Apple: Positioned To Win In Search And In Financial Services
Contributor since 2013 / 6811 Followers
Summary:
- Apple’s potential increased negotiating power with Google could lead to higher revenue from their search engine partnership.
- Apple’s expansion into financial services demonstrates its ability to leverage its extensive install base to explore new markets.
- Despite Apple’s long-term growth potential, its current valuation appears to be on the higher side, warranting caution for potential investors.
Shahid Jamil
In December 2021, we released an article emphasizing Apple’s (NASDAQ:AAPL) advantageous position to lead the charge in constructing the metaverse, thanks to its robust competitive strengths that allow it to successfully compete across various digital spheres. Since the publication of that piece, our hypothesis has been validated as Apple has significantly outperformed and made remarkable progress in developing its AR/VR technology. We anticipate that the company will soon unveil a product in this domain, as well as make advancements in software, services, and financial services.
The recent developments at Apple have painted a promising picture for the company’s future, from its potential increased negotiating power with Alphabet’s (GOOGL) (GOOG) Google to its bold move into financial services. As we discuss these positive aspects and their implications for investors, it’s important to note that while we are neutral on the stock due to its current valuation, we maintain a bullish stance on Apple’s long-term prospects. In this article, we will explore Apple’s negotiations with Google, its expansion into financial services, and whether its current valuation is justified.
Google Negotiations
Recently, The New York Times reported that Samsung is considering replacing Google with Bing as the default search engine on their phones. This development is surprising, given that Samsung phones operate on Google’s Android system. However, we believe this shift could potentially increase Apple’s negotiating power with Google, as Bing becomes a more serious competitor.
Apple currently earns approximately $9 billion per year from Google for making Google the default search engine on iOS. In the past, negotiations between Apple and Google were relatively well-balanced, with Apple providing a massive, valuable user base and focusing on the best user experience, while Google remained the superior search engine. The news about Samsung potentially switching to Bing, however, could create leverage for Apple to argue that Bing has closed some of the gap, potentially resulting in more negotiating power and increased revenue from their relationship with Google.
Apple’s Traffic Acquisition Cost (TAC) revenue is driven by distribution agreements with search engine providers, including Google’s contract with Apple, which sets Google as the default search engine for Apple’s Safari browser and other search access points across Apple devices. With Microsoft emerging as a potential alternative to Google, Apple gains more bargaining power to better monetize their extremely attractive installed base of over 2 billion devices.
Apple has the option to renegotiate with Google for better terms or consider switching to Microsoft when the current agreement expires. Renegotiation would involve securing a higher amount per search. However, switching to Microsoft poses risks. If users continue to choose Google over Microsoft, the volume of search for which Apple gets paid will decline, and a higher rate per search might not offset the share loss in aggregate search. Furthermore, if Google can monetize search at a much higher level, it could be difficult for Microsoft to compete for the contract.
Push Into Financial Services
Recently, Apple has entered the competitive US market for bank deposits by partnering with Goldman Sachs to offer a high-interest savings account for Apple Card holders. This move represents a further step for Apple into financial services, and it may not be long before the company considers offering lending products.
The new savings account offers a 4.15% savings rate, which is relatively in line with other high-yield savings accounts (HYSA) that offer 3.5-4.75% annual percentage yields (APYs). Although the savings account will have a minimal bottom-line impact, we believe this is another excellent example of Apple leveraging its extensive install base to expand into new markets.
Apple’s move into savings followed another major development just a few weeks ago when it announced Apple Pay Later in the U.S. This is the company’s Buy Now, Pay Later (BNPL) offering, which allows consumers to split purchases into multiple payments.
The primary goal of Apple’s consumer finance offerings, including Apple Card, is likely to drive greater adoption of Apple Pay. We anticipate that Apple will continue to expand and strengthen its portfolio to explore various avenues in addressing the multi-billion-dollar payments market.
Launched in 2014, Apple Pay experienced a slower adoption rate than anticipated. Although digital payments gained traction in developing Asian countries, it has been challenging to penetrate Western markets where consumers are accustomed to credit/debit card payments. Over time, digital wallets have gained popularity in the US, and this trend is expected to continue as the smartphone generation increasingly dominates the economy.
The “Tap to Pay” feature, announced in early February 2022, allows vendors to accept payments directly on their iPhones. Stripe will be the first payment platform to offer this feature after Apple’s official release later this year. Initially, the feature will be introduced with Stripe’s point-of-sale app, but Apple intends to release their own POS app eventually. Apple is likely to target micro-sellers initially, which account for roughly $446 billion in gross sales.
Concern: Valuation
Our analysis indicates that Apple’s current valuation is trading at a significant premium, at 26.4x its forward 12-month consensus earnings per share (EPS). This is towards the higher end of its five-year range, which falls between 12x and 34x. While this may appear high, it is important to note that Apple has successfully transitioned into a software and services business, leading to increased earnings visibility, reduced revenue volatility, and an improved gross margin and operating margin profile.
The current fiscal year 2023 is expected to be a modestly down year for Apple’s EPS, which could explain the higher multiple investors are placing on trough earnings. However, fiscal year 2024 is expected to see an acceleration of 11% year-over-year in EPS to $6.62. When compared to the S&P 500, Apple is trading at a 45% premium, which is close to the high end of its five-year range, varying between a 20% discount and a 50% premium.
There are several exciting developments within the company, such as its push into financial services, which have the potential to fuel growth. However, given Apple’s immense size, it would require significant success in these new ventures to materially impact its overall growth trajectory.
As strong believers in Apple’s long-term prospects, we still find the current valuation to be somewhat rich. We prefer to be cautious and refrain from adding shares at these levels, as we believe there are better entry points that may present themselves in the future. While Apple remains an innovative and resilient company, its current valuation demands a level of growth that may be difficult to achieve, and we find it prudent to wait for a more attractive valuation before considering an investment.
Conclusion
Apple’s recent moves, such as increasing its bargaining power with Google and pushing into financial services, are testament to the company’s innovative and forward-thinking approach. However, the current valuation of 26.4x its forward 12-month consensus earnings per share (EPS) suggests that the stock might be trading at a premium. Although Apple has successfully transitioned into a software and services business, leading to increased earnings visibility and reduced revenue volatility, its immense size means that significant success in new ventures is needed to materially impact its overall growth trajectory.
While we are optimistic about Apple’s long-term prospects, we believe that caution is warranted in the short term due to its rich valuation. Investors may want to wait for a more attractive entry point before considering an investment in the company. In the meantime, it’s crucial to keep an eye on Apple’s ongoing innovations and market expansion to stay informed about its growth potential and future opportunities.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.