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What Startups Might Broaden Apple’s Services Push?

Posted on Monday, Feb 4th 2019

Early this month, Apple (NASDAQ: AAPL) CEO Tim Cook had warned of a bleak first quarter, the first-ever decline in a holiday quarter due to decline in Greater China. Last week, Apple announced the details of its earnings. The bright spot in its earnings was its performance in Services.

 Apple’s Financials

Apple’s first quarter revenues declined 5% over the year to $84.3 billion. EPS was up 7.5% to $4.18. International sales accounted for 62% of the revenue. Analysts had estimated earnings of $4.17 per share on revenue of $83.97 billion.

Company gross margin was 38%. Products gross margin was 34.3% and services gross margin was 62.8%.

By segment, Apple’s iPhone revenues declined 15% over the year to $51.98 billion versus analyst estimates of $52.67 billion. Services revenue grew 19% to an all-time high of $10.9 billion versus analyst estimates of $10.87 billion. Revenue from Mac grew 9%, iPads grew 17%, and Wearables, Home and Accessories grew 33% to $7.3 billion, driven by sales of Apple Watch and AirPods. It sold 46.9 million iPhones and 9.7 million iPads during the quarter.

Revenue from Greater China declined by 27% to $13.17 billion, mainly due to price wars. China’s economic slowdown and the ongoing trade war between China and the US have added to uncertainties in the market.

For the second quarter, Apple forecast revenues of $55-$59 billion, ahead of the market’s forecast of $58.83 billion. Gross margin is expected to be between 37% and 38%. The company ended the quarter with $245 billion in cash plus marketable securities. It returned over $13 billion to its investors during the December quarter.

Apple’s Acquisitions

Apple has always believed in small but strategic investments. Over its 42-year history, it has acquired 103 companies but only one of them was over $1 billion. The acquisition in question is that of Beats Electronics in 2014 for $3 billion. Aided by its huge cash pile and Tim Cook’s new leadership, we expected Apple to take a bolder acquisitive route with the acquisition of Netflix, perhaps. However, it has shied away from any such big acquisitions and now the opportunity has passed.

In 2018, Apple acquired eight companies. California-based Next Issue Media helps its customers develop, distribute, sell, and consume paid digital content of magazines and newspapers. Founded in 2009, it had raised $50 million. Apple also acquired its digital magazine subscription service Texture.

Colorado-based Akonia Holographics focuses on the development of advanced data storage technologies based on holography. It was founded in 2012 and had raised $11.6 million.

Apple has also acquired assets of Dialog for $600 million, $300 million for its patents and to license its power management technology and $300 million as a prepayment for Dialog products that will ship over the next three years. UK-based Dialog Semiconductor (NASDAQ: DLGS) makes energy-efficient, highly-integrated, and mixed signal ICs for mobile, IoT, and solid-state lighting applications.

California-based Asaii is an automated machine learning A&R and music management platform. It was founded in 2016 and had raised angel funding from The House Fund.

California-based Silk is a machine learning company using on-device AI to empower businesses to build the next generation of intelligent connected devices. It was founded in 2015 and had raised $2.5 million in funding.

UK-based Platoon discovers emerging talent and provides them with the platform to create, distribute, and commercialize exceptional creative work. It was founded in 2016 and was bootstrapped.

UK-based Shazam Entertainment was acquired for $400 million. Founded in 2000, Shazam is an app that identifies music playing around you. It had raised $143.5 million and has over 17 million monthly visitors.

Apple’s Services Focus Paying Off?

Revenue from services, which includes iCloud, the App Store, Apple Music, Apple Pay, iTunes digital content, iBooks, AppleCare, has grown from less than $8 billion in calendar 2010 to over $41 billion in calendar 2018. There are over 360 million paid subscriptions across its services portfolio, up by 120 million over the year. Apple Music has over 50 million paid subscribers and Apple Pay recorded over 1.8 billion transactions during the quarter. The company expects the number of paid subscribers to cross 0.5 billion in 2020. It is launching a video subscription service in April.

Going forward, Services will play a more vital role in reviving Apple. Services business accounts for 13% of the total revenue and 21% of gross profit dollars but analysts expect it to grow to as much as 30% of revenue and 46% gross profit dollars by FY23.

Payments, healthcare, music, and video are a few areas that I can see Apple Services dominating in a few years. What other capital-efficient startups can Apple acquire to boost its Services portfolio? In my recent article on Bootstrapping to an Exit, I had discussed the benefits of bootstrapping and capital-efficient startups in exits. Apple is perhaps one of the best exits for bootstrapped and capital-efficient startups.

Apple’s stock is trading at $166.52 with a market capitalization of $785.19 billion. It had peaked to a record high of $233.47 in August last year. It was trading at a 52-week low of $142 in early January following Tim’s warning.

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