As many investors know, Apple (NASDAQ:AAPL) is having a difficult time with its iPhone business right now. A slowdown in China's economy, last year's battery-replacement program, and a decrease in carrier subsidies have all made Apple's large customer base hesitant to upgrade their phones. The slowdown in iPhone sales is currently causing Apple's overall revenue and operating income to decline, as iPhones account for more than 60% of the company's revenue.
However, all of Apple's non-iPhone businesses grew last quarter. One particular bright spot was the services segment. Investors and analysts tend to like service companies much better than device companies, since services are often distributed as subscriptions, producing the consistent recurring revenue that investors love.
While Apple's services business produces a rather small portion of its revenue today (12.9% last quarter), a growing, high-margin services business is highly attractive to investors. During Apple's recent earnings call with analysts, management broke out the profitability of the services business for the first time and spent lots of time going through the segment's impressive statistics. Here are the highlights.
1. Growth: 19%
If there's one thing investors love more than subscriptions, it's growth. Fortunately, Apple's services division revenue rose 19% last quarter. CEO Tim Cook also revealed that Apple is growing its services business across geographies -- even reaching an all-time high in China, where the iPhone is struggling. That's because the services segment is tied to Apple's installed base, not iPhone sales in any particular quarter.
The installed base of Apple devices is still growing, reaching 1.4 billion last quarter, up from 1.3 billion a year ago. Even the "struggling" iPhone reached an all-time-high installed base of over 900 million iPhones worldwide.
As long as the installed base of iPhones and devices keeps growing, and as long as Apple continues to unveil new services, the services segment should continue to grow steadily. Management has unveiled a target of $50 billion in services revenue by 2020. With $10.9 billion in services revenue last quarter, it looks like Apple should have no problem getting there.
2. Subscriptions: 360 million
As I mentioned before, investors and analysts love subscription businesses. Not all of Apple's services division is made up of subscriptions. Yet between iCloud, Apple Music, AppleCare, and other offerings, subscriptions make up a meaningful percentage of the services division. While Apple has taken some flak for no longer disclosing iPhone unit sales, active subscriptions is one metric that the company is now happily disclosing.
And why not? The company now has 360 million paid subscriptions -- up 120 million year over year. That's right: Apple grew its number of subscriptions by 50% last year. For comparison, Netflix, a company with a rather high-priced stock, grew its subscriber count by 26% in 2018.
Apple management guided to a target of 500 million subscriptions by sometime in 2020, which means that it expects solid subscriber growth for the next couple of years, at least.
3. Gross margin: 62.8%
Not only is the services segment growing strongly, but for the first time, management reported the services segment's gross margin, which came in at an impressive 62.8% last quarter. This margin figure expanded by 170 basis points quarter over quarter and 450 basis points year over year, which is also encouraging.
That seems to indicate that Apple's services gross margin can continue to expand, though it may not happen every single quarter. CFO Luca Maestri pointed out: "[I]t's important to keep in mind it's a broad portfolio with very different gross margin profiles within the portfolio. ... And if, at times, we grow services that are at a level of gross margin which is below average, as long as this is good for the customer and as long as we generate gross margin dollars, we're gonna be very pleased."
That seems to be a warning not to expect services margins to increase every single quarter. Still, directionally, it appears that Apple's services gross margin should generally increase over a number of years as the segment grows.
Finally, investors also love businesses with diverse revenue streams, which are usually awarded higher valuations than businesses dependent on a single customer or product. One impressive feature of Apple's services business is its diversity, spanning iCloud, AppleCare, Apple Music, Apple Pay, and App Store commissions and advertising.
Among those, management said that no one service accounted for more than 30% of Apple's total services revenue, and no single subscription app in the App Store accounted for more than 0.3% of services revenue.
That diversity should help make Apple's services business relatively stable -- certainly more stable than the iPhone business.
Look over here!
Apple's management has taken great pains this year to direct investors' eyes away from the iPhone and toward services. With numbers like these, it's easy to understand why. I expect services to become more of a focus for investors, which I think will be good for Apple stock.
Billy Duberstein owns shares of Apple and Netflix. His clients may own shares of some of the companies mentioned. The Motley Fool owns shares of and recommends Apple and Netflix and is long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.