The second cut was the deepest, slashing $22 off what was already one of the Street's lowest 12-month price targets.
From a note to clients by analyst Rod Hall that landed on my desktop early Friday:
We believe that Apple plans to account for its 1-year trial for TV+ as a ~$60 discount to a combined hardware and services bundle. This method of accounting will likely result in lower up front ASPs and margins and then higher services revenue growth. Effectively, Apple’s method of accounting moves revenue from hardware to Services even though customers do not perceive themselves to be paying for TV+. Though this might appear convenient for Apple’s services revenue line it is equally inconvenient for both apparent hardware ASPs and margins in high sales quarters like the upcoming FQ1’20 to December...
Assuming 25% gross margin contribution from free trial TV+ revenues results in a negative calculated impact to EPS of 16% in FQ1’20 and 14% for FY20 in total but, importantly, no impact to cashflow.
We are modifying our model to account for this change but we currently assume this is an introductory offer that runs for just one year. Should it run longer our out year forecasts would also likely need to be adjusted in a similar way...
Maintains Hold rating, lowers price target to $165 from $187 (from $189 the day before).
My take: The first ($2) price cut came out of the blue. For the second ($22), Hall shows his math:
Transaction and accounting example
- Assumptions: A customer purchases a new iPhone 11 Pro for $1,000 (rounding price for reading ease) and opts in to the TV+ free trial.
- How is this transaction seen from an accounting perspective? From Apple’s accounting point of view this transaction is seen as an iPhone 11 Pro + TV+ bundle valued at $1,060 with a total $60 discount applied (i.e., discount equal to 1-year trial of TV+ at $4.99/month). However, the discount is not solely apportioned to the TV+ revenue but rather is proportionately applied to both the iPhone 11 Pro and the TV+ package.
- The math. Mathematically, we believe that the discount in this case is allocated by first calculating the combined percentage discount which would be $60/$1,060 = 5.7%. Next this discount is applied to the iPhone and the TV+ package with the iPhone discounted to $943.40 = $1,000 x 94.3% and the TV+ annual value discounted to $56.60 = $60 x 94.3%.
- Financial statements impact. The iPhone, assuming it is normally purchased and not on an installment plan, shows up at the lower ASP of $943.40 in FQ1’20 to Dec but at a lower gross margin because COGS is unaffected by the discounting. The discounted TV+ revenue shows up as a credit to Deferred Revenue and then will be recognized on a monthly basis over the 12-month trial period. We believe that TV+ COGS will be allocated to this revenue stream on a monthly basis as well.