Morgan Stanley: Apple’s 2020 10-K highlights government regulatory risks

But analyst Katy Huberty doesn’t view antitrust scrutiny as a “material near to medium term risk” to Apple’s services business.

From a note to clients that landed on my desktop Monday evening:

Risk factors broaden to include potential adverse implications from heightened legal and regulatory investigations. Apple made notable changes to its risk factors, particularly around potential pressure on App Store commission and Services gross margin.

Specifically, Apple notes the potential risk of reduced, narrowed or eliminated App Store take rates, which could have material adverse impacts on Apple’s financial condition and operating results. Previously the risk factor focused on the risk of developers reducing their use of App Store.

Apple also specifically added ‘Services’ to the risk that gross margins can vary significantly and can change over time. We believe these changes stem from the heightened regulatory focus on App Store and large technology companies broadly. On this point, Apple added a risk that the outcome of litigation or government investigations could impact Apple’s relationships with business partners which could have a material adverse impact on Apple’s financials, likely alluding to the Google risk.

Legal and regulatory investigations take time and we believe both Apple and Google have strong arguments in defense of App Store take rates and Google’s licensing fee, respectively. So while it’s important to monitor developments on these fronts, we don’t view it as a material near to medium term risk to Apple’s Services business.

Maintains Overweight rating and $136 price target.

Cue Exhibit 4:

apple huberty regulatory risk

My take: Huberty has more to say about lower warranty accruals and a decline in normalized gross margins, but the regulatory risks in the 10-K are what she chose to put in her headline.

15 Comments

  1. Robert Paul Leitao said:
    Anyone see a real risk to Apple on a near-term basis from regulatory or antitrust scrutiny?

    Apple is prudently advising of potential risks in its regulatory filings. I agree with Katy Huberty the risk may not be material in the near term. However, Washington’s anti-trust priorities may soon change and the EU is also looking at Apple’s practices and strategic approach to its fastest-growing revenue segment. For competitive reasons Apple may also adjust its distribution fees and policies over time.

    Investigations do take time and in my view it would be challenging for any party to legitimately claim Apple has abused a dominant market position and is adversely suppressing competition and through the company’s practices is stifling innovation. In my view, reading these risk factors in the company’s 10-K can be unsettling. However, revealing potential risk factors is necessary to comply with regulations.

    1
    November 2, 2020
    • Gregg Thurman said:
      Anyone see a real risk to Apple on a near-term basis from regulatory or antitrust scrutiny?

      The only risk I see to Apple’s bottom line is any increase in its legal costs to defend against spurious suits, which will never amount to anything material.

      Apple’s App Store is no different than what Disney does with its theme parks: if you want your product on the inside you got to pay the piper what the piper wants. Once inside you have to adhere to Disney’s specs on quality, etc.

      There are alternatives to Disney’s amusement parks, but all competing themes are different from Disney’s: none are based on Disney franchises. They may have water rides, but none are based on Pirates of the Caribbean, or Roger Rabbit, etc.

      4
      November 2, 2020
  2. Fred Stein said:
    We have to laugh when folks call Apple’s 30% fee for providing a technology platform and a highly prized, highly secure market place a “tax”….. because the top rate for US income tax is 37% and in CA, where Apple has HQ, we pay on top of that. (And I’m a liberal, not a conservative.)

    Seriously, Apple’s 30% fee is: 1) fair; And, 2) competitive, or low, relative to other premium market places. Further, what precisely would legislation or regulation do? Would they change the rate? and to what level? and only apply to Apple and no other market place?

    More:

    4
    November 3, 2020
  3. Fred Stein said:
    Continued: We have real challenges with the concentration of power and wealth. The digital transformation, globalization, the talent economy, capitalism, etc. have positive and negative impacts. Simplistic or ideology-based solutions won’t help. Micro-managing Apple by third parties can’t work.

    Finally, the vast majority love Apple and it’s the most widely held stock. Apple does NOT hurt anyone. That stalls political attacks on Apple.

