Toni Sacconaghiof Bernstein Research
today offers up the view that Apple
’s (AAPL) services business has for some time now been boosted largely by payments from Alphabet
’s (GOOGL) Google
unit, which may be paying Apple as much as $3 billion this year to be the preferred search engine on the company’s Web browser on its iPhone and iPad.
Sacconaghi sees that as a double-edged sword
. It shows the strength of Apple’s “ iOS
” platform, and he expects the money from Google to continue to grow as the iOS user base expands.
But,”Google could ultimately decide that its search position is sufficiently strong that it no longer needs to pay to be the default browser. ”
Those payments may have made up as much as 25% of Apple’s operating profit the last three years, surmises Sacconaghi, who covers Apple and has an Outperform rating, and a $175 price target, on its shares.
“Services has become an increasingly important part of Apple over the last several years,” writes Sacconaghi, noting that Apple doesn’t report the individual items that make up its services revenue.
He notes that “while investors typically think of the App Store and iTunes/Music as the key drivers of services, Apple’s 10-Q reporting reveals that Licensing revenues have been the biggest or second largest contributor to Apple’s YoY services growth in 10 of the last 11 quarters.”
Continues Sacconaghi, “Court documents indicate that Google paid Apple $1B in 2014, and we estimate that total Google payments to Apple in FY 17 may approach $3B.”
Sacconaghi explains his math:
Our estimate is triangulated in a number of ways: (1) third party market research suggests that Google’s total mobile revenues have increased from $16B to $50B (i.e., have tripled) from CY14 to CY17 (Exhibit 3); accordingly, payments to Apple likely have increased commensurately (to $3B) since then; (2) In the last two quarters, Apple’s Services revenues have increased YoY by $2.4B, with the App Store being the biggest contributor (which we model has increased $1.35B YoY), and Licensing revenues to be up by the second largest amount, which could be up $500M or more – suggesting that total licensing in the last two quarters is increasing at a rate of $1B per year this year; and (3) Google’s distribution Traffic Acquisition Costs (TAC – the amount it pays OEMs and carriers for search placement) is 2.2x what it was in 1H 14 (Exhibit 4), again suggesting that if Apple held share, payments from Google to Apple might be up a similar amount to $2.2B (or more assuming Apple gained share). We note that press reports have indicated that the revenue share between Apple and Google was at one point 34%1, which if true and still the case today, would point to a much higher than $3B in payments from Google to Apple today.
Sacconaghi sums up his findings by saying that “while it’s hard to say if Google might ever choose not to pay Apple, it certainly represents a potential risk for Apple.” Nevertheless, for the moment, he is focused on the forthcoming “ iPhone 8
,” or iPhone X, as some are calling it. He believes that the wave of upgrades to that model “will be significant,” and that gives the stock “attractive risk reward” for now.
Apple shares today closed up $2.37, or 1.5%, at $159.85.