Apple Inc. (AAPL) - Get Report shares jumped to a fresh all-time high Wednesday after Morgan Stanley's Katy Huberty, one of Wall Street's most respected analysts, boosted her price target on the stock based in part on the growth potential of its nascent AppleTV+ offering.
Huberty improved her Apple price target by $42 per share to $289 each, while holding her overweight rating in place, while arguing that the AppleTV+, which launches next week, could become a $9 billion revenue business by the company's 2025 fiscal year, even if only 10% of Apple users end up paying for the service. Huberty expects annual net paid subscriptions of around 136 million over the next five years, and sees solid expansion of the stock's price to earnings multiple ahead of its 5G iPhone launch in 2020.
The market view is that with the launch of TV+, Apple is entering a new, more capital intensive market with a low probability of generating a positive return for shareholders. Based on our in-depth analysis of the accounting treatment and economics behind Apple's soon to launch streaming video service,"Huberty wrote.
"We disagree, and see Apple TV+ boosting Services revenue growth by 2 points in FY20, adding 1 point, on average, to Apple EPS in FY21 and beyond, and contributing an incremental $3 per share to Apple's valuation in our updated $289 sum-of-the-parts-driven price target," she added.
Apple shares were marked 1.34% higher in early Wednesday trading to change hands at $243.18 each, a fresh all-time high that extends the stock's year-to-date gain to around 53.7%, before paring that advance to trade at $242.75 each.
Apple released three new versions of its iconic smartphone last month, with benchmark iPhone 11 version was priced just under $700, a $50 discount to the current iPhone XR.
Apple also indicated a drive towards more competitive pricing with a $4.99 base cost (as well as trials and discounts for new hardware buyers) for its Apple TV+ streaming service, a similar tag for its gaming offering -- Apple Arcade -- and a reduced $199 price for its retained AppleWatch 3, announced alongside a new fifth generation offered unveiled by CEO Tim Cook.
Apple's gross margins have been narrowing for the past few quarters, falling 700 basis points from the same period last year to 37.6% over the group's fiscal third quarter.
Apple no longer provides a breakdown of iPhone unit sales, making average selling price estimates nearly impossible to calculate, but indicated a 12% year-on-year contraction last quarter as customers -- particularly outside of the United States -- balked at the $1,099 price point for last year's iPhone XS Max.
The pricing impact on Apple's services margins could also be diluted by the competitive entry points for Apple TV+ and Apple Arcade, but at a healthy 64.1% last quarter, with an installed base of 1.4 billion, last month's new additions to the services suite won't likely have a meaningful near-term impact.
"We expect Apple TV+ gross margins to be artificially high in FY20 due to the boost of users signing up for a free year of service alongside a more evenly spread content cost amortization schedule, but as not all redeemers convert to paid subs and amortized production costs ramp beyond FY20," Morgan Stanley said.
"We expect Apple TV+ gross margins to fall to the high 30% range troughing in FY22, and expanding back towards 50% in FY25 as TV+ reaps the benefits of a scaling subscriber base," the bank added.