Apple earnings preview: Are services sales at risk from greater regulation?

April 27, 2021, 9:00 PM UTC

Apple reached $2 trillion in stock market value last year thanks partly to incredible sales and profit growth in its services businesses, like music subscriptions and app purchases. But lately those areas are drawing attention for all the wrong reasons, threatening to hobble one of the company’s most profitable revenue sources.

For Apple’s upcoming quarterly earnings report on Wednesday, analysts expect strong services revenue growth of 17%, to almost $16 billion. The biggest growth engine in the segment for some years now has been the App Store, which collects a commission on the sale of mobile apps, app subscriptions, and in-app purchases.

On many sales, Apple gets a 30% cut, though it takes only half that from smaller developers and long-term subscriptions. Although impossible to know exactly how much money this tax brings in, it adds up based on the size of the overall service business, where revenue totaled $57 billion last year, up 18% from 2019.

So what’s the problem? Lawmakers, academics, and rival say Apple is abusing its dominant position controlling the hardware and software on iPhones to squeeze out unjustified charges and improperly quash competition. They’d like to see Apple lower its commission rates, accept third-party payments systems, and even possibly allow app sales outside its own app store.

The company maintains it has done nothing wrong and says some of the attacked practices are needed to protect the privacy and security of its customers’ data.

The attacks came to head last week at a Senate hearing of the Judiciary Committee’s antitrust subcommittee. Next week, they’ll get an even bigger airing as the trial for Epic Games antitrust lawsuit against Apple opens in Oakland, Calif.

Apple was already lambasted at the Senate hearing. “How does Apple justify the 30% commission fee rate when the cost of running the app store is so much lower than the revenues the company generates from the app store,” Sen. Amy Klobuchar, who chaired last week’s hearing, said. “Those look like monopoly profits.”

Kyle Andeer, Apple’s chief compliance officer, responded that Klobuchar’s profit estimates for the app store were much too high, though he didn’t supply a figure, and said that Apple was supporting developers who wanted to sell apps. “Apple has invested significant sums in technologies, resources, tools to allow developers to build their apps,” he said.

Still, critics took on Apple’s tactics, which include barring apps from even alerting customers of cheaper ways to pay for services on a web site. “It is amazing how much they’ve done the same dirty, old business practices,” Mark Cooper, director of research at the Consumer Federation of America, testified at the hearing. “And those hurt consumers. We learned that a long time ago and out best protection is real competition. This is a space in which we don’t have it.”

On Wall Street, the antitrust concerns have barely registered. In part that’s because during the pandemic, Apple customers forced to work and learn from home have been snapping up new hardware at a rapid pace, making the company less dependent on services revenue for growth. But the pandemic effect could wear off later this year. And while some states are considering legislation to force Apple to ease up on app store charges, Apple defeated the efforts in Arizona and North Dakota.

In a report on Monday, Cowen analyst Krish Sankar rates Apple’s stock as “outperform” and set a target price of $153, 14% above the current price of $134.72. But he warned that some “near term risks” were building in the area of services, citing the beginning of the Epic Games trial.

Longtime Apple analyst Katy Huberty at Morgan Stanley, who rates the company “overweight” with a target of $158, left any mention of the antitrust problems to a short list of “risks to the downside,” which included, “Increased regulation, particularly around App Store.”

And in a report last month, UBS analysts David Vogt’s only discussion while upgrading Apple to “buy” with a target of $142 was among the downside risks that “Apple reduces AppStore fees further impacting Services growth and margins.”

(Correction: This story was updated on April 27 to correct that Apple only takes a commission on app sales, not free apps.)

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