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Apple Streaming – Potentially Worth Billions To The Bottom Line

Jul. 14, 2015 3:04 PM ET  |  13 comments  |  About: Apple Inc. (AAPL)
 Summary
  • A new network TV streaming service may be announced this fall.
  • Recent news suggests that the necessary deals are coming together.
  • Such a service might bring in $4 billion to the bottom line.

Apple Streaming – Potentially Worth Billions

The June 8 Apple (NASDAQ:AAPL) World Wide Developers Conference has come and gone with no mention of a streaming TV service. The service that the Wall Street Journal reported for this fall is expected to carry the major TV channels in an over the top (OTT) service that would allow you to bypass the normal cable providers.

Today, new news from the NY Post states:

  • “The platform is ready and it rocks,” said one source.

According to the article:

  • …talks with all four networks are rapidly gaining momentum, The Post has learned.

A year ago I wrote a piece, Apple’s New Strategic Centerpiece. This year I believe is when this plan will be implemented – the Apple TV will move wholeheartedly from self-proclaimed “hobby,” to full fledged, critical product.

Apple TV is a small set top box that connects to the internet (typically via wifi) and provides content to your entertainment system. Currently, it provides access to several services. I describe what is currently available, and what is rumored to come in my survey post The Coming Revolution.

What to expect

The Apple TV sold for several years for $99, until in March the price was dropped to $69. At the same time, Tim Cook announced a special deal for early release of the HBO Now streaming service from parent company Time Warner (NYSE:TWX).

Apple’s plan is clear – get the price for the ATV low enough to increase purchases, and then, like the Kindle from Amazon (NASDAQ:AMZN), let subscription services bring in the real revenue. Perhaps the most exciting expectation for the updated device is the streaming OTT service for major networks.

Streaming services

The video streaming service should include video from the networks, including local affiliates. According to the Post article:

  • But networks don’t control affiliate feeds. So Apple CEO Tim Cook’s team asked the networks to obtain those rights – instead of having Apple chase those rights around the country itself.

The article continues that the networks are close to having these rights.

The new service will allow a user to pick the channels desired and not subscribe to all the others. This should lead to both increased control by the consumer and reduced cost.

Model

The important thing here is the business model that Apple would use. While there are several possibilities, there are two major models of operation.

First is one in which Apple itself provides the complete service, serving out the content, while licensing from the networks and other providers. In this scenario, Apple would essentially replace the cable company and provide all the physical and logistic infrastructure. It would receive all the income and pay out royalties and licensing fees.

In a second model, providers would provide a channel app similar to what HBO Now, Netflix, ESPN and ABC do now. Here, Apple would provide logistic support, including centralized billing, but the provider would be responsible for streaming and would “own” the customer and that revenue. Apple would receive a fee, a percentage of the subscription. This would be similar to the app store (where Apple takes 30% and gives the rest to the app developers) and what’s presumably done with HBO Now.

How much?

The question is: How much could Apple potentially make from a streaming TV service?

The NY post article reports that Apple is asking 30% (what it charges for apps and in app purchases in the App Store), but that this is being negotiated. This seems hard to justify given the economics of the situation. My guess is that 15-20% will be the final number for Apple’s fee.

To analyze this, let’s look at some facts, all for the U.S. market.

  1. At the end of 2014, the US contained ~120,600,000 households.
  2. Of these, over 96 million had broadband internet.
  3. Also about 96 million are pay-TV subscribers of some sort.
  4. The number of cable TV subscribers in 2014 was 39,250,000, down from 41 million in 2013.
  5. Cable industry revenues from subscriptions for 2013 were $99 billion, up from $72 billion the year before.
  6. The average monthly cable subscription fee was $86 in 2011 and is expected to be $123 in 2015, and may top $200 in 2020.

So how much of this pie can Apple expect to ingest?

I would like to note a few more facts:

  1. “TV Everywhere viewing, for example, has seen 282% growth year-over-year, with Apple TV devices doubling their share of premium video viewing quarter over quarter from 5% to 10%-overtaking Roku.” (Adobe Digital Index – ADI)
  2. Cable suffered a loss of 1.18 million subscribers in 2014.

What is happening is clear:

  1. Cable and satellite services are beginning to lose customers,
  2. OTT services are growing rapidly, and
  3. Apple is one company that’s leading and growing rapidly in this area.

Writes ADI:

  • Apple devices currently drive 62% of all authenticated pay-for-TV video views.

(click to enlarge)

The chart shows that Apple devices have an enormous lead in video viewing, and that the Apple TV has shown a remarkable gain (to 10%) over the past year to become the No. 1 set-top box.

