Bernstein's Sacconaghi Breaks Down The 'Surprising Strength' Of Apple's Services

Apple Inc. AAPL's second-quarter earnings report signaled its Services business remains strong and adjusted for one-time factors grew 27 percent versus 23 percent, 25 percent, and 24 percent in the prior three quarters, according to Bernstein.

The Analyst

Bernstein's Toni Sacconaghi, Jr. maintains a Market Perform rating on Apple with an unchanged $190 price target.

The Thesis

Apple's "surprising strength" in its Services business begs the question: where exactly is the growth coming from? The company's recent regulatory filing does offer some clues and it's likely that nearly all of the Services incremental growth seen in the recent quarter came from Licensing (mostly from Traffic Acquisition Cost from Google), Sacconaghi said in a research note.

The iCloud subscription business grew 50 percent in the second quarter and may have accounted for $1.7 billion in revenue in the first half of the year, the analyst wrote. The iCloud business may have contributed 400 basis points to total Services growth which marks an increase from just 300 basis points a year ago. However, iCloud growth was likely mostly offset by slowing growth in other segments, such as the App Store and Apple Music.

What Is Next?

The analyst is modeling the following for the full fiscal year 2018:

• App Store: $12.904 billion (41.7 percent growth).
• iTunes: $2.03 billion (-28.9 percent growth).
• Apple Music: $3.089 billion (47.1 percent growth).
• Apple Care: $5.271 billion (28.8 percent growth).
• Licensing: $6.8 billion (37.7 percent growth).
• iCloud: $3.66 billion (43.5 percent growth).
• Other: $3.164 billion (1.4 percent growth).
• Total Services: $36.917 billion (23.1 percent growth).

Based on the analyst's forecast for each individual contributor in the Services business, the segment will see a growth deceleration in the fiscal third and fourth quarters as the Licensing business laps its contract renegotiation with Google.

Bernstein analysts "continue to doubt that Services can sustainably grow at 20%+ - without the introduction of new services offerings." That said, Apple is likely to achieve its objective of doubling total Services revenue to $49 billion by the end of fiscal 2020, Sacconaghi wrote.

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