Apple (NASDAQ:AAPL) reported earnings on Monday and while the results were mostly solid, the guidance that the company provided left many disappointed. Some analysts and investors have already stepped in to call the ensuing sell-off overdone, reiterating their buy ratings. As the dust settles, however, the shareholders need to look ahead. Among the things that have caught my eye in the earnings report was the fact that the iTunes, software and services revenue has increased 19% YoY. This is remarkable, considering that in September Apple started giving some of its own software away for free with the purchase of a new device. I believe, that one of the reasons for this decision may have been the fact that the App Store, the fastest growing component of iTunes, has been getting increasingly more profitable.
As I wrote in my previous article, the App Store's revenue, which is going to reach over $5 billion this year, is set to get an additional boost if/when Apple opens up Apple TV for developers. According to a new rumor, Apple is set to do just that in the near future. While there have been rumors about this in the past that so far have failed to materialize, I believe it's only a matter of time before Apple does that. If it proves to be true, Apple will be in a great position to disrupt yet another industry- video game consoles.
Incidentally, Carl Icahn published a letter to the shareholders a few days ago, in which, among other things, he outlines his vision for the company's future.
We believe ultra high definition represents a major catalyst for the next TV replacement cycle and a promising moment for Apple to introduce its first new product in this category.
He mentions that the new product could bring $40 billion in yearly revenues for the company. Icahn also makes a projection in terms of the gross margins, which, he believes, could come in line with the company's average GM. Personally, I think this is highly speculative. Surely, Apple's gross margins vary a lot by product line and it's not known what pricing/margin strategy Apple would choose to better compete with others. It's hard to predict the pricing of a new Apple's product, let alone its gross margin.
At the moment, Apple doesn't make much profit selling its set top box. However, the sales have been accelerating. In May 2013 Tim Cook announced the sales figure for Apple TV: 13 million, with about half sold over the previous 12 months. Given the growth momentum, I would estimate the current sell through at over 2 million per quarter, which is a lot for a device that's not being actively marketed and not positioned as anything more than a digital media player. These numbers are also more or less comparable to the sales volumes of video game consoles.
What Icahn doesn't mention though, is the new potential revenue source that this move might open up for Apple. In the past couple of years, mobile gaming has been growing by leaps and bounds and has become a very hot area, with most of the growth in the overall gaming industry coming from this segment. The industry is projected to grow to $111 billion by 2015. But there was another piece of news that wasn't reflected in the Gartner's report at the time. After 14 years, China has finally lifted a ban on video game consoles. While Sony (NYSE:SNE) and Microsoft (NASDAQ:MSFT) are unlikely to benefit much, it creates an opportunity for Apple. As a major player in the space of mobile gaming, Apple stands to grab a sizeable share.
While Sony PlayStation 4 and the Xbox One may be fine devices, they address a far more limited market than Apple's devices do. Thus, they are not as attractive for game developers as iOS is. It took almost 7 years for Sony to sell 80 million PS3s, and similarly, it took Microsoft almost 8 years to sell 80 million Xbox 360 units. At the same time, Apple is on track to sell its billionth iOS device by the time the year is over.
Also, while the number of games for the new generation of consoles is in the hundreds, there are already tens of thousands of titles in the App Store that could be adapted for Apple TV. The new, powerful 64 bit A7 chip is capable of running very graphic intensive games and it looks to be ready to take on consoles and PCs. While the current, 3rd generation Apple TV comes with the A5 processor, if Apple were to release a device capable of running the latest apps, it would likely come with the latest and most capable chip.
There was another recent acquisition that helped ignite the rumors surrounding Apple's plans for the living room. In November 2013, Apple acquired PrimeSense, the company that was behind Microsoft's first generation Kinect. It produces motion detection sensors and it's speculated that the technology could be later incorporated into Apple's TV set.
With PC sales in secular decline, I believe that PC gaming revenues are also likely to suffer. Moreover, as PC games are widely pirated in countries like China, this does not benefit the profitability of video game producers. The developers are, therefore, more likely to gravitate toward platforms such as Apple's, where pirated games are not available. Some top grossing mobile games are already iOS exclusive, which signifies the attractiveness of the platform.
The emergence of in-app purchases has completely transformed the way mobile games are monetized. Nowadays, in most cases, gamers don't have to pay anything upfront to download and start enjoying a game, but having gotten the taste of it, many of them choose to purchase extras. This has resulted in a superior monetization rate for developers, as I highlighted in my previous article. While gaming consoles of the new generation have begun experimenting with this model, it's not nearly as widespread as it is in the App Store.
I believe, that by opening up Apple TV for developers, be it in the form of the current set top box or a full fledged TV set product, Apple will create a significant new market. While it's hard to speculate on the pricing and gross margins of the product itself, one thing is for certain: the move will further accelerate the revenue growth for the increasingly profitable App Store and make Apple's ecosystem even richer and more attractive both to the users and content producers.
With exciting new prospects on the horizon, Apple remains a buy. While many are focused on the gross margins and the growth rates of the company's existing product portfolio, they completely discount potential new growth avenues for Apple.
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.