Apple's Next Big Thing (Probably Not What You Expected)

| About: Apple Inc. (AAPL)

There has been plenty of speculation over the past year about whether or not Apple (NASDAQ:AAPL) can continue to prosper in the wake of Steve Jobs' death or if there is anything groundbreaking in the pipeline. While most people are focused on an "iWatch" or an "iTV", they could be missing the big picture. Apple is a secretive company that is all about dazzling consumers. While a functional, interactive watch and an interactive television would be a great steps in advancing the technological envelope, they would not, by themselves, be sufficient to bring Apple back to being the world's largest (by market cap) and most exciting company. Available information leads to the conclusion that Apple has something far bigger in its pipeline.

Breaking Away from Google

Historically, Google (NASDAQ:GOOG) has primarily been a search company and Apple has been a consumer electronics company, so they were natural business partners. Apple benefitted by using Google for searches and mapping on its iOS platform, which made iPhones and iPads highly functional. Similarly, Google benefitted by selling advertisements using the information it gathers through its searching and mapping services. An analyst at Morgan Stanley estimated that Google makes $1.3 billion in revenue annually from being the default search engine in the Safari browser on iOS, but pays Apple $1 billion for the right to be the default search engine. Apple enjoys the $1 billion of pure profit, while Google benefits from a virtual monopoly on iOS searches. However, their relationship has become heated in the past few years as Google's Android platform has encroached in Apple's mobile device space.

It's no secret that Google is now Apple's biggest competitor and that the two technology giants are trying to sever ties with each other so that they are not relying on their adversary for core aspects of their respective businesses. This trend became apparent when Apple removed Youtube and Google Maps from the core bundle of apps in iOS 6 and released is own mapping software (Maps). Although Maps was initially full of bugs and not well received (it has since been improved), it signaled the beginning of the end for the partnership between Apple and Google. One obvious solution to Apple's search problem would be to partner with Yahoo and to integrate Yahoo's search engine into all Apple products. This, however, is very unlikely since Yahoo's search capabilities are mediocre and likely would not be up to Apple's standards in the long run.

Recent Acquisitions

In the past couple of years, Apple has been bolstering its technology portfolio in preparation for the day when it becomes independent from Google. For example, Siri was originally an iOS app that was going to be made available for BlackBerry and Android as well. However, in 2010, Apple saw the possibilities of having an intelligent "personal assistant" in its devices and purchased Siri in order to make it proprietary in the iOS operating system. Google released Google Now in 2012 in order to directly compete with Siri. When directly comparing the two, many people say that Google Now is slightly quicker than Siri, but it lacks Siri's human-like personality. The difference in speed is because Siri first attempts to use Yahoo's inferior search engine and other reputable online resources such as Wikipedia, WolframAlpha, and Yelp to answer basic inquiries in order to prevent Google from routinely obtaining search information on Siri users. Siri will, however, use Google resources as a last resort. The table below illustrates Siri's reliance on various services to deliver data. The numbers from Piper Jaffray show that Siri has cut its reliance on Google by half in iOS6.

Google takes pride in Google Now's ability to learn about its users' preferences and to provide more customized information. Google Now's functionality is perfectly suited for the Google Glass platform. This is obviously a key area of the mobile market where Apple is lacking, especially considering the high probability that Apple will be releasing some type of wearable technology such as an iWatch. A robust version of Siri would be one of the most important functions of a "smart watch" or other form of wearable technology, as well as an attractive function for integration into other products such as vehicles.

Although there has been no official announcement yet, it seems likely that Apple recently acquired Grokr, a predictive search and discovery service, since Grokr's website now has the following message on its homepage and the app is no longer available in the App Store.

Apple would have a strong motive to purchase this type of service in order to upgrade its search capability. Further, Apple owns the trademark for "NeXT" from its purchase of Next Computer, Inc. from Steve Jobs in 1997. Given the type of service Grokr offers, and the name change, it's highly probable that an exclusive relationship with Apple (through acquisition or otherwise) is behind the message on Grokr's homepage.

What Does All of This Mean?

There is good reason to believe that Apple will unveil its own search engine within the next 12 months. There is the potential for such a service to have a substantial impact on Google and on the future of search engines as a whole. Rather than competing directly with Google's notoriously broad search capabilities and massive amounts of information, Apple will likely personalize its search offering. The search engine will use machine learning and restrict the information only to relevant sources that the user trusts. It will be location and circle of influence based. Apple will implement its personalized search ability across the iOS ecosystem by integrating the improved Siri into apps and having loadable native commands to run those apps by voice. This design will differentiate Apple from Google through data presentation, not quality or quantity of search materials. It is the principle difference between Apple and Google and has repeatedly been demonstrated by the competition between iOS and Android. Apple's competitive advantage lies in its user-experience and ecosystem design that everyone recognizes.

An Apple search engine has surely been in the pipeline for at least a few years. A project of this magnitude takes time to build. It is no coincidence that Apple has been acquiring companies that offer mapping and location-based services as well as building massive data centers across the U.S. Assuming that the predictive search and discovery tool Grokr (now called NEXT) was recently acquired by Apple, it would indicate Apple's serious interest in personalized search. It would not be surprising to see Apple's counter to Google Now called NEXT. It would give Apple the opportunity to make witty comparison advertisements as it has done with past products.

Google has shown that search is a lucrative business because of the massive amount of user information and the advertising that goes along with it. Apple's iOS platform is an important part of that business. Personalized search tools would create the opportunity for personalized advertising, which could be quite profitable. Google currently generates around $31 billion of revenue annually on search. Even if Apple were to take only 10% of that market share from Google, it would represent incremental revenue of $3.1 billion. Estimating that Apple would make a 20% profit (after tax) on the $3.1 billion, this would increase earnings per share by almost $1, which would increase the share price by over $10 at the current multiple. These quick estimates are conservative and do not take into account the growth prospect of competing in search or the likelihood that Apple's entry into that market with personalized search capability might substantially improve its P/E ratio.

At this point, a personalized search engine could be nearing completion and in user testing or it could be receiving some final tweaks in preparation to be launched shortly. Apple has far too much money and technology for it to pass up the opportunity to enter the $30+ billion search industry. Personalized search would integrate perfectly into Apple's lines of products. The combination of wearable technology and personalized search mean would allow Apple to once again unveil the next game changer. With Apple's stock currently trading at a multiple of 10.6, the market is no longer adding a premium on the future Apple products, as it did last summer. Its current valuation combined with the growth opportunity related to entering the search business currently makes Apple an attractively valued stock for a long-term investor.

Disclosure: I am long AAPL. 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.