Are Investors Ignoring a Real Risk to Apple's Future?

Apple (AAPL 1.27%)  seems to have everything going for it after another quarter of blowout earnings. However, Congress has its sights set on several big technology companies -- and no matter your market capitalization, the government is bigger. Apple hasn't grown by making huge acquisitions, and it doesn't completely dominate a system, like Amazon.com's (AMZN -1.64%) lead in e-commerce. However, Apple's App Store seems to be a real antitrust risk that few are taking seriously.

Do not pass go, do not collect $200

Congress is targeting four companies over antitrust concerns: Alphabet (GOOGL 0.55%) (GOOG 0.74%), Apple, Amazon, and Facebook (META -0.52%). The central theme of the ongoing antitrust investigations center around what, if any, unfair practices each of these companies might be engaged in.

Image Source: Getty Images.

Daniel Roberts of Yahoo Finance concluded that "Apple in particular, has reason to be the most unbothered of the four when it comes to lawmakers threatening antitrust action." Unlike Apple, the other companies have made significant acquisitions, or they clearly dominate a certain business. Theoretically, the government could force these Goliaths to divest previous acquisitions or change their business models.

But these arguments seem to miss that a monopoly doesn't have to result from acquisitions. Consider the near-perfect example of Microsoft's (MSFT 0.37%) antitrust issues in the 1990s. The company dominated PC operating systems and included its Internet Explorer browser with each copy of Windows. A federal district judge ruled that this tying practice was unfair, and Microsoft should be split into two different companies. If a higher court hadn't reversed this decision, today's Microsoft might be a quite different company.

Most antitrust issues are decided based at least partially on the Sherman Antitrust Act . The Act says that "only unreasonable restraint of trade through acquisitions, mergers, and exclusionary tactics" constitute a violation. That last item -- exclusionary tactics -- should worry Apple investors.

One of these things is not like the others

The four companies in the government's sights seem to have obvious differences in antitrust risk.

(Source: Investopedia. Table by author.)

The list above isn't meant to be exhaustive, yet we can see a clear difference between the four companies. In traditional search, Google may be the leader, but Facebook received 1.5 billion searches every day last year. And more consumers start their online shopping search on Amazon than anywhere else.

When it comes to Facebook, the pandemic-driven user growth from Twitter  (TWTR), Snapchat  (SNAP -2.72%), and Microsoft-owned LinkedIn likely helps fend off regulators' worries.

What about Amazon? Since Q1 2017, at least 50% of Amazon's unit sales have come from third-party sellers. This would seem to argue against the e-commerce giant being anti-competitive. While it's true that Amazon takes a cut of third-party sales, so will eBay (EBAY -0.14%) -- normally with 10% final value fee, payment fees, and other potential upgrade costs. If you choose Etsy, you'll pay similar transaction and payment fees, listing fees, and more. It's also possible, if less desirable for customers, to sell through options like classifieds or other apps.

Where Apple is concerned, there is no other legal way to download and install an app on an iOS device. If a lack of competition constitutes a monopoly, this could be a problem for the company.

Breaking a monopoly?

Looking at how the App Store works, the facts seem to stack up against Apple. First, Apple alone decides what apps it allows into its store. According to the company, 60% of the apps are approved, yet 40% are rejected for "minor bugs, followed by privacy concerns."

Second, Apple takes a commission of 15% to 30%, depending on the situation. With no other option, developers either pay or lose access to millions of iOS users. Apple goes out of its way to say that 84% of its apps are free and developers pay nothing. However, there is a $99 annual fee to be part of the Apple Developer Program .

Third, there are examples of companies with brand recognition being able to bypass the Apple toll, but smaller developers don't have a choice. For instance, the email app Hey charges $99 annually, but didn't offer an option to pay through the App Store. Apple reportedly told developers to add an in-app subscription option or face the app being removed.

By contrast, Netflix (NFLX -3.92%) and Spotify (SPOT -7.28%) no longer allow customers to sign up for their service through iOS to avoid paying Apple's fees. It seems the App Store is the very definition of a monopoly. If the government decides this is the case, the Apple of today could be vastly different than the Apple of tomorrow.

How antitrust action could alter Apple

Last quarter, Apple generated $13 billion in services revenue, which generated a gross margin of more than 67%. However, a strong antitrust action could change some of the math. Apple Music costs about the same as its competition, yet Apple doesn't have to pay a 15% to 30% commission to sell its own service.

The European Commission has an ongoing investigation into Apple's App Store practices. The preliminary investigation found Apple Music's competitors have either removed their in-app subscription option, or raised their prices in the app to pass Apple's fee on to customers. Apple's App Store Review Guidelines specifically say that subscriptions, in-game currency, or access to premium content, must use in-app purchases. Requiring the use of Apple's in-app purchases, instead of allowing developers to utilize payment methods outside of Apple, is the very definition of  "exclusionary tactics" mentioned in the Sherman Antitrust Act.  

Meanwhile, Apple Arcade's curated games, "will not be available on any other mobile platform or in any other subscription service." In addition, it is not possible to play these games on iOS without subscribing to Arcade. Though the game developers obviously choose whether they want to participate in Arcade, they have little choice about the limitations. It's not unique for certain games to be platform-specific (many gaming consoles have titles available only on that particular system), but this isn't one game or a few games -- it's roughly 100 games that are essentially locked away from Android users and all non-Arcade subscribers. The fact that some Arcade games are available on PS4, Xbox One, and PC, but not on Android, seems designed to stifle mobile competition.

Antitrust action could force Apple to spin off the App Store, or at least open its ecosystem. Opening its App Store to competition would mean having to charge less to app developers to effectively compete. This action would potentially slow revenue growth and compress margins. A full spinoff would mean Apple would be required to pay a commission for its services, like Apple Music, that have gotten a free ride so far.

With Apple shares trading at a forward P/E ratio of more than 33 -- far higher than they've been at any point in the past decade -- they can't really be referred to as a great value. 

It's difficult to gauge how Apple ultimately be affected by ongoing antitrust concerns. However, investors should be aware of this risk to the company's future, and adjust their expectations accordingly.