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Apple Inc. (AAPL) Is Becoming a Services Company

Dana Blankenhorn

The next earnings report for Apple Inc. (NASDAQ:AAPL) is due Nov. 2. When most analysts look inside the numbers, they’ll be checking for how many iPhones are sold. Others will be looking to the size of Apple’s cash hoard, and still others at its potential tax liability.

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I’ll be looking at service revenue, because that will tell the tale of Apple’s future.

As I have written before, CEO Tim Cook has used iPhone profits to make Apple a cloud company, and you can see the results in its services revenue. Services revenue came in at $7.26 billion last quarter, up 22% from a year earlier. Total revenue was $45.4 billion.

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Apple is expected to have revenue of $50.94 billion for the September quarter, which is the fourth quarter of its fiscal year, and earnings of $1.86 per share.  Margins are expected to be 38%.

Without revenue from services that would not be possible.

Why Services?

Without services, Apple is a slow-growth company. Even with services, revenues were up just 7% year-over-year.

As with its phones, Apple has demonstrated a unique ability to get people to pay big for the same thing other customers pay less for. For instance, it charges $10 per month for its music service, while Amazon.com, Inc. (NASDAQ:AMZN) charges $7 per month to its Prime customers for its music service. Apple gets customers to pay for games and fitness apps that users on other platforms download free, with ads.

The man behind Apple’s retail stores, George Blankenship, says services are also the future of the shopping mall.  In his opinion, easy shopping, fast WiFi, and delivery services will make shopping centers relevant for millennials and their Generation Z siblings, and I believe him.

Because Apple owns its own cloud data centers, it can earn maximum margins from this trend. Instead of renting the space it uses for services, it owns the space, with all the tax benefits. Steve Jobs dismissed services as the tail wagging the dog. For Tim Cook, this is the dog.

Danger in Services

There are, of course, dangers in being a services company, both for AAPL stock and its shareholders.

For Apple, there are the same hazards bedeviling companies, like Facebook Inc (NASDAQ:FB) and Alphabet Inc (NASDAQ:GOOGL), in holding personal data on hundreds of millions of customers. There are increasingly diverse global laws on handling that data, with attendant costs, and there is the risk of a breach. There are partner relationships to manage, sometimes with unreliable partners.

For shareholders, there is also the question of how high Apple’s services ceiling might be, and how much competition it may face as it expands its services footprint. Right now, AAPL is being careful to offer non-controversial services, but what happens as it starts to store fitness and health data?

Apple’s Bottom Line

Right now, AAPL stock is selling for roughly 17.4 times earnings. This is much, much higher than in mid-2016, when its price to earnings multiple was in the low teens, but still short of where the market is selling. The stock’s rise has been entirely due to multiple expansion.

The assumption remains that Apple is no longer a growth company. The stock price is expected to rise or fall based on demand for its phones.

But I don’t think that’s where you should look. Services are now over 15% of Apple revenue. They are the fastest-growing part of the company. Since they’re tied to Apple’s proprietary operating system, they are crucial to maintaining brand loyalty.

What Apple’s new services are, and how well they do in the market, should be at least as important to investors as the details of the new iPhone.

Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance, The Reluctant Detective Travels in Time,  available now at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing, he owned shares in AMZN and FB.

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