generate the same margins. But they also say that the segment carries higher margins than the rest of the business.
This makes perfect sense since hardware generally carries lower margins than software that is increasingly offered as a service these days. So as the mix of this business grows, it will fetch stronger margins for Apple.
Also, while Apple has successfully convinced customers its devices are worth the money, hardware innovation hasn’t been that great in recent times and could get more difficult going forward. So differentiation could be rooted in the software ecosystem more than it has been thus far.
Apple shares currently carry a Zacks Rank #3 (Hold). Technology stocks with better prospects are Anixter International , Aspen Technology (AZPN - Free Report) , KLA-Tencor (KLAC - Free Report) or Inphi Corporation , all of which have a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Apple Inc. Price
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Our experts cover all kinds of trades… from value to momentum . . . from stocks under $10 to ETF and option moves . . . from stocks that corporate insiders are buying up to companies that are about to report positive earnings surprises. You can even look inside exclusive portfolios that are normally closed to new investors. Starting today, for the next month, you can have unrestricted access. Click here for Zacks' private trades >>