Goldman Sachs cuts Apple target twice in two days

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.

See also:

19 Comments

  1. Chris Ferebee said:
    “Hold” and a target of $165? What’s next? “Buy” and a target of $95?

    Is he watching Trump’s pals front-running AAPL and trying to get a piece of the action?

    2
    September 13, 2019
  2. David Drinkwater said:
    All this clever math on an individual iPhone 11 Pro plus a year of TV+ assumes that that is the sum and total of Apple’s income. Apple will sell a lot more than one iPhone 11 Plus and TV+ pairings, and it may well (expect to) sell more iPhones 11Plus *because* it comes with a new service offering “free”. So if Apple sells more phones at slightly lower margin, it still comes out ahead. 6% more units may be hard to expect, but the TV+ content does add value for Apple independently.

    1
    September 13, 2019
  3. Adam Foster said:
    FYI: Just ordered my new iPhone 11 Pro Max – completely maxed out! Delivers Sept 20TH.

    3
    September 13, 2019
  4. Patrick Beyrouti said:
    The assumed accounting treatment is WRONG !!
    If anything APPLE will be showing inflated revenues .
    They will account the sale of an iPhone for $1000 NOT $940
    and will account for the sale of a one year subscription for $60 ( eventually amortized)
    that will be offset with a voucher for $60 that will go from the marketing budget .
    GOLDMAN’s analyst surely underestimates Apple’s accounting sharpness!
    APPLE iPhone margin will not be touched ! $60 will never be accounted as a discount !!

    3
    September 13, 2019
    • Aaron Belich said:
      No kidding. Why would it ever go against Hardware? It’s a Services charge. If not apart of a marketing budget, it would ding Services accounting. AppleCare+, iCloud, Music, etc… those would see a hit, if at all. Oh wait. It’s already been accounted for because it’s just billing $0.00 against a customer for 12 months for something that Apple has already paid for. Hollywood isn’t on a net 365 days terms repayment plan from Apple.

      Who accounts the way Rod is accounting? This seems absolutely ludicrous the more he tries to justify himself.

      1
      September 13, 2019
    • Turley Muller said:
      That accounting is right. Since Apple is promising a year of service it has a performance obligation. The customer is paying for two items – the hardware and the Apple TV+ service bundled in a single `purchase. That’s most definitely the correct accounting treatment and the first thing that popped in my head when I learned of the free year trial.

      However- It won’t exactly play out like that. There will be parsons/families that purchase more than one hardware product yet they are only entitled to a single free subscription. There will be others who never redeem the offer. They may try to estimate the redemption rate and set up a reserve or perhaps they defer and don’t recognize any of the service revenue until the 3 months expire. That point it would be all hardware revenue.

      I don’t see how it could be recognized as a promotion expense or recognized in COGS because there is not any variable cost.

      0
      September 13, 2019
      • Patrick Beyrouti said:
        Sorrryyyy . NO!

        When you go to a store you will be buy an iPhone at full price and invoiced at full price.
        Theres is no REAL bundle here. you are told about the APPLE TV+ . which is activated with an Apple ID . Only if you opt to activate your free subscription , Apple will recognize a revenue and offset it with a marketing expense. MAY will not opt in !
        ARE you new to Apple APP store , iTunes store ? …..

        0
        September 13, 2019
        • Turley Muller said:
          That’s not the new a accounting rules.- ASC 606. Apple already defers a portion of hardware sales for free services like iCloud and maps and recognizes that as service revenue. You are only invoiced for the phone. You only amount paid is price of the phone. Nothing about the free iCloud and maps services. But that’s not how FASB sees it. They are distinct performance obligations. The Apple TV offer is no different than Siri. Maps. Etc. another free service included in the purchase.

          0
          September 13, 2019
  5. Rick Johnson said:
    Please post the spreadsheet of analysts again that reveals how clueless this bozo is.

    2
    September 13, 2019
  6. Fred Stein said:
    Apple clearly took a strategic approach with aggressive pricing across the board for the long term.

    Speaking of long term, Rod Hall ought to give a nod to the potential of Apple Card plus whatever new financial services Apple brings. So far Apple adds about one fintech service each year. Apple adds more countries, more stores, and more users to their fintech business.

    Arcade targets children of all ages. It is an evergreen services revenue stream, driving iPad and iPhone device upgrades for years.

    Investors can rejoice that Apple spends a few $B to achieve long term goals. More so, since Apple’s SG&A is well below norms. SG&A is the right category for these incentives.

    0
    September 13, 2019
  7. Chris Ferebee said:
    @Turley I certainly don’t understand accounting, but precisely because there is no variable cost (the marginal cost of delivering TV+ to every iPhone buyer is zero) how does the performance obligation enter into it?

    Apple is investing in TV+ content relative to a multi-year ROI on content over a billion users.

    You could just as easily argue that the free year of service is a promotional expense on TV+, which is being showered on new iPhone buyers, Apple’s most engaged users and influencers. Don’t forget that an increasingly large segment of Apple users is being served by used devices, as announced in Lisa Jackson’s profound and underrated segment in the 2018 keynote.

    0
    September 13, 2019
    • Turley Muller said:
      It’s a performance obligation because it’s s promised service that will take Apple a year to fulfill. A customer buys an iPhone with the expedition of receiving that service.

      It’s the same thing with Apple’s free iOS updates. And the web services. – maps. Siri. iCloud. That’s why Apple has always deferred a portion of the hardware sale. Back in the day Apple had to defer the whole damn iPhone sale. Rules changed and only had to defer 15-25. So…. just add Apple TV to the list of current services that are deferred. – free iOS updates. iCloud. Siri. Maps. Etc. and it makes sense.

      0
      September 13, 2019
  8. Gregg Thurman said:
    Well I think the whole thing is moot. The pricing on the iPhone 11, coupled with the A Series performance and battery boost is going to cause a great Nancy of the 900 billion iPhones in the base to upgrade.

    Think battery life (number 1 reason to upgrade) as the driver this cycle. If 5% of that base upgrades Apple sells 45 million iPhone 11 units. Then you have a smaller number that buy the latest greatest and want the Pros camera (and battery life) – add another 20 million units.

    The above is all SWAG, but the point is that iPhone sales are going to be strong during the December quarter, stronger than we’ve seen in a while.

    Then you’re going to have a great many that aren’t in the market for a new iPhone until next year (5G?) that will sign up for Apple TV+ now AND PAY THE $4.99 a month (me). I’m going to sign just to watch The Morning Show. Hell, I’m paying $4.99 to RENT a single movie right now. $4.99 is nothing, not when you compare it to the $20 the cable operators charged to get HBO (on top of their inflated and worthless Basic package)

    Hall may have the accounting correct, but he is myopically focused on that, and ignoring the increase in iPhone and Services revenue that Sept 10s announcements are going to generate.

    Further, if the “freebie” negatively impacts margins it will only do so to the extent that buyers of hardware take advantage of the promotion. I think WS will forgive the dip in margins, recognizing the future high margin revenue those participants represent.

    1
    September 13, 2019
    • Fred Stein said:
      Crazy that so few understand the ‘health club membership’ model. Free three month in January and they pay forever and never keep new year’s resolutions. No one will lift a finger, literally, to save $4.99.

      0
      September 13, 2019
  9. Gregg Thurman said:
    On occasion Apple has shared total subscribers. It will be very interesting what the report (anything) this October and the following January.

    That’s my focus, not some esoteric accounting rules.

    0
    September 13, 2019

Leave a Reply