“Our detailed, bottoms-up services build suggests a 5-year revenue CAGR of 19 % (vs -1% for iPhone)“, says analyst Timothy O’Shea. Jefferies believe that Apple intends to tell a compelling services story when it discloses gross margin for the first time ever next earnings. It anticipates that Services will pull off a gross margin between 60-66%, above consensus of 56%.
The company models App Store growing from $13 billion in 2018 to over $32 billion in 2023 (19% 5-yr CAGR), with 80% gross margin. Apple Music is forecast to be growing much faster, from $3.7 billion in 2018 to $16 billion in 2023 (34% 5-yr CAGR), but with lower gross margin of 19%.
“The opportunity for investors is that these higher margin, higher growth software businesses deserve a higher multiple vs the lower margin, lower growth hardware business”, says Jefferies, which anticipates that services will continue to grow to deliver 41% of gross profit by 2023.
However, its optimism around Services is offset by reduced expectations for iPhone. It is lowering 2019 iPhone unit, iPhone revenue and EPS estimates by 3%, 3%, and 4%, respectively. It now expects Apple will sell 71.7MM iPhones in the first quarter of 2019 and 206MM for the full year, below the consensus (74MM/210MM). But Jefferies concludes: “while we are reducing iPhone and EPS estimates for F'19, Apple's iPhone business still looks sufficient to build a massive, high margin, high multiple Services business over time.”