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Stock Strategist

Apple's Live TV Service May Keep Customers Tuning In

We think that while the firm won't differentiate itself in content, its streaming will provide some advantages.

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Our bullish investment thesis for  Apple (AAPL) centers on our view that customer switching costs will allow the firm to retain most of its existing iPhone user base, enabling the firm to make repeat sales of premium-priced iPhones over time. We believe an over-the-top, or OTT, Live TV service presents a particularly promising source of customer stickiness and we suspect many investors are hoping for an announcement along these lines at Apple’s upcoming iPhone 7 launch. We're not particularly optimistic that a Live TV service will be announced this fall, as we would have typically seen far more rumors and leaks by now. But we still foresee an Apple OTT TV service arriving someday (late next year would be our bet) and we're interested in its potential to enhance iOS ecosystem lock-in. We doubt a Live TV service will provide a big boost to Apple's bottom line in isolation, but again, the far more important financial consideration is that a Live TV service could help to protect Apple's massive crown jewel iPhone business. We continue to think about almost all of Apple’s new hardware, software and services in this context. We continue to maintain our $133 fair value estimate and narrow moat rating for Apple.

Media content negotiations have likely held up an Apple Live TV service in recent years as we suspect content owners have preferred to move slowly to date, favoring owned firms (like Hulu) and traditional TV distributors ( Dish (DISH), DirecTV). Hulu (now owned by four major media providers) could be particularly well positioned to emerge as a leading cross-platform service. However, we think that content providers want as broad a distribution as possible, which will eventually allow an Apple TV service to come to market. Compared with competing offerings, we don’t expect Apple to garner differentiation via unique content rights, but we do expect the firm to have a few advantages in Live TV.

We will maintain our $133 fair value estimate for Apple for now, even though the company was hit with a EUR 13 billion ($14.5 billion) tax bill by the European Commission, which ruled that Ireland gave illegal tax benefits to Apple. We concede that $3 per share, or just over 2% of our fair value estimate, is at risk with the ruling, but the timing and amount of the final payment remain uncertain. Apple will not take a financial charge for the tax bill in its near-term results, and the fine may be placed in restricted cash but will not be immediately paid out. We expect both Apple and Ireland will appeal the ruling, and a final decision could take years. Apple has almost $215 billion in international cash on hand, so the record tax bill will make only a small dent in the firm's cash cushion. Further, Apple indicated that the ruling will not have an effect on its long-term tax rate, presumably because its Irish tax structure in question was modified in 2015. Regardless, we continue to view Apple as fundamentally undervalued, and the company remains one of our best investment ideas in the tech sector.

In essence, the European Commission considered Apple's tax structure within Ireland, which was in compliance with Irish and international laws, as anticompetitive, as Apple received tax breaks (presumably in exchange for creating jobs in the region) that allowed the company to pay a tax rate as low as 1% in 2003 and 0.005% by 2014 on all revenue from the European Union, not just sales within Ireland. We estimate that Apple earned roughly $71 billion in cumulative operating income in Europe over the time frame in question (2003-14).

We foresee a bounceback in revenue with 4% growth in fiscal 2017 along with the launch of the iPhone 7. Longer term, we foresee Apple returning to growth and achieving modest iPhone revenue growth in the low-single-digit range, with unit sales growing at a mid-single-digit pace. We envision Apple’s iPhone unit sales growing at a similar pace to the high-end of a maturing smartphone market. While we’re not overly bullish on long-term iPhone growth, we think that Apple’s moat will help the firm retain most of its current customers, thus making iPhone revenue more resilient than the ups and downs witnessed by other hardware-only smartphone makers. Longer-term, we model average revenue growth for Apple as a whole in the 4% range. We expect strong growth from Other Products (including the Watch and TV) and Services, but slower growth from larger businesses like iPhone, iPad, and Mac.

Brian Colello does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.