There have been many reports that cable cutting is becoming more common, particularly in the desirable 18-34 age range, where 90% stream video. Additionally, cable companies have terrible customer satisfaction ratings.

This means that Apple is now positioned to break out as the leader in OTT enablement and that a well accepted streaming service could very well provide the impetus to initiate a mass migration to OTT, cable-cutting services.

Business Intelligence reports:

  • Note the plummeting blue line below. That’s Comcast (NASDAQ:CMCSA) (NASDAQ:CMCSK) and Time Warner Cable’s (NYSE:TWC) revenue going down the drain as consumers are increasingly cutting the cord in favor of set-top boxes like Roku and Apple TV:

(click to enlarge)

Numbers

Note:

  • I am assuming that the service would work on the second model given above, with Apple being a facilitator and not a replacement cable company, and that Apple will receive a fee for its services.

So I’m focusing on the approximately $140 billion in cable and satellite subscription revenue just to get an idea of what’s possible.

I’m projecting out three to five years and making the following assumptions that are a bit aggressive, but not irrational.

  1. $100 billion target cable subscription base.
  2. $40 billion target satellite subscription base.
  3. In five years 30% of current subscribers will switch from cable/satellite to OTT network TV provisioning.
  4. These subscribers represent 40% of revenues, that’s $56 B, as higher paying customers see the most benefit, and thus are more likely to switch.
  5. Driver of switch is a 20% reduction in cost to consumer. (Also more flexibility in choice.)
  6. This reduction of subscription fees gives a total OTT subscription value of$45 B ($56 x .80).
  7. Apple streaming service provides 50% of this new, overall OTT service –$22.5 B.
  8. Apple takes 10% to 20% fee, for income of $2.25 B to $4.5 B.

The result is that Apple sees an annual revenue stream of up to $4.5 billion – and this is just the US.

At first glance, this does not seem that large compared to Apple’s $212 billion ttm gross revenue, but one needs to remember that this would be almost all profit.

Apple would not directly stream any content. Apple TV would only make the connection and Apple would handle billing. The expenses for this would not be great since the infrastructure and procedures are already in place for related services.

Therefore, I would suggest that about 80% of Apple’s cut would go to the bottom line. (Note: this is not 80% of the streaming revenue.)

If you add in international sales, then revenue would grow to the $3 to $5 billion range, and net would be $2.4 to 4 billion. This would add up to 8% of the last 12 months net income of $48 B. This is significant indeed for what’s essentially a sideline to the main business.

Aside

Interestingly, Barron’s reported on a conference call with JPMorgan analysts discussing this very topic. While they were working on the model that Apple would provide a complete service with more or less fixed subscription rates, they used similar margins giving estimates for 5%, 17% and even up to 26%. They note:

Turning to the cable and telco implications, Cusick noted that he’s always been very skeptical about claims regarding Apple storming the TV content world. Said Cusick, there was always “a misunderstanding by tech investors of the complexity of the bundle,” such as Disney-ESPN or Fox and Fox News.

This argues to my reasoning that the independent channel model may be more likely as it sidesteps these issues. The downside here is that discounts for buying multiple channels may be difficult to manage.

This model also is supported by the NY Post article.

In any case, it is clear that Apple will get some margin above and beyond licensing costs.

Conclusion

Apple reported in January that it had sold some 25 million Apple TV units since the product was initiated. This reflected an increase of 5 million for the previous announcement nine months earlier. This is tiny compared to the roughly 700 million iPhones sold worldwide to date. While no one expects Apple TV sales to reach that number, clearly there is room for growth. With growth already accelerating, it is easy to see 100 million units installed in just a couple of years.

A more powerful new product with new streaming, apps, games and Home Center should drive real growth, add a significant revenue stream, and bring new customers to the platform. As such, it is the epicenter of Apple’s new strategy.

As we have seen, streaming video alone could easily add $2.4 billion to the bottom line (or even more if our assumptions turn out to be conservative). That would be roughly $0.50 per share.

It is important to note that this revenue is not the only motivation behind Apple’s venture into streaming, and I think this is essential for the investor to note if he is to understand Apple.

· Streaming also is a very important strategic move to place the Apple TV at the center of people’s homes.

The other features of the device (apps, games, home control center) all add up to make it uniquely suitable to this function. As such, it will bring the Apple ecosystem to more and more people, as described here.

An April 30 Parks Associates press release noted:

  • “The paradigm is changing, thanks to the growing amount of online and OTT content available to connected CE, which has allowed streaming media devices to carve out a key niche in the connected home,” said Barbara Kraus, Director of Research, Parks Associates. “With the popularity of content streaming, CE manufacturers must innovate to create unique user experiences.”

Apple most certainly is innovating here.

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