The Justice Department’s antitrust lawsuit against Google focuses on deals the company has signed to be the default search engine on mobile devices and web browsers.
The biggest of these default search deals is with Apple.
Through its placement as the default search engine in the Safari browser for the iPhone and iPad, Google covers 36% of search queries in the U.S. Consequently, Apple devices accounted for nearly half of Google search traffic in 2019, according to the lawsuit.
Google pays Apple handsomely for that placement. The DOJ cites “public estimates” saying that Google pays Apple between $8 billion and $12 billion per year to be the default search engine on Apple products.
Apple accounts for the Google payment as part of its services business, which had $46.2 billion in sales in fiscal 2019, accounting for 17.7% of the company’s total revenue.
Apple execs have drawn a lot of attention to this business in recent years, with Tim Cook promising in 2017 to double its revenue by 2020. (Apple met that promise). Apple’s services business has contributed to the company’s growing value, which passed $2 trillion this year, because it makes the iPhone maker look more like a software company, which generally have higher multiples than hardware makers.
When Apple discusses its services business, it focuses on subscriptions it sells directly to consumers such as Apple Music, Apple TV+, iCloud storage, and its forthcoming Apple One bundles that wrap them up at a discount.
But the DOJ lawsuit highlights that “services” is a catch-all line item.
Services revenue includes sales from iTunes and Apple’s streaming services, but it also includes revenue from distributing apps and in-app purchases on the App Store, AppleCare warranties and licensing — which includes Google’s traffic acquisition (TAC) payments — according to Apple’s annual filing.
Assuming that the DOJ’s assessment of Google’s payment is accurate, it made up between 17% and 26% of Apple’s services revenue.
In other words, a huge component of the business that represents Apple’s future is a payment from a single partner, Google.
In the light of regulatory pressure on both Apple’s licensing business with Google, and separate pressure on App Store practices given congressional hearings and a lawsuit with Epic Games, investors will likely take another look at Apple’s services story.
“We don’t view the quality or sustainability of Apple’s Services business as on par with many of these other companies whose only business is Services,” Goldman Sachs analyst Rod Hall wrote last month. “For example, we estimate that Google TAC payments have contributed more to overall Services and Services growth than many investors appreciate.”
Now, some analysts are worried that the antitrust attention on Google could lead to changes that would make Apple’s services business look less profitable, which could mean a lower value for Apple stock.
“Ultimately any changes to the rev share agreement could lead to a potential rev/margin headwind in services that may result in the valuation multiple contracting,” Bank of America analyst Wasmi Mohan wrote in a note this week.
