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Apple investors hope short-term pain will lead to long-term gain

apple knife stab

16% growth in the steadily growing software and services business seems to be enough to rally investor confidence in the face of declining revenues.

Perhaps this is another lesson Apple can teach the world; how to effectively manage investor expectations. Total revenues are declining faster than the service division is growing, but with a 5.4% jump in share price in overnight trading, Apple investors seem to be buying into the short-term pain, long-term gain message from the technology giant.

For some the earning call might have been a shock to the system, explaining the immediate 1.93% drop in share price before markets closed. Total revenues for the quarter ending March 30 declined to $58 billion, down 5.2% year-on-year, while iPhone revenues dropped to $31 billion, a 17.8% dent in the same shipment figures from 2018. But the services division is the glimmer of hope.

“We had great results in a number of areas across our business,” said CEO Tim Cook during the earnings call. “It was our best quarter ever for Services with revenue reaching $11.5 billion.

“Subscriptions are a powerful driver of our Services business. We reached a new high of over 390 million paid subscriptions at the end of March, an increase of 30 million in the last quarter alone. This was also an incredibly important quarter for our Services moving forward.

“In March, we previewed a game-changing array of new services each of them rooted in principles that are fundamentally Apple. They’re easy to use. They feature unmatched attention to detail. They put a premium on user privacy and security. They’re expertly curated personalized and ready to be shared by everyone in your family.”

Although the Apple DNA is not rooted in the software and services world, this has to be the future. Overarching trends are indicating hardware is becoming increasingly commoditized, refreshment cycles are growing, and consumers are less likely to pay a premium for trusted brands. Apple is a company which defied these trends for a period, though not even the iLeader could deny the inevitable.

This is the critical importance of the software and services division; renewed, recurring and new revenues to replace the increasingly difficult, demanding and diversified hardware world, which is epitomised by the dreary global smartphone market.

Although Apple recently decided against releasing shipment figures during its earnings calls, it is still breaking out the revenues associated with products. The iPhone, the segment which drove growth in recent years, declined by 17.8% year-on-year. Part of this can be pinned on changing consumer behaviour, though you also have to look at the individual markets.

In China, Apple has been struggling. Canalys estimate smartphone shipments in the market have declined 3% year-on-year for Q1, though the locals are turning towards domestic brands. In years gone, Apple was a brand seen as somewhat of a status symbol, though it appears this is a concept which is quickly dissipating as the firm only collected 7.4% of market share over the first three months of 2019, a year-on-year decline of 30%.

Total revenues for China have not declined quite as dramatically, a 21.6% year-on-on-year dip to $10.2 billion, though Apple is not alone. OPPO, Xiaomi and Vivo also saw their year-on-year sales dip, with only Huawei coming out on the up. Here, Huawei managed to grow its shipments by 41%, taking 34% of the Chinese market share for Q1.

Another challenging market for Apple has been India. The story here is more forgiving however, as this is a much more cash-conscious market. Apple will of course want to maintain it position as a premium brand, therefore India, despite all the promise it offers, is not tailor made for its ambitions. Until consumer attitudes shift towards more premium devices, Apple will struggle.

Globally the smartphone market has not been helping either. According to Strategy Analytics, shipments decreased 4% year-on-year for the first quarter, with Apple slipping to third place overall.

Market share Q1 2019 Market share Q1 2018
Samsung 21.7% 22.6%
Huawei 17.9% 11.4%
Apple 13% 15.1%
Xiaomi 8.3% 8.2%
OPPO 7.7% 7%

These figures are not the end of the world, but it is a demonstration of consumer trends. There might still be an appetite for purchasing new devices, though there is seemingly a preference for those brands which might are cheaper. Such is the minimal differentiation between brands these days, why spend a premium when there is little need?

However, there is hope for Apple. Consumers might be getting frustrated over a lack of innovation in the hardware space, leading to longer refreshment cycles and a preference towards cheaper or refurbished devices, but the introduction of 5G might well change this.

With 5G devices being launched consumers will have something different to think about. Although 5G-capable devices are certainly not a necessity, and won’t be for a considerable amount of time, the ability to shout about something genuinely new might reinvigorate consumer appetite for purchasing new, and premium, devices. This could work in Apple’s favour.

That said, with Apple unlikely to release a 5G-capable device until 2020, the next few quarters could also demonstrate similar year-on-year declines. Apple seem to be happy to swallow this decline, sacrificing the ‘first to market’ accolade, but this how Apple traditionally approaches the market; it doesn’t aim to be first, but best.

For the moment, and the long-term health of the company, this does not seem to be the central point however. Apple is seemingly attempting to slightly shift the focus of the business, becoming more reliant on software and services, and it does seem to be working. As you can see from the table below, the ratio is shifting.

Product revenue Services Revenue Ratio
Q2 2019 46,565 11,450 81.3/19.7
Q1 2019 73,435 10,875 88.2/12.8
Q4 2018 52,919 9,981 84.1/15.9
Q3 2018 43,717 9,548 82.1/17.9
Q2 2018 51,947 9,190 85/15
Q1 2018 79,768 8,471 90.4/9.6
Q4 2017 44,078 8,501 85.9/16.1

The results in the table above do look quite confusing, though you have to consider that Q4 is usually the period for Apple’s flagship launch, skewing the figures towards the product segment, while Q1 accounts for Christmas, again tilting the figures. The general trend is looking favourable for the software and services division.

The last couple of months have seen Apple release several new services which will continue to bolster this division also. Whether it’s the content streaming service, news subscriptions, credit cards, iTunes or the App Store, the business is driving more investment and attention to this strange new world of software and recurring revenues. The ratio should continue to balance out, though we strongly suspect it will never get close to parity.

Another factor which you have to consider when it comes to the investors is the monetary gain. Yes, the long-term picture is looking healthier, but the firm has also announced it is increasing the dividend by 5%. This will keep cash-conscious and short-term investors happier, encouraging more to hold onto shares despite the downturn in revenues. The team has also announced a share buy-back scheme, up to $75 billion, which could be viewed as another move to protect share price. Although these could be viewed as short-term measures to cool the market, the overall business is looking healthier.

Apple is recentring the business, with more of a focus on software and services. The firm has defied the global hardware trends for some time, but they do seem to be catching up. What is important however is the management team recognising hardware will not be a suitable floatation device for Apple in the long-run. To continue dominating the technology world, Apple will have to spread its wing further into software, just as it is doing.

And perhaps the most critical factor of this transformation; investors seem to have confidence in the team’s ability to evolve.

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