Morgan Chief Analyst: Apple’s App Store business continues to grow but the service business is at risk

Morgan Stanley, the investment bank, reportedly stressed that Apple’s services business remained at potential risk, even as revenue from the App Store continued to grow in October. ‘App Store’s net income is expected to grow 30 percent year-on-year in October, based on Sensor Tower’s initial data,’ wrote Katy Huberty, chief analyst at Morgan Stanley, according to an investor report.

Morgan Chief Analyst: Apple's App Store business continues to grow but the service business is at risk

The App Store is expected to earn $1.9 billion in October, up nearly 240 basis points from the September quarter.

Revenue is broad-based and similar in Apple’s top 10 markets. Despite concerns about some of the negative impact of Fortnite’s removal, spending in the gaming sector still accounts for the majority of spending on the App Store.

“These trends indicate that users continue to participate in the App Store with strong frequencies,” Herbert wrote. “

But in a separate study, Herbert noted that the potential risks to the service business are growing. And Apple itself warned investors that changes to app Store commissions could affect the company’s profits.

Herbert believes Apple’s latest risk factor is that the App Store may face more scrutiny and regulatory attention.

In addition to Apple’s possible adjustments to the share of revenue from in-app purchases, the company stressed that its business partnership is another risk, and that the so-called business partnership may refer to Apple’s partnership with Google on iOS search. The Google-based case could take years to come to fruit, and Herbert does not believe that review of the deal poses a near- or medium-term risk.

Once Google’s case is closed, Herbert said the risk may be more on “a fixed portion of the amount than a variable part.” “Google currently pays Apple about 15 to 20 per cent of its service revenue, but Morgan Stanley believes that most of the money Google pays Apple is variable and depends on search revenue. In other words, Herbert expects the financial risk to be smaller than currently expected.

“Furthermore, these surveys often take years, giving Apple effective protection against the potential impact of Google’s deals by giving it time to increase user usage of other services,” Herbert said.

In the report, Herbert also noted that Apple’s gross margin fell to 37.2 percent in September from a year earlier, after normalizing warranty accruals. Gross margin fell by about 150 basis points in the September quarter compared with the previous 20 basis points increase in gross margin.

Form 10-K of the annual report also shows that non-trade receivables from suppliers decreased by 6 per cent in the September quarter. This entry reflects the inventory levels of Apple’s supply chain partners. But Herbert expects non-trade receivables from suppliers to return to growth in the December quarter.

Herbert’s 12-month target price for Apple shares remains unchanged at $136 a share. Apple’s shares are currently trading at $109.88.