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iPhone sales down but revenue keeps growing: Apple’s new driving force

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Up until recently, Apple’s share price lived and died by the number of iPhones it shipped each quarter. This focus however ignored the value of Apple’s customers and the services business they were driving.

In the past two quarters, Wall Street analysts and the market has started to appreciate Apple’s Services business, and even then, only because the iPhone X failed to ignite a new iPhone super cycle.

In the most recent quarter, Apple’s Services business grew 31% to more than $9 billion dollars for the quarter. This was the fastest growth rate since 2013.

Underpinning this accelerating growth is 1.3 billion active Apple devices globally, a figure that CEO Tim Cook says is growing in the double digits. Cook also revealed that Apple’s paying subscribers reached 270 million, up 100 million from a year ago and up 30 million from the previous quarter.

To put this subscriber count into context, Netflix has 125 million global subscribers, more than 100 million households are members of Amazon Prime, and Spotify has more than 70 million paying subscribers. These subscription services all cost around $120 dollars per year.

While Apple’s implied service revenue per subscriber is higher at $140 dollars, it should be noted that not all customers who spend money in the App store count as subscribers.

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What is more insightful is that, by our estimates, Apple’s services revenue per active device is less than $30 dollars a year, and assuming just under two devices per customer, revenue per customer is around $50 dollars a year.

This suggests there is ample room for Apple to grow its services revenue in the years ahead.

The other benefit of Apple’s services growth is that services gross margin is much higher than the overall blended gross margin. Wall Street analysts estimate services gross margin to be between the high 50s and high 60s, compared to the overall gross margin of 38%.

Incremental services gross margin is likely to be even higher, as the incremental commissions that Apple receives from the App store are likely to fall straight to the bottom line.

Although the market has finally caught on to the power of Apple’s services business, our expectations framework suggests that at the current share price, the market expects services revenue per customer to have plateaued for at least the next 10 years.

To the extent that Apple’s service revenue per customer can close the gap with other popular subscription services, the stock may still represent compelling value.

Written by Roger Montgomery

Roger Montgomery

Roger Montgomery is the chairman and CIO of Montgomery Investment Management.

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