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China Clouds Shroud Apple’s Progress
Apple's December quarter and guidance highlighted the impact China's macro slowdown had on Apple's business. That reality diluted investor optimism around the long-term progress the company is making when it comes to growing its active base, launching Vision Pro, and entering generative AI likely this spring.

Key Takeaways

China sales hit the wall, triggering a 5% guide down in March.
The product flywheel is intact, as evidenced by the installed base of active devices accelerating growth to 10% YoY.
A long-term headwind around the App Store
Apple will likely show its first generative AI model at WWDC, paving the way for the company to lead in personalized AI.
Vision Pro is here and has meaningful long-term potential.

China impact on guidance

Shares of AAPL traded down 0.5% following earnings and guidance that calls for a slowdown in Mar-24.

Taking a step back, the December quarter was solid, reporting 2% revenue growth (Street was looking for 1% growth) along with 4% earnings upside. Overall, the iPhone grew at 6% YoY, the best growth since Sep-22. That growth was achieved despite China sales (18% of revenue) being down 13% YoY in the quarter. It was the worst quarter in China since Sep-20 when revenue declined 28%. The reason for the China softness is mostly macro-related, given the iPhone gained market share in the quarter, based on data from IDC. To put the strength coming from the rest of the world into perspective, Japan grew at 15%, Europe at 10%, and the Americas at 2%.

The impact of China was especially felt in the guidance. Apple expects sales in the March quarter to be down about 5% YoY, compared to previous expectations for 1% growth. Apple explained the Mar-24 weakness was in part due to difficult comps resulting from an unexpected boost in Mar-23. When iPhone 14 production shut down due to COVID-19 in November 2022, Dec-22 orders went unfilled until the following quarter. That shutdown pushed about $5B in sales from Dec-22 into Mar-23 creating a tough comp in Mar-24.

The company highlighted that adjusting for this $5B, revenue in Mar-24 would be flat YoY. While this perspective helps understand Apple’s true growth rate, it begs the question: Why did the company not mention the $5B benefit when they reported the Mar-23 quarter? I believe the reason is it would have made the Mar-23 quarter look less impressive.

Setting aside my disappointment that Apple has been inconsistent in reporting material one time items, the company’s true growth in Mar-24 (flat YoY) should be the best since Sep-22.

The table below shows Apple’s reported revenue growth as well as adjusted growth (had there been no shutdown) for the current and previous five quarters.

The product and services flywheel is intact

Apple continued to grow its active device installed base, an important metric for long-term investors who look for Apple to win customers and expand the number of devices and services that they purchase. The company reported a 10% YoY growth in the active base, reaching over 2.2B devices. That marks a step up in growth from 2022 when the base grew by about 8%.  

The active installed base topic is important because it’s the foundation of what is driving, what I believe is, a new chapter of how investors view Apple. Over the next five years, I continue to expect investors to see Apple as a “can’t live without” consumer staples company. The Apple flywheel is alive and well, following a 20-year success story in which consumers buy one Apple product, fall in love, buy another product, add a service, upgrade, and repeat.


Changes to the App Store

In March, Apple will begin to make changes in Europe to the App Store that