Will Apple Pay Be A Growth Engine?

| About: Apple Inc. (AAPL)
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Can Apple double the size of its Services business to generate, by 2020, the equivalent of Facebook’s, Netflix’s and Twitter’s revenues combined?

Today, I look at how Apple Pay may help the company on this quest.

Apple Pay has potential to be one of the driving forces of growth for Apple’s Services. But the opportunities do not come without challenges.

Late last week, sell-side analyst Toni Sacconaghi questioned whether Apple (NASDAQ:AAPL) could indeed double its Services business over the next four years, as CEO Tim Cook has promised. In his view, such an aggressive growth target would likely "require the introduction of new services," possibly through acquisitions.

Credit: Forbes

The graph below illustrates what the doubling of Apple's Services business might look like, if executed as planned. The blue line indicates the quarterly YOY growth through F4Q20 and assumes a constant growth rate of 18.9%, for simplicity. For comparison, the Services segment has grown at an average pace of 21.6% per quarter over the past five quarters.

As the blue bar on the right suggests, if Apple is in fact able to double the size of Services by the end of fiscal 2020, the segment alone would generate about as much revenues in a quarter as Facebook (NASDAQ:FB), Netflix (NASDAQ:NFLX) and Twitter (NYSE:TWTR) did in 4Q16 combined. It looks indeed like a very tall order.

Source: DM Martins Research, using data from company reports and Seeking Alpha

Can Apple pull it off? And what might be the key drivers that would allow this aggressive growth in Services to take place?

To help answer these questions, let's look at one business within Apple's Services segment that I believe does not get enough attention from investors and analysts: Apple Pay.

The future of payment?

Apple Pay is the company's secure payment system launched in 2014 that allowed Apple to keep a hefty 0.15% cut of every transaction generated through the platform in the United States. Tim Cook seemed very excited about the service when he said, just over a year ago, that "money will be forgotten by history, thanks to Apple Pay."

I have been anxiously awaiting the day when bills and coins will become obsolete, freeing up my pockets from unnecessary weight and volume. I don't think that Tim's prediction is far-fetched, especially in the longer term, as the popularity of non-cash payments has increased fast. According to the UK Cards Association, contactless transactions had increased in the country by 155% YOY in November 2016 - to be fair, off a small base of 127.5 million transactions in November 2015.

Deloitte had already identified a turning point in usage of mobile payments back in 2015 (at which point Apple Pay was supported only in the U.S., U.K., Canada and Australia) as "the multiple pre-requisites for mainstream adoption - satisfying financial institutions, merchants, consumers, technology vendors and carriers - (had been) sufficiently addressed." The consulting firm seemed to believe that contactless payments had yet to see a significant ramp up in usage, provided that a few challenges like security could be better addressed.

Echoing Deloitte's findings, Business Insider estimated that mobile in-store payment volume in the U.S. would reach $500 billion by 2020 - suggesting an eye-popping 80% CAGR from 2015 levels.

Source: Business Insider

Apple is likely to bite off a chunk of this expanding market as more retail vendors globally adopt its payment platform. Last year marked the introduction of Apple Pay in China and at major retailers like KFC and Starbucks. And playing in Apple's favor, growth in Apple Pay revenues should be largely independent of future device unit sales as I believe penetration (i.e. increased service adoption per active user) will be the key factor behind the eventual success of Apple's payment service.

These are the good news - a fast increase in usage of contactless payment methods and a meaningful adoption ramp up that has yet to happen, even in developed markets.

But here is the bad news: Apple is not the only kid on the block. Tech powerhouses like Google (NASDAQ:GOOG)(NASDAQ:GOOGL), Samsung (OTC:SSNLF) and PayPal (NASDAQ:PYPL) are heavily vested in making their own solutions thrive. It is worth noting that many competing payment solutions can still be used on an Apple device, usually through downloadable apps. And from a broader perspective, payment processing giants like Visa (NYSE:V) and MasterCard (NYSE:MA), while partners in enabling the Apple Pay service, also can be thought of as large competitors - why learn how to use a new payment processing tool when I can swipe my plastic card or punch in my credit card number online as I have always done?

The impact of the challenging competitive landscape seems to be reflected in consumers' usage of Apple Pay in lieu of other payment options. As the graph below indicates, fewer potential Apple Pay users seem to use Apple's payment platform whenever they have a chance to do so: 22% in October 2016 vs. 48% a year earlier. Conversely, more than 35% have either stopped trying to use or rarely consider using Apple Pay (myself included), up from 18% in the prior year.

Source: pymnts.com

While the addressable market is likely to increase substantially, the same cannot necessarily be said about the usage of a specific payment platform.


Apple Pay has the potential to be one of the driving forces of growth for Apple's Services segment. But the opportunities do not come without challenges and risks. While the market is likely to expand fast over the next few years, competition also is likely to become tighter, driving pricing pressures and fierce battles for market share.

I would not be surprised, however, to see Apple Pay become a key contributor in the doubling of Apple's Services segment by 2020. The business is still small today, but has significant room to become a much more meaningful revenue generator in the future.

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Supporting Documents

  1. AAPL_Feb_2017.xlsx

Disclosure: I am/we are long AAPL, GOOG.

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.

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