APPLE'S TRANSITION TO SUBSCRIPTION SERVICES

Not only is Apple once again the most valuable company in the world, but it has been one of 2019’s top-performing stocks. As of mid-December, the stock was up over 85% for the year—which is remarkable when you consider that sales of the Apple iPhone have stagnated in the last few years.

After years of outperformance, Apple’s stock price only just managed to keep up with the market from 2016 to 2018. By the beginning of 2019, the company’s best years seemed to be behind it and analysts were beginning to call it a value stock rather than a growth stock. So, what changed in 2019?

Three things have driven Apple’s stock price over the last year:

Increased AirPod Sales in 2019

Firstly, sales of Apple’s AirPods headphones have outperformed the market’s expectations by a large margin. AirPods which were only launched in 2016, now accounts for more than a quarter of the entire headphone market—more than any other brand. The company is now projecting sales of over 100 million units in 2020. According to one report, if the AirPods product line was a separate company it would be the 32^nd largest in the US.

New iPhone Sales Model

Secondly, Apple has embraced a new sales model for the iPhone. When the iPhone was first launched it was far better than anything else on the market, which meant Apple could sell it at a premium price. Since then the incremental improvements have lessened, while the functionality of other smartphone brands has caught up.

Apple is now allowing consumers to trade in their old iPhone. Apple is buying used iPhones for a much higher price than competitor brand smartphones can command in the second-hand market. Consumers now view iPhones as assets that retain their value, meaning an upgrade is more affordable. By selling refurbished iPhones, Apple is also gaining new customers who would not be able to buy the latest model.

The success of Apple’s AirPods and the new sales model have provided a welcome boost to Apple’s revenues and stock price. But the long-term value driver for Apple is likely to be a third factor—its transition from a hardware business to a services business.

Apple Subscription Services

Apple realized some time ago that it can’t maintain the growth rate investors are accustomed to by selling iPhones, iPads, and other hardware devices. The company also quickly saw the potential of the App Stores and iTunes Store after they were launched. In addition, Apple watched the success of subscription businesses like Netflix, Amazon Prime, and Spotify.

Apple’s new area of focus has been subscription-based services and media products. Apple Music competes with Spotify and other music streaming services. iCloud offer users cloud storage and synch neatly with the company’s other products.

Apple Arcade is a subscription-based online Video Arcade that was launched in September this year. Within three months the arcade already gives users access to over 100 games with more being added weekly. The service costs users $4.99 a month.

More recently Apple has launched Apple TV+, a subscription-based video-on-demand service. Like other streaming video services, Apple will be producing its own content for the service which costs $4.99 a month.

Apple is also moving into healthcare. Healthcare is most efficient when patients maintain an active lifestyle and when problems are detected early. The Apple Watch which collects biometric data can assist with both. Apple hopes to build an ecosystem of products and services around its watch and healthcare apps.

The payments industry is also in Apple’s sights. Apple Pay is a mobile payment solution that can be used with the iPhone, Apple Watch and iPad. Apple Pay has advanced security features including two-factor authentication using fingerprints and facial recognition. Of course, the company also has Apple Card a credit card which is connected to the Apple Pay wallet.

What does this mean for Apple?

Apple’s subscription services are not just another revenue source for the company—although they are that too. Firstly, subscription services generate recurring revenue which will provide the company with more stable and predictable cash flows.

Secondly, each service adds more value to the existing ecosystem. Each new service is an opportunity to bring new customers into the ecosystem. And each new subscriber is a potential customer for all the other services, as well as Apple’s hardware products.

It may take a few years for some of the new services to gain critical mass. So, it’s possible that they will not add to the bottom line and may even be a drag on profits. This means that if AirPod and iPhone revenues lose momentum at some point in the next year or two, Apple may have a few weak quarters. This is the opportunity long term investors should be looking for to load up on the stock.