Sizing Up Apple Music’s Profit Potential

What's old has become new again at Apple (Nasdaq: AAPL) with music. It is taking center stage in the company's recent new product push.

After years of speculation, Apple's recently released streaming service – Apple Music – aims to reassert Apple's dominance in the digital music space it once revolutionized, even as a new wave of competitors including Spotify, Tidal, Rhapsody, Google Play Now, and others look to expand their own services. So with Apple Music having been live for several weeks now, how much could the new service impact Apple's financial performance?

Running the numbers
A key challenge in assessing Apple Music's potential impact lies in finding the best way to measure its potential user base. In researching for this piece, sell-side analysts and other journalists cited a number of potential measuring sticks for Apple Music including the following:

• The total number of iTunes accounts
• The total installed base of iPhones and iPads
• The number of paid subscribers from competitors like Spotify
• Apple's own internal targets

Each idea has its own logic, so let's briefly examine each data point to see what we can estimate.

During its earnings call last April, Apple stated that iTunes enjoyed an installed base of 800 million accounts . And with Apple embedding Music directly into iTunes, this seems like a reasonable starting point to frame our analysis. But just how large a percentage of this installed base is it reasonable to assume Apple can convert into Music subscribers? Per The Wall Street Journal, only 110 million  (~13.5%) of total iTunes users purchased at least one song in 2014. Complicating matters further, only roughly one-quarter of that 110 million actually spent more than $110, roughly the equivalent of a full-year Apple Music subscription, on music last year. Since this roughly matches the user-type willing to pay for an Apple Music subscription, this

Source: Appleseems like a reasonable estimate of possible Music users. Unfortunately for Apple investors though, this only translates into roughly $3.3 billion  in annual sales for Apple Music.

seems like a reasonable estimate of possible Music users. Unfortunately for Apple investors though, this only translates into roughly $3.3 billion  in annual sales for Apple Music.

Looking at the iOS device installed base, Tim Cook mentioned that Apple had sold over 800 million iOS devices (iPhone, iPad, and select iPods) as of WWDC 2014, the most recent public announcement on the matter. Factoring in subsequent iOS unit sales, Apple has sold over 1 billion iOS devices . The problem with using this figure to estimate potential Apple Music subscribers is twofold. First, we'll need to know the number of active iOS devices, not the cumulative iOS devices sold. And second, like above, gauging exactly what percentage of active iOS users would subscribe is again hugely unscientific. We can always guess, but it's probably more useful to leave this as dead end rather than risk dreaming up pointless estimates.

Moving on, we can look at what other services have achieved. We know Spotify has roughly 15 million paying users out of 65 million total accounts. Were Apple to match Spotify's installed base, it would yield Apple Music revenue of $1.8 billion. However, given their size differences, using a simple head-to-head comparison of the two is a relatively blunt means of analysis.

Finally, Apple's internal user target leaked early last month , which claims the company hopes to add a whopping 100 million subscribers to Apple Music. The exact timing for this goal isn't clear, but this vastly exceeds all other projections I've seen. However, Apple also has a historically been rather adept at predicting device/service demand, so this perhaps makes sense to include as a high-end estimate for Apple Music's potential impact. If Apple were to reach this impressive figure, it would yield just under $12 billion in annual sales . Again, not exactly small change, but only 6.6% in fresh growth off of Apple's FY 2014 revenue base .

Here's a quick snapshot of the above estimates respective potential impact on Apple's estimated FY '15 sales.

Source: Yahoo! Finance, author's calculations

Hopefully the high-level point proves obvious – Apple Music will barely impact Apple's financials in a year when the average analyst expects the giant from Cupertino to produce sales of $232 billion. However, that doesn't mean Apple Music isn't vitally important for a few reasons.

An important drop in the bucket
Despite its lack of economic impact, Apple Music provides a number of important indirect, non-financial benefits investors need to understand For starters, Apple Music should, on the margin, help increase the overall stickiness of Apple's ecosystem. This is as much a defensive maneuver to keep a key piece of the smartphone experience firmly within Apple's grasp against increasingly powerful rivals like Spotify and Pandora. Second, Apple Music is a multi-platform service, so Android and Windows users can also enjoy the service. This creates an additional channel for Apple to potentially steal users from the competition, a Trojan horse of sorts. So while Apple might not mint money with Music, there's still plenty of reasons investors should love its new service as well.