Epic Games has handed Apple (NASDAQ:AAPL) an epic defeat. Epic Systems, the maker of “Fortnite” and other popular games, launched a massive lawsuit against the company years ago for allegedly anticompetitive behavior. And, in a surprise to many observers, a judge largely agreed.
On Sept. 10, a judge ruled on the long-running Epic versus Apple lawsuit. Epic had claimed that Apple was acting in a pattern of monopolistic behavior and demanded an open marketplace for applications. Apple, not surprisingly, rejected the monopoly charges and sought to maintain the status quo.
The judge gave a split decision. According to U.S. District Judge Yvonne Gonzalez Rogers, Apple itself is not an antitrust monopoly. And it will continue to have the ability to make all apps for iPhone be downloaded through its exclusive store. However, the judge found that Apple couldn’t continue to force all payments to occur through its App Store. And that’s a big win for Epic and other app developers.
Now app developers can drive payments traffic through their own websites and avoid Apple’s onerous transaction fee. This fee is as high as 30% for companies with more than $1 million in annual net sales on its platform and 15% for companies with less than $1 million in sales.
App Store Decision Isn’t Entirely Unprecedented
Now, this decision was not totally unexpected. Apple had already run into issues with certain types of apps on its store. Indeed, it recently made an agreement with the Japan Fair Trade Commission (JFTC) to allow “reader” apps to set up payment options outside of the app store. This would allow developers of content-based apps such as magazines, newspapers, and music streaming services to avoid the app store fee.
However, according to Wamsi Mohan of Bank of America research, the JFTC agreement only involved apps making up approximately 20% of Apple’s revenues, and it was likely the hit would be even less than that.
While Apple would have seen no big loss from letting some newspapers and similar businesses run their own payment plans, the Epic situation is a whole different matter. Now, virtually all of the app store’s revenue is potentially at risk. According to the ruling, approximately 70% of Apple’s app store revenue currently comes from gaming apps.
Gaming Revenues Under Fire
So, to be clear, Apple’s App Store revenue, at least as of now, is in large part a tax on the online gaming ecosystem. Thus, it should be no surprise that Epic – a leading mobile gaming company – is the one that ultimately caused Apple’s payment monopoly to fall.
Simply put, this is a life-or-death matter for gaming companies. The difference between earning 70%-85% and nearly 100% of their customers’ payments can be the difference between a game publisher producing fat profits or just getting by.
Let’s put some numbers on this. Zynga (NASDAQ:ZNGA) is perhaps the most obvious example. The company gets a massive portion of its revenue from purchases facilitated by the Apple app store. It has to share 30% of that at present. Analysts suggest that if Zynga can move those to a different payment ecosystem with a far smaller cut of revenue, Zynga’s profits could more than double. That extra cash flow for Zynga would come directly from Apple’s bottom line.
ZNGA stock surged 6.3% on the day the judge’s decision was announced. If, in fact, the decision holds up under appeal and Zynga is able to monetize its games much more efficiently, shares could have far more upside in the coming weeks and months.
Broader Impact and the Bullish Perspective on AAPL Stock
It’s far from just Zynga, either. You have all the game makers, video and music streaming apps, dating sites, travel apps, and much more that stand to benefit if they can avoid the 15%-30% Apple store tax. This could be a breakthrough moment in internet history, allowing all sorts of businesses to finally reach agreeable levels of profitability. But, payments are something of a zero-sum game. As more digital revenue is distributed to the app developers and websites, Apple will have to settle for a smaller piece of the pie.
In a way, AAPL stock bulls can argue that this news isn’t really so bad. After all, Apple was arguably taking too big a cut of the app ecosystem and thus stifling innovation. In theory, if app developers earn more from the App Store, they will produce more and better products for Apple, and, in particular, in comparison with Android. This, in turn, could make the ecosystem more sticky and help sell more iPhones and other ancillary services.
AAPL Stock Verdict
That’s the bullish spin, and it’s not entirely without merit. However, make no mistake about it. Apple has generated a ton of its recent revenue growth from its App Store tax on the internet and digital economy. Getting 15%-30% of payments going through people’s phones is simply an unimaginably lucrative position.
Now, as Apple’s take rate falls sharply, both its current profits and future profit growth will be curtailed. That, in turn, will be a major headwind for AAPL stock. Given that Apple was already selling at a high valuation, with this negative catalyst now in effect, traders should move to the sidelines.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.
