Investors Cheer as Apple Services Takes Center Stage

Apple Inc. (AAPL) has given investors reason to believe that there’s more to its business than selling as many new iPhones as possible at high prices.

The tech giant reported quarterly results after the bell on Tuesday, warning that weak sales are expected to persist in the current quarter as it continues to grapple with tepid demand for its flagship smartphones in China. The company said revenues are likely to come in between $55 billion and $59 billion in the first three months of the year, slightly lower than what analysts were estimating.

Apple’s latest caution of lackluster iPhone sales failed to deter investors this time around. The shares rose 5.73% in after-hours trading as the stock market took comfort from signs that the company’s transition away from depending on hardware is going well.

Apple revealed that there are now 1.4 million of its active devices, including 900 million iPhones, in circulation that are capable of generating recurring revenues. They appear to be doing a fine job of executing that mission, too. It now has 360 million paid subscribers to its own and third-party services and expects that number to cross 500 million by 2020.

Services Margin Outpaces Estimates

Revenues from the tech giant’s services business, which investors are counting on to fuel growth as the smartphone market slows, jumped 19% to a record $10.9 billion in the quarter. Even more encouragingly, it appeared that services such as Apple Music and the App Store churn out decent profits, too. Services gross margin hit 63%, up from 58.3% a year ago and comfortably outpacing analyst estimates.

Wedbush analyst Daniel Ives told MarketWatch that these developments, together with relief that sales guidance didn’t come in even lower, understandably left investors feeling hopeful that Apple is turning a corner.

“The line in the sand was 60% gross margins,” said the analyst. “The services business may have been something [investors] were underestimating in terms of just how profitable it is.”

Ives, who has an outperform rating on Apple shares with a $200 price target, expects more investors to jump on board now that the market has a decent indication of where future growth is coming from, comparing Apple’s transition to Amazon.com Inc.’s (AMZN) cloud computing venture.

“When Amazon broke out AWS margins, that was a defining period for Amazon, because investors then started to give them more credit,” he said.

Investors Are Understandably Cautious

King Lip, chief strategist at Baker Avenue Asset Management, also believes that Apple has lots of potential. Speaking to CNBC, the analyst said the shares are cheap because investors are understandably cautious that the years of robust double-digit growth are now behind the company. To change this perception, he added that the market will need to see greater evidence that Apple can deliver on its services potential.

Lip said Apple must bring new apps to market to take advantage of the huge number of iPhone users across the world. “900 million iPhones, there’s a lot of services that can sell through that,” he added.

“The services number is good, and that is the growth engine going forward that people will continue to focus on,” said Ivan Feinseth, an analyst with Tigress Financial Partners, to Reuters.

Apple is also ready to address the high price of its phones in overseas markets where local currencies have weakened against the U.S. dollar. "As we’ve gotten into January and assessed the macroeconomic condition in some of those markets, we’ve decided to go back to more commensurate with what our local prices were a year ago in hopes of helping the sales in those areas,” Cook told Reuters.