Apple CEO Tim Cook kicked off 2024 amidst a whirlwind of challenges. His company weathered an onslaught of setbacks in the past few months. From patent disputes stripping features off two smartwatches to impending antitrust lawsuits from the US Department of Justice, the tech titan faced a barrage of legal woes. Additionally, news of dwindling market share in China, the second-largest smartphone market, cast a shadow over Apple’s global standing. Adding fuel to the fire, Wall Street analysts echoed a once-unthinkable sentiment: Apple’s stock appeared overvalued. To make matters worse, longstanding rival Microsoft briefly dethroned Apple as the world’s most valuable company on January 11th.
When Apple released its most recent quarterly earnings on February 1st, the string of bad news continued. According to equity researchers, the company’s revenues increased very little, in the final quarter of 2023.
Recently, Apple decided to put the company through another test. After developing and talking up the Vision Pro augmented reality (AR) headset for a few years, it will begin shipping the device. The expensive device, which will retail for $3,499, is a significant wager on a novel technological ‘platform’ that, perhaps in the future, Apple hopes will displace smartphones as the focal point of users’ digital lives and the iPhone as the source of its creator’s wealth.
Early signs suggest that Apple should be concerned about the future of the device. The well-known streaming services Netflix, Spotify, and YouTube have declared that they will not support the headset version of their software. Nobody explained why. However, it’s also possible that they’re all in direct competition with Apple’s streaming services, and creating an AR app is probably going to be expensive.
Despite various concerns, Apple’s stock price has remained relatively stable in January, providing Tim Cook with some reassurance amidst the challenges. After being surpassed by Microsoft a few days earlier, it regained both its heavyweight stock market title and its $3 trillion valuation. Additionally, considering the headset’s limited initial production, the short-term impact on Apple’s revenues from a failed launch of the Vision Pro will be zero.
However, it would be foolish for Apple’s CEO to ignore the complaints from the new year, because of the larger challenges they indicate for the business. Three main categories can be identified from these: growing geopolitical tensions; slowing iPhone sales; and antitrust and legal issues. Now, none of these are existential. However, there’s always a chance that one will upset the Apple cart. Could they prevent Apple from holding the top spot in the world’s most valuable company rankings for more than a week, is still a question.
Even though Apple’s market value has been in the top ten globally since 2010, it was trading at a low valuation in relation to profits until a few years ago. It was perceived as a hardware manufacturer, a more challenging industry to grow than software. Its price-to-earnings (p/e) ratio, which measures investors’ expectations of future profits, was below 20 for a significant portion of the 2010s, similar to that of Lenovo or HPE, two uninteresting computer manufacturers with slow growth and narrow margins. It was also lower than the S&P 500 index average for large American corporations.
According to broker Toni Sacconaghi of Bernstein, this began to change in 2019. The $1 billion or so users of Apple devices receive software from the company’s “services” division, which started to generate revenue. The two largest components of this category are the App Store, which brings in an additional $24 billion annually, and the advertising business, which Bernstein values at $24 billion annually (including about $20 billion from Google for setting its search engine as the default on Apple devices). In addition, Apple provides streaming services for Apple TV and Music, as well as a rapidly expanding payments business. Services generate $85 billion in revenue annually, or 5% of total sales. They only made up $24 billion, or a tenth of total revenue in 2016.
This contributed to investors’ conviction that Apple was no longer a stuffy hardware manufacturer. It was a software platform that allowed paying users to be added for a nominal fee. This translated into more recurring revenue and higher profits—Apple’s services division has a gross profit margin of 71% as opposed to 37% for devices. With services accounting for a larger portion of the company’s revenue, Apple’s overall profitability increased from 38% in 2018 to 44% in 2019. The fact that it was selling more upscale, high-margin iPhone models helped with that as well. All of this contributed to Apple’s p/e ratio rising to approximately 30, well above the average for the S&P 500 and higher than Alphabet’s (Google’s parent company).
Apple’s legal troubles present one set of risks that could reverse its p/e progress. Certain ones, like the patent issue, seem like small threats. The medical device manufacturer Masimo owned patents pertaining to an oxygen-measuring sensor, which were found to have been infringed upon by Apple in October, according to a federal agency called the International Trade Commission. Apple discontinued offering the versions with the problematic technology. However, after turning off the disputed sensor, it began selling them again on January 18.
