Apple: Don't Underestimate The Power Of App Store Sales

| About: Apple Inc. (AAPL)

Summary

Apple App Store customers opt for other Apple devices based on apps already purchased.

The gap between Apple and Google downloads is widening, not shrinking.

Apps revenue to ultimately drive more sales of Apple computer products.

App Annie Report: Facts, Figures and the Future

App Annie released their 2015 retrospective and it makes for very interesting reading.

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Source: App Annie Retrospective

2015 was a bumper year for both Google (NASDAQ:GOOG) (NASDAQ:GOOGL) and Apple (NASDAQ:AAPL), but for very different reasons. The year saw Google smash Apple in the download stakes, hitting double the numbers Apple did. That's seriously impressive. What isn't so impressive is that, despite all those additional downloads (and the attached overhead), Apple pulled away in trackable revenue.

The market is missing an important part of Apple's potential when forecasting future stock value: how integral App Store sales are to Apple's overall offering. This area of sales alone is central to the business cultivating an evergreen ecosystem of customer loyalty where iPhone, iPad, computer or app purchases influence future purchases.

Success in China

iOS has had an amazing year in growing/generating revenue. A major contributing factor has been Apple's success in China.

Click to enlargeSource: App Annie Retrospective

China has catapulted to the third spot in iOS revenue territories and demonstrated 100% growth in revenue year-on-year. The forecast is for China sales to surpass those in Japan and hit second spot during 2016.

Subscriptions and Monetization

A key aspect of the report for me is the trend in developed markets for Apple. In the US, Apple saw downloads drop 20%, but revenues rose by 20%. This allows us to draw a picture of consumers who are more selective in what they download, but are also far more willing to pay for quality when they find it.

Further to this is the rise of subscription services. Music, video, TV, dating and more show us that people are willing to make long-term commitments to brands they like. What is interesting about this trend is it creates even more lock-in to the platform and ecosystem.

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Source: App Annie Retrospective

Seeing the growth in music subscriptions above, we can only deduce that "Music Industry 2.0" is in full swing and music purchases are going to disappear entirely in the future. It's key to note that this figure does not include the 10M paid subscribers Apple already has for its Apple Music service as Apple's own apps are not tracked in App Annie.

Wearables

The wearable market definitely came into its own last year - especially for Apple. The number of apps on the App Store grew from 3,000 in April to over 14,000 in December. The stats are a bit thin in this report, but it's interesting that they are starting to emerge and we expect to see this market really starting to consolidate and grow in 2016.

Apple as Major Media Distribution Player

Apple generated $20 billion from it's AppleCare, Apple Pay and Internet Services in FY 2015. This covers the iTunes Store, App Store(s), iBooks Store and Apple Music. So nearly the same total revenue of $24 billion the company generated in FY 2007. This is quite remarkable, especially when you compare it to Google Play, which has far greater reach and far lower revenue according to all industry pundits (source: Variety, TechCrunch).

Google is obviously coming along for the ride, but seems to be struggling to monetize the market in the same way Apple has. If you factor in the 30% growth shown in the report for App Store revenue and consider the 10M subscribers new to Apple Music, we're more than likely looking at a division of Apple that has surpassed the entire Apple business of 2007 within eight years of it being born.

Outlook

Apple's evergreen ecosystem of products, apps, services and distribution is great news for investors. What the App Annie report has shown is just how central App Store sales are to this model. Consumers prefer to purchase apps through the App Store and it follows that they will prefer to buy more devices compatible with those apps.

iPhone users looking for a tablet, for instance, are more likely to opt for an iPad because all their apps will be available without further purchase. Follow this up the food chain and those same users are therefore more likely to buy an Apple computer eventually - for the same halo effect.

We believe this ecosystem approach to be fundamental to both Apple and Google's future growth, but we think the effect will be far more pronounced on Apple's long-term revenue and profitability than everyone is giving it credit for.

We're still forecasting 10% growth at the bottom line for Apple, despite the negative press that it is receiving around iPhone sales. We believe investors are going to see a drive in sales through three avenues of growth:

  • More software sales and subscription revenue
  • More hardware sales as a result of the ecosystem halo effect
  • Revenue will continue to grow in Apple's Internet Services collective

As the image below illustrates, over the past 3-5 years, we've seen Apple's share price bounce around our fair value line and this is the lowest it's been in relationship to that. As a result, we're still very much long on the tech behemoth with a fair value of $146 - 52% upside to the current price. The only contributing factor to our "Hold" rating is the timing - we'd recommend waiting for the market to react to this discount before wading in - if you're not in it already.

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Source: stride.ws

Disclosure: I am/we are 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.