Apple's bread-and-butter iPhone business has been seeing slowing volumes growth, while its other major products such as the Mac and iPad are seeing sales stagnate or decline. Accordingly, Apple has been changing its narrative to investors, projecting digital services as the next big lever of growth. Over FY’18, the Services segment emerged as Apple’s fastest-growing business, with revenues growing by 24% year-over-year to $37.2 billion. However, Apple provides very little transparency relating to this business in its financial reports, making it difficult for investors to gauge its major drivers. In this note, we try to break down the various drivers of the services business, using select figures that Apple discloses and other publicly available data.
View our interactive dashboard analysis on What’s Driving Our $225 Price Estimate For Apple. You can modify any of our key drivers and forecasts to gauge the impact on the company’s valuation and arrive at your own price estimate. Our price estimate is about 25% ahead of the current market price.
App Sales Are Likely The Biggest Driver Of Services Revenue
The App Store likely remains the biggest driver of Apple’s services revenues. Over CY’17, Apple noted that its developers earned $26.5 billion from the App Store, marking a 30% year-over-year increase. Since Apple typically splits the revenues from the App Store on a 70%-30% basis, this would imply that Apple’s share of revenues stood at $11.35 billion. If we assume that the growth rate stood at 20% for 2018, App Store revenues would stand at about $13.5 billion, accounting for about 36% of total Services revenue.
Licensing Could Be The Second Largest Contributor
While Apple receives licensing payments from various third parties, a bulk of the revenues likely come from search behemoth Google, which pays Apple to be the default search engine for Siri and the Safari browser on Apple devices. Goldman Sachs estimates that these fees – which Google dubs traffic acquisition costs – stood at roughly $9 billion in FY’18. This itself would account for nearly 25% of Apple’s total Services revenues for the year, and it’s likely that these revenues are almost pure profit for Apple, since there are no direct expenses involved. Apple has indicated that licensing was a major contributor to sales growth in its Services segment last year.
Subscriptions Seeing Rapid Growth
Subscriptions could be another big driver of the services business. While Apple sells its own subscriptions such as Apple Music, which had over 50 million subscribers as of May, the company has noted that overall paid subscriptions made on its platforms as of October stood at 330 million, marking a 50% year-over-year increase. Apple takes a recurring commission (typically 15%) from subscriptions made on its devices. If the average subscription is priced at $10 per month, this would translate to a revenue run rate of about $6 billion per year. We estimate that the figure is slightly below that, however, as the average subscription figure is likely less than $10.
Apple Care, Apple Pay And Others
Apple also has multiple other Services-related businesses such as the Apple Care extended support and warranty program, iCloud and iTunes. While revenues from these services are likely to account for a meaningful part of Apple’s Services revenues, the related margins could be somewhat lower as costs are likely higher, especially for iTunes (content-related costs). The Apple Pay service could also be a strong growth driver over the long run, although Apple is still in the process of doing a lot of heavy lifting in terms of bolstering its installed base.
