On the very first day of the new quarter, one Wall Street analyst sounded the alarm on Apple stock. According to Goldman Sachs’ Rod Hall, there is “significant downside risk” to investing in shares of the Cupertino company at current levels.
At the core of the analyst’s fears is Apple’s services segment. Today, the Apple Maven looks closer at the argument, and assesses the merit of the bearish call.
Drop off in services
Goldman Sachs defends the idea that Apple is worth only $83 per share, which represents more than 30% downside risk. One of the factors that could lead the stock lower is worse-than-expected service revenues in 2022. Below is the analyst’s quote:
“We believe there is significant downside risk to CY’22 consensus for Services revenue driven primarily by a slowdown in App Store growth post COVID. We also flag the possibility of a drop off in Apple TV+ revenue if Apple were to end the one-year free trial on the purchase of new devices though we are now assuming continuation of the free trial in our forecasts."
Based on the above, there are two key pieces to the services puzzle. First, the research shop sees post-pandemic headwinds that would likely be caused by a return to normal: from staying at home trends to “get outside” habits.
I think it is not hard to understand the logic here. Will consumers be as compelled to sign up for services like Apple Arcade, for example, if the alternative is to seek other forms of entertainment offscreen, which were largely not available in 2020 and parts of 2021?
Regarding the App Store, I could even add another risk. Epic Games and other tech companies, in addition to governments around the world, have been targeting Apple for its position as a powerful gatekeeper of the app ecosystem.
Under pressure, the Cupertino company could be tempted to lower its commissions even further – although, for now, the impact of doing so has been minimal.
The second piece pertains to Apple TV+ more specifically. The company used an aggressive marketing strategy last year by offering one free year of the service to buyers of new Apple devices. As the trial period expires in July 2021, Goldman Sachs seems to believe that renewal rates could be lower than currently projected.
Once again, regardless of whether it will prove right or wrong, the thesis has some merit. The streaming video space has become increasingly competitive, as established players like Netflix are challenged by both capable (e.g. Disney+) and more speculative (e.g. Walmart’s VUDU) newcomers.
The counterargument to the bear
I believe that all of the above are fair questions or fears to raise about Apple’s service business. But at the same time, the bearish thesis only tells one half of the story. Every business has strengths and weaknesses, risks and opportunities. It is unfair to dwell only on one side of the argument.
While there could be a temporary decline in demand for Apple’s services, I believe that the secular trends towards streaming audio and video entertainment (Apple TV+, Apple Music), cloud (iCloud) and mobile payments (Apple Card, Apple Pay) are irreversible. Apple’s services segment is on the right side of these trends.
Also, Apple has vast resources to invest in new offerings, which could help the company to monetize on the expanding installed base of Apple devices. The most recent ventures have been Arcade and Fitness+, but the opportunities have probably not ended there.
Lastly, the services segment performed particularly well in the most recent quarter. Revenues were up 24% year-over-year, the most since fiscal 2019.
Were the thesis about temporary stay-at-home tailwinds accurate, an even more noticeable top-line increase would have happened during the thick of the pandemic, in the June and September 2020 quarters.
A bearish thesis can be controversial, especially among current shareholders. But being able to analyze the flip side of a bullish argument is an important skill in investing.
I asked Twitter if there was merit to Goldman Sachs’ fears over service revenues and the potential share price decline. Here are the responses:
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(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting The Apple Maven)