Is Apple Inc.'s Biggest Opportunity Going Under the Radar?

It's a huge opportunity for Apple. Yet very few investors likely understand it fully.

Jun 20, 2014 at 9:25AM

Think Apple (NASDAQ:AAPL) is running out of growth opportunities? Think Again.

One glimpse at this chart shows the incredible growth of one of Apple's smaller, yet key businesses.

The chart above, by number-crunching, chart-loving longtime Apple analyst Horace Dediu, shows the growth in app downloads versus Apple's plateauing music download business.

But what about app download revenue? Even better, what about profits?

Quantifying the scale of Apple's app business
Unfortunately, since Apple doesn't break out its app business from its iTunes, software, and services business, this opportunity is often overlooked. Making matters even more difficult, the company uses different forms of revenue recognition within the segment. The slowing iTunes music and video business, for instance, is accounted for using gross revenue. For the App Store, on the other hand, Apple accounts for revenue using the agency model, only booking the revenue it actually keeps.

The result is that Apple's iTunes business looks rather boring. Consider this chart.

Apple Itunes Revenue

Revenue for Apple's iTunes, software, and services segment was restated in fiscal 2013. Backdated restated figures used in chart. Fiscal quarters used.

But buried in this segment is a key growth opportunity for Apple, according to one analyst.

In fact, Apple's app business is one of the key reasons Societe Generale analyst Andy Perkins said (via Fortune) in a note to investors on Wednesday that he raised his price target to $105.

Most Apple commentators focus on Apple's hardware business, which is unsurprising given its size. ... However, tucked away in the notes and management commentary are some intriguing details about app revenues. Using these details we calculate that apps are one of the few areas at Apple showing very good sales growth (100%+ in 2013) and are an increasingly important source of operating profits (8% of the total in 2013). We think this area is poorly understood but could be a key growth driver for Apple's future profits.

Eight of operating profits and growing by triple digits, Apple's app business could be a key source of future earnings growth in the coming years.

Need more perspective? Dediu said at his Asymco blog in February that if App Store revenues were booked with the same gross revenue accounting process as music and video sales, App Store revenues would nearly triple combined music and video sales today.

As app revenues continue to grow as a percentage of Apple's total iTunes business, the trend of declining year-over-year revenue growth rates may soon stabilize and begin to rise again.

Images

iPhone 5c 

Best of all, app revenue is likely to be a far more reliable and consistent form of sales than product revenue in the coming years. In other words, investors can count on Apple's app business to continue to rake in cash for the company over the long haul.

With the app business growing rapidly and becoming increasingly important to Apple's earnings, it's important for investors not to underestimate the potential of this key business.

An investment opportunity worth a closer look?
Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming its everyday impact could trump the iPod, iPhone, and the iPad. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!

Daniel Sparks owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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