Is that a failure, or an opportunity? Maybe Apple Music is barely getting started.
In a note to investors, RBC Capital Markets’ Amit Daryanani wrote that Apple would have to grow revenues from its services division by 18% over the next four years. While the numbers may sound high, Apple’s services division has grown 21% annually over the last five years. Daryanani’s prediction comes from Apple Service revenue over the past several years.
However, Apple Music and iTunes have maintained a low gross margin at 15%.
According to Daryanani, App Stores, iTunes, Apple Music, AppleCare, and the Apple Update Program have largely contributed to the division. The Cupertino-based company has earned strong revenue in the services division thanks to strong consumer loyalty and “synergetic benefits.”
Daryanani’s growth numbers may face a significant impact from the “super cycle” between iPhone 7 and 8. Last June, Credit Suisse correctly calculated a “muted” and “modest” upgrade cycle for the iPhone 7. Instead, Credit Suissie and analyst Kulbinder Garcha foresaw strong numbers for the 2017 iPhone. They believe the iPhone 8 will successfully court new users and accelerate upgrades among existing iPhone users.
The rumored “cord-cutting” iTV launch also contributed to Daryanani’s estimates.
The App Store will keep bringing in strong services revenue for the division, per Daryanani’s estimates. It may bring in 85% of gross margin estimates. Apple Pay has proven a success among consumers, as the service may hit at 80%. Yet, digital downloads numbers keep falling, as the service may only bring in 25%.
However, since Apple released its music streaming service, Apple Music, it has only reached a 3% install base. 97% of core Apple users have yet to purchase a paid subscription since its launch two years ago.
Instead of considering Apple Music’s streaming service as a failure, Daryanani called Apple’s service “a very underpenetrated opportunity.” He also highlighted the dismal numbers as a “very attractive opportunity for user growth.”
RBC Capital Markets increased its Apple stock price target to $155 thanks to successful Apple service performance. The “super cycle” will also lead the Cupertino-based company to year-over-year revenue growth.
What could harm Apple’s estimates in the long run? Daryanani listed “execution stumbles,” “greater-than-expected iPod cannibalization,” and “channel conflicts or execution” as theoretical factors.
Daryanani’s estimates led to surging stock prices last week. However, Daryanani failed to lay out a game plan on how the company will increase overall subscriptions. Apple Music has yet to capitalize on appealing to its established user base to increase their paid subscription numbers.
Meanwhile, Spotify has recently surpassed 50 million paid subscribers, jumping 20 million in just one year. Yet, Apple Music only launched two years ago and sports 20 million paid subscribers. Spotify reached the 50 paid subscribers mark after 10 years.
Numbers aside, the bigger question in investors’ minds is: wow will Apple Music continue establishing a strong presence and get high paid subscription numbers? Should it worry about first place, or should the service conform to a strong second, behind Spotify?