iPhone sales might be down for Apple (NASDAQ:AAPL) amid the coronavirus pandemic, but Apple users are spending a lot more in the App Store while staying indoors. App Store sales climbed 35% in the first two months of Apple's third quarter, Morgan Stanley analyst Katy Huberty estimates. Importantly, growth accelerated from April to May, even as economies started to reopen.
"High levels of engagement have sustained as the 'new normal' (at least in the near-to-medium-term) includes more time spent indoors, which should remain a tailwind to App Store performance," Huberty wrote in a note to investors.
Overall, Huberty expects strong App Store sales to lead to a 16.7% increase in services revenue for Apple versus the 12% she previously modeled. That's over $500 million in additional revenue. Considering that the App Store is one of Apple's highest margin services, that revenue will likely produce a profit margin well above Apple's average services gross margin of about 65%.
Are subscriptions behind App Store sales growth?
Apple is seeing tremendous growth in subscriptions. During its second-quarter earnings call, management said it ended the quarter with 515 million subscriptions across the services on its platform. That's up 125 million from a year prior. It notably set a new record for net subscriptions last quarter with 35 million.
That momentum likely followed through in April and May. Streaming video subscriptions are booming. Mobile gaming subscriptions may be climbing as well, including Apple's own Apple Arcade service.
An acceleration in subscription growth through the App Store would produce a more permanent step up in App Store revenue. Apple still takes 30% of subscription revenue for the first year before reducing its take to 15%. It may have custom deals worked out with big streaming services and other subscription offerings.
Investors should look for additional commentary from management during its next earnings call to see if there was another significant step up in subscriptions.
Mobile gaming is booming
Mobile games accounted for 68% of Apple's App Store revenue last year. And smartphone users have been ramping up the time they spend with mobile games while stuck at home. Mobile gaming increased 24% in the last two weeks of March. Total mobile gaming revenue accelerated from March to April, reaching 10% month-over-month growth.
While game revenue may seem more fleeting, studies show consumers are downloading new games more often since social-distancing measures were put in place. That includes people who weren't playing mobile games previously, or were perhaps very casual gamers. It's very possible these new habits will become permanent even as countries and states begin loosening restrictions.
A small increase in gaming revenue would have a major effect on Apple's App Store revenue considering the relative size of the vertical.
What it means for Apple's bottom line
Huberty sees the surge in App Store revenue as having a sustained effect on Apple's bottom line. She sees earnings per share of $1.99 for the June quarter for the FAANG stock versus her prior estimate of $1.92. Importantly, she also sees the September quarter getting a similar boost in earnings, indicating sustained App Store spending at least through the rest of Apple's fiscal year.
While $500 million in incremental revenue is just less than 1% of Apple's total revenue, it can have a significant effect on Apple's earnings due to the high gross margin of the sales and through the leverage of its fixed operating expenses for the App Store. That means nearly all of that revenue is trickling down to the bottom line and should provide significant support while iPhone sales are slumping.