Are Investors Overlooking Apple's Next $50 Billion Business?

The law of big numbers makes it increasingly difficult for large corporations to grow at rate investors find exciting. Apple has relied primarily on the sale of tangible products - its devices. But growth has slowed.

Consumers, especially those facing income constraints as the developed world's population ages and competition keeps compensation down in the developing world, need only so many of them and are not necessarily willing to replace them every year or two. 

There is an answer: the intangibles made manifest by the service economy. From texting to cloud storage to Apple Music, there is potentially significant growth available. Some of this may come from new offerings, but as the following article explains, Apple does not currently charge for many of its extant services which could become revenue sources. Intangible services providers like Google - and even Microsoft - enjoy higher price-earnings multiples than Apple. To keep up, it will have to change. JL

Kif Leswing reports in Business Insider:

Apple has 588 million users worldwide. This is important as Apple is trying to change its story: The vast majority of its revenue comes from selling premium hardware. But Apple wants to become "a services company," like Google or Microsoft, because services provide a lot of the value in using a device. The challenge is to increase the services it can generate from one of its customers. Apple services revenue could more than double by 2020 to $53 billion.
Apple, the world's most valuable company, isn't shy about revealing how many of its computers, tablets, phones, and smartwatches are in use: over 1 billion, according to CEO Tim Cook. 

But that number isn't a good reflection of how many users Apple has, because many iPhone users also own a Mac or iPad, for example. 

Analysts from Credit Suisse have crunched the numbers and collected some survey data, and have figured out a good starting point for the number of global Apple users.

Apple has 588 million users worldwide, Credit Suisse estimated in a note published on Monday. If there are exactly 1 billion active Apple devices in use, these findings mean the average Apple user owns 1.7 devices. 

This figure is important as Apple is trying to change its story: The vast majority of its revenue comes from selling premium hardware. But Apple wants to become "a services company," like Google or Microsoft, because services provide a lot of the value in using a particular device — the best phone in the world with a sub-par mapping service, for instance, isn't as useful as a cheaper phone that knows exactly where you are. 

(Those companies also trade at a much higher price-earnings ratio than Apple does. The PE ratio is the market price of the stock divided by the last four quarters of income. The higher the PE ratio, the more expensive the stock.)

To understand a services business, analysts need to know how many users it has. Credit Suisse looked into products like iTunes, App Store, Apple Music, iCloud, and Apple Pay, and concluded that Apple's services growth and potential means that the company warrants a higher valuation than it's currently getting.

Apple as a subscription

In fact, the note estimates that Apple services revenue could more than double by 2020 to $53 billion. Apple bragged that it managed to book $21 billion in services revenue last year, while alluding that that figure by itself was larger than some of its competitors. (Facebook reported $17.9 billion in revenue for 2015, for example.)
But it's not just the size of Apple's installed base that makes its services an attractive investment. Apple users are significantly richer than non-Apple users. According to Credit Suisse:

• Emerging market Apple users have 50% higher per-capita incomes
• Apple users use their devices more often with 63% of mobile traffic coming from Apple devices compared to 29% from Android
• Apple users tend to replace their old devices regularly
• Apple enjoys a nearly 90% retention rate among its customers

As Credit Suisse points out, Apple doesn't even necessarily directly charge for all of its services. Its popular iMessage texting service, for example, is free, which means its price is essentially built into the cost of an iPhone or iPad.
As the analysts write:

While monetizing many of these services is not Apple's primary objective, it does allow the company to price at premium levels. We would argue that whether it is the customer lock-in and essential headache of leaving the iOS ecosystem or the loyalty to the brand, the output is the same – once an individual or family is part of the Apple ecosystem, they will very rarely leave it.

The end conclusion is that while Apple books its revenues and earnings based largely upon a point of sale, the actual installed base of over 1bn active devices presents a largely reoccurring cash flow stream as users will replace and upgrade their devices due to the innovation and introduction of new products over time.

So the challenge for Apple is to increase the amount of services revenue it can generate from one of its customers — getting him or her to sign up for iCloud storage and Apple Music, for example, which come with monthly fees — while still providing good value for its premium computers and phones, which have Apple services baked into the price.
One problem is that Apple's services can be unreliable, and have attracted snickers from those who think the company lags behind Google, Microsoft, and Amazon at providing basic software services like data storage.

But Apple's clearly investing in this field. For example, it's planning to open up several data centers and it's been hiring distributed computing experts. It reportedly has a effort called "Project McQueen" to do more of its online computing in-house. Online services are a critical challenge for the world's most valuable company if it wants to become even more valuable. 

Credit Suisse adjusted its target price for Apple to $150 from $140 per share.