Apple Inc. (AAPL - Free Report) is gearing up to become a major producer of original content. Per The Wall Street Journal (WSJ), the iPhone-maker plans to invest $1 billion in 2018 in original television (TV) shows and movies. According to Bloomberg, a team led by former Sony Corp (SNE - Free Report) executives Jamie Erlicht and Zack Van Amburg – who were hired in June – is in charge of buying/producing content for Apple Music.
Apple’s investment is miniscule compared with other dominant names in the video streaming industry. Per Business Insider, peers like Netflix (NFLX - Free Report) , Amazon (AMZN - Free Report) and HBO have budgets of almost $7 billion (as reported by Variety), $4.5 billion (JP Morgan estimates) and $2 billion (spent in 2016 and “couple of billions” to be invested this year), respectively.
Business Insider recently quoted a report from an analyst at RBC Capital Markets, according to which, Apple’s investment in original programming poses significant threat for music streaming service, Spotify. The service has approximately 50 million paid subscribers compared with Apple Music’s 27 million. Per the analyst, “Apple would only need to attract 7-8 million new subscribers to offset the $1 billion investment over the next three years.”
Apple’s $1 billion investment will definitely improve its competitive position in the rapidly growing video streaming market. However, in order to become a top original content producer, the company may need to increase spending in the long haul, which, given Apple’s strong balance sheet will not be a major concern.
Apple stock has gained 36.6% year to date, outperforming the 34.7% rally of the industry it belongs to.
Apple Services to Get Better
Apple’s strategy to diversify into the streaming business is a positive, primarily due to the favorable industry trends. Apart from a shift in viewers’ preference to online streaming from legacy platforms, binge viewing is catching up fast. Further, cost advantage over legacy platforms is attracting new subscribers.
Per Research firm MarketsandMarkets, the industry is anticipated to grow from $3.25 billion in 2017 to $7.50 billion by 2022, at a compound annual growth rate (CAGR) of 18.2%.
We note that Apple’s current TV offerings – Planet of the Apps as well as Carpool Karaoke: The Series – have failed to live up to expectations. However, the presence of Jamie Erlicht and Zack Van Amburg, who have successful productions like Breaking Bad and The Crown to their credit, can do wonders for the company’s original content offerings in the long haul.
We believe that the expanding original content portfolio will improve user engagement that will ultimately benefit Apple’s fast-growing Services business. In the last quarter, Services – including revenues from Internet Services, App store, Apple Music, AppleCare, Apple Pay, and licensing and other services – surged 22% year over year to nearly $7.3 billion. More importantly, the number of paid subscribers grew 20 million to a total of 185 million.
Not Interested in Netflix Anymore?
Over the last few years, there have been rumors about Apple’s possibility of buying out Netflix. A likely deal would have been beneficial for both the companies. Apple’s massive cash resources would have helped in rapidly expanding Netflix’s streaming portfolio. On the other hand, the streaming company’s fast-growing subscription-based recurring revenues would have provided the much needed impetus to Apple’s slow-growing, hit-driven and iPhone-dependent business model.
However, Apple’s growing focus on becoming a major streaming provider now puts the possibility of such a deal to the back burner. As far as investors are concerned, they would deem it prudent for the company to spend $1 billion on producing content of its own rather than buying Netflix at a huge premium.
Moreover, Netflix is trading at a premium in terms of Price/Sales (P/S). Currently, the stock has a trailing 12-month P/S ratio of 7.30, which compares unfavorably to some extent with what the S&P has witnessed in the last year.
Currently, both Apple and Netflix carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks Rank #1 (Strong Buy) stocks here.
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