To be honest, I’m still not 100% sold on Apple (NASDAQ:AAPL) despite the huge rally in Apple stock of late. The AAPL stock price has risen 49% over the past year, adding over $360 billion in market value.
The catalysts for the rally are twofold. First, the market seems to be far less concerned about so-called commoditization of the iPhone. The long-held bear case for Apple stock was that lower-priced competition eventually would be good enough.
The thinking goes that cheaper models would undercut Apple’s pricing power and at some point leave it a better version of Dell Technologies (NYSE:DVMT) or HP Inc (NYSE:HPQ), if not quite as bad as off as one-time market leader BlackBerry (NYSE:BB).
But with the success of the iPhone X after early concerns investors seem satisfied that Apple can at least keep hardware revenue stable.
The second is increasing optimism toward Apple as an ecosystem. Once consumers buy hardware, Apple can generate billions annually in revenue through its App Store, Apple Music, and other options. Those billions come at high margins driving consistent profit growth even if user base increases (and hardware upgrades) slow.
I still see some reason for skepticism on both fronts. Admittedly, the AAPL stock price still isn’t pricing in that much growth at ~14x forward earnings, backing out net cash. But the market clearly has bought into the story and recent events suggest that’s probably not going to change any time soon, if at all.
The Bear Case for Apple Stock
The short version of the bear case toward AAPL is relatively simple. The iPhone still generates over 60% of revenue. And as lower-priced competitors from Asia improve, and as replacement cycles lengthen, that revenue should start declining at some point.
After all, Apple can’t take pricing forever, and unit sales already are declining: they fell 6%+ between FY15 and FY17, and are up less than 1% through the first three quarters of fiscal 2019.
If iPhone revenue starts declining, there’s really little Apple can do. As I’ve pointed out before, the iPhone has been such a success that everything else simply pales in comparison. Apple wearables revenue is to estimated to be over $10 billion, for instance. That’s roughly one-fourteenth of iPhone revenue for what would be an enormous, game-changing hit at pretty much any other company.
And as I pointed out last month, the AAPL stock price has reflected the fear of “peak iPhone.” Over the past few years, Apple stock has tended to pull back after major launches. Investors get excited about the new phones, and once they’re launched, inevitably ask, “OK, what now?”
The AAPL Stock Price Continues to Rise
From that standpoint, the recent rally in Apple stock is particularly intriguing. The stock did see some initial modest weakness after the launch of the iPhone XS but it has rallied strongly the past few weeks to yet another all-time high.
At least in the early going, that suggests the correlation between launch cycles and the AAPL stock price might be over. And recent news explains why investors are more bullish this time around and might stay that way.
Apple, Google, and Microsoft
The first bit of news is an analyst estimate that Alphabet (NASDAQ:GOOGL,GOOG) unit Google is paying $9 billion a year to remain the default search engine on Apple’s Safari. That figure is up from an estimated $1 billion just a few years back.
If ever there was a data point to prove the ecosystem argument, that would seem to be it. Google not only is a tech giant itself; its Android OS is essentially the only competitor to Apple’s iOS in mobile. And yet Apple’s leverage is such that it can acquire a revenue stream probably worth at least $100 billion (assuming high margins) from its own rival.
The second is an argument this week in Barron’s that Apple should follow a move by fellow tech titan Microsoft (NASDAQ:MSFT). Microsoft has rolled out subscriptions for its Surface devices, which include Office 365. Barron’s argues that Apple should do the same thing bundling Apple Music and other services with the hardware for a flat monthly fee.
The case from Barron’s makes some sense though it’s not necessarily a revolutionary idea. But it’s worth highlighting because it shows how investors are viewing Apple at the moment. The ecosystem argument clearly has taken hold.
To the market, Apple no longer looks like a hardware-reliant company with a few services offerings. Rather, it appears more like a diversified behemoth with potential to better monetize the millions of customers using that hardware.
Admittedly, I still question whether that’s quite the case. But it appears I’m in the minority. And until that changes, the AAPL stock price should continue to rise.
As of this writing, Vince Martin has no positions in any securities mentioned.