The main legal issues Apple is currently facing are related to its services division. EU regulations, a sizable market, will take effect in March and compel Apple to permit app installations on its devices without going through the App Store. This makes charging the 30% fee that it charges for the majority of in-app purchases more difficult for it (Apple has filed a lawsuit against the rules).
According to reports, the DOJ is investigating why Apple’s messaging service isn’t available on competing smartwatches and whether the smartwatch performs better when paired with the iPhone than when used alone. Apple may lose out on almost $20 billion in essentially free money each year if courts in a different lawsuit against Google support the DOJ’s claim that the company’s default-search agreements with device manufacturers are anti-competitive. The way Apple charges developers to sell their apps in the App Store has already changed as a result of a lawsuit brought in 2021 by the video game developer Epic Games.
In legal disputes, Apple is not without defence. It swiftly discovered a workaround for the App Store policy modifications brought about by Epic, allowing it to continue collecting large fees. It will likely take years before the DOJ’s case against Google is resolved. Its anticipated lawsuit against Apple is comparable. Investors appear unfazed, as has been the case with many antitrust cases against Apple.
The second area of concern, the company’s slowing core business, is where it is most exposed. In 2018, Apple sold roughly 220 million iPhones, just slightly more than the 217 million it sold in 2017, according to a poll of analysts. Maybe not much more than that in 2024. Apple was able to temporarily offset declining sales with higher prices. However, from an average of 10% between 2012 and 2021, annual revenue growth has dropped to 2% in the last two years.
Rivals are attempting to chip away at Apple’s market share in high-end devices by taking advantage of consumers’ desire for “generative” artificial intelligence (AI) that resembles ChatGPT. By the end of January, Samsung, a leading South Korean tech company, plans to introduce a new line of artificial intelligence-powered smartphones. Vibrant features will include enhanced photo and video editing, as well as real-time voice translation. The devices could go on sale eight months ahead of Apple’s upcoming iPhone models. On the other hand, Apple has said little about its plans for the hottest thing in tech since, well, the iPhone.
“We’re investing quite a bit,” Tim Cook noted cryptically on the company’s most recent earnings call.
China, where Apple makes up 17% of its total revenue, is another market where it is competing fiercely with Apple. An investment bank called Jefferies claims that Apple’s smartphone market share fell in the nation last year. In the meantime, the leading domestic tech company, Huawei, saw an increase of about six percentage points. In August, Huawei surprised observers of the industry—as well as the US government, which for years had prohibited the company from receiving US technology due to national security concerns—by releasing the first 5G device with cutting-edge chips made in China as opposed to imports. Chinese consumers, feeling patriotic, rushed to buy the phone and additional Huawei devices as well.
Concerns regarding Apple’s advancements in AI might be exaggerated. The investment bank Morgan Stanley’s Erik Woodring identifies indicators that show the business is making significant investments. The company’s scientists and Columbia University researchers collaborated to release the open-source Ferret artificial intelligence model in October. After two months, Apple released a paper outlining how these models might operate on smartphones, which have far less processing power than the data centres that are usually used for this kind of work. A South Korean tech blogger claimed in January that artificial intelligence (AI) improvements for Apple’s robot assistant, Siri, would be included in an operating system update, potentially arriving as early as June. Apple is rumoured to be incorporating generative AI into its own search engine.
However, China poses a greater threat than previously thought—and not just because Huawei has revived. Apple’s growth aspirations rely heavily on its performance in emerging markets, especially the largest one. During Apple’s last three earnings calls, Tim Cook began by discussing the company’s sales outside of the wealthy world. He was certainly thinking of China.
Apple’s supply chain exposes it to risks related to China. Even with widely reported attempts to shift some production to India, about 90% of iPhones are still made in Chinese factories. As are the majority of Mac computers and iPads. For at least the next five years, according to Sacconaghi of Bernstein, Apple will be extremely vulnerable to a major geopolitical escalation, such as a conflict over Taiwan.
Aside from a Chinese invasion of Taiwan, other things could harm the business. Increasing trade barriers and Sino-American tensions would undoubtedly result from Donald Trump’s potential return to the White House, now that he has virtually secured the Republican nomination. He is by no means a China dove, even if Joe Biden wins in November’s presidential election against Trump. In response to US sanctions, the Chinese government is starting to retaliate. It has already prohibited the use of certain Micron chips—manufactured in Idaho—in infrastructure projects. There were rumours in September that government officials were forbidding the use of Apple products. The incident alarmed investors even though the authorities subsequently refuted the allegations.