What's Driving The Ramp In Apple's Services Revenue?

Apple Inc. AAPL's growth in its Services business is a well-known story, but what's powering the growth is less known. A Morgan Stanley analyst said they have the answer.

The Analyst

Morgan Stanley's Katy Huberty maintains an Overweight rating on Apple's stock with an unchanged $200 price target.

The Thesis

Apple's Services segment includes the following businesses:

App Store.
iTunes.
Apple Music.
Apple Pay.
AppleCare.
iCloud.
Licensing revenue.
Other software.

The combined segments posted a 31-percent growth rate in Apple's fiscal second quarter, which marks an acceleration from 27-percent growth in the December quarter.

In a regulatory 10-Q filing, Apple said the strength in Services is attributed "primarily to licensing, App Store and AppleCare," Huberty said. The lack of accompanying detail makes it difficult to quantify the contribution of each individual business, the analyst said.

Fewer than half of all Apple users pay for at least one service today, which leaves a "significant low-hanging fruit," Huberty said. It would be reasonable to assume Apple will achieve its target of doubling Services revenue in fiscal 2019, which is one year earlier than Cupertino initially guided in January 2017.

Here are Huberty's takeaways on Apple's Services segment:

The largest absolute dollar contributors in the March quarter were licensing/search payments and the App Store.
The App Store generated $3.4 billion in revenue.
The App Store is growing in-line with the overall Services business.
Licensing, Search and Other generated nearly $1.9 billion.
Licensing/Search and the App Store are the two highest-margin businesses in Services.
ApplePay grew at 116 percent, Apple Music grew at 69 percent and iCloud grew at 49 percent.
These lower-margin businesses require investments in data center infrastructure and/or content.