    1
    November 3, 2020
    • Robert Paul Leitao said:
      Fred: Good points!

      So what’s a “fair” distribution fee? What’s an “appropriate” level of privacy and security versus Apple’s strict standards? If Apple is “unreasonably” controlling access to the App Store, what agency or regulatory body “should” set the terms and standards?

      Does anyone think there’s merit to anti-trust or anti-competitive claims?

      1
      November 3, 2020
      • Fred Stein said:
        @Robert Paul: Is there merit to anti-trust, anti-competitive?

        As others have stated, stores, of all sorts, sell their own merchandise. The App Store represents a minor segment of the content streaming and gaming businesses.

        W.r.t. search, the claim is tenuous. Bing, owned by MSFT, has about 8% share despite Windows holding 92% of the PC market. That indicates customer choice, not collusion.

        AND.. over the last 2 decades, the Mac went from 4% share to 8% share. Quality and customer choice won.

        No case, IMHO.

        0
        November 3, 2020
      • Gregg Thurman said:
        NO

        That said I didn’t think there was any merit in the Book Store anti-trust case either.

        0
        November 4, 2020
  4. “Does anyone think there’s merit to anti-trust or anti-competitive claims?”

    I do. As my friends here are probably tired of hearing, I think there’s merit in the complaint that Apple favors its own apps in a platform it controls.

    1
    November 3, 2020
    • Arthur Cheng said:
      PED, that is no different than a supermarket, like Whole Foods, put their own brand in a more favorable shelf position.

      If it is not for the platform, whether it is iOS or Android, the app makers will have to find a way to sell their stuff on their own.

      0
      November 3, 2020
      • “PED, that is no different than a supermarket, like Whole Foods, put their own brand in a more favorable shelf position.”

        If there were only two supermarkets in the world and Whole Foods was one of them, those favorable self positions could be at risk.

        0
        November 3, 2020
        • Robert Paul Leitao said:
          @PED As you have famously said over the years you are not an Apple shareholder with the exception of the share(s) you purchased to attend the annual meeting. On this topic your point of view is decidedly in the minority.

          Here’s a question for you and my fellow subscribers: Does the fact that so many of us are shareholders influence our points of view on this issue and other issues related to Apple? If Apple wasn’t the company in the cross hairs, would our views on what might constitute anti-competitive behavior be different?

          I’m not saying anyone is disingenuous. But is our outlook and our opinions influenced by the fact that we are invested in the company in many different ways such as the products we choose to buy and the way we invest our resources? It may be a topic worth covering in a future post.

          0
          November 3, 2020
  5. Kirk DeBernardi said:
    @ PED —

    “As my friends here are probably tired of hearing, I think there’s merit in the complaint that Apple favors its own apps in a platform it controls.”

    Not so much getting tired of hearing, but moreover, getting curious of you not having (as yet) cited exact examples of this. Also, simply controlling a platform is not inherently monopolistic.

    One valid concern might be the accusation of developers not being treated equitably.

    There could develop a valid future argument that Apple’s ecosystem would borderline on a monopoly (and a damn good one at that once EVERYONE’S onboard).

    Until such a time, I’ll subscribe to Tim Cook’s stated affirmation that Apple does not have a dominant marketshare in any area of competition.

    This, however, does not preclude Apple getting swept up in the monopoly-hunt riptide.

    0
    November 3, 2020
  6. Romeo A Esparrago Jr said:
    From PED’s article “ Apple says its competitors use ‘illegitimate means.’ What does that mean?”

    [Apple says it] “ faces substantial competition in these markets from companies that have significant technical, marketing, distribution and other resources, as well as established hardware, software, and service offerings with large customer bases. “

    My take?
    Apple seems to be documenting in the 10-K they are not doing anything anti-trust, there is lots of competition qualified enough as a good consumer choice now & into the future, all being done legitimately by Apple (compared to others) within current laws.

    Apple looks prepared to reply to claims by those who think there’s merit to anti-trust or anti-competitive claims.

    2
    November 3, 2020

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