It's only been a few months since Netflix (NASDAQ:NFLX) killed support for billing through Apple's (NASDAQ:AAPL) App Store, directing new and returning members to sign up for the service outside of Apple's walled garden. In doing so, the dominant video streamer can get out of paying Apple's 15% to 30% cut on subscription revenue in a bid to expand its own operating margins.
Apple could already be feeling the lost sales as the Mac maker focuses on its own strategy of growing its services segment.
The second-largest App Store category is slowing down
Morgan Stanley analyst Katy Huberty put out a research note recently, noting that the App Store's entertainment category is already seeing a meaningful deceleration in revenue growth, citing data from mobile analytics firm Sensor Tower. Total App Store revenue in the March quarter grew an estimated 15% to $3.7 billion, down from 16% growth in the December quarter and below Huberty's estimate of 17% growth. The analyst is modeling for total services revenue of $11.5 billion.
However, revenue from entertainment apps saw a more significant slowdown, growing an estimated 26% in the March quarter. That's down from 39% growth in the December quarter and 76% growth in the September quarter. The quarters prior to that would often see triple-digit gains. "Entertainment is a category to keep our eye on after a significant deceleration. Entertainment (which does not include music) is the second largest App Store category," Morgan Stanley analysts wrote while pointing to Netflix as one of the most prominent entertainment apps. Sensor Tower previously estimated that Netflix grossed $853 million in 2018 on iOS, pegging Apple's cut at $128 million to $256 million depending on the age of the subscriptions.
App Store downloads during the quarter also declined, but the analysts point out that spending isn't necessarily tied to downloads due to the growing popularity of using in-app purchases for monetization as opposed to up-front purchases.
Companies have been more aggressively pushing back against Apple's tax in recent months. Spotify, which isn't included in the entertainment category, recently filed an antitrust complaint against Apple in the European Union, arguing that the tax is anticompetitive since Apple competes with Spotify in music streaming. Apple is preparing to compete more directly with video-streaming services like Netflix, unveiling Apple TV+ a couple weeks ago as "the new home for the world's most creative storytellers." Given its expansive -- and constantly growing -- slate of original content, Netflix might dispute that characterization.
First-party services to the rescue
Speaking of Apple TV+, which launches this fall at an unspecified price point, Huberty thinks the forthcoming service will help reaccelerate services growth in the latter half of 2019. Of the four services that Apple announced, three of them (Apple Card, Apple Arcade, and Apple TV+) won't launch until later this year. Apple keeps 100% of first-party services revenue, so those services have greater potential to boost the services segment, even if Apple also has to operate and pay for them directly.
The recent slowdown was mostly in line with Huberty's expectations and doesn't change the long-term thesis around the services business. The analyst reiterated an overweight rating and $220 price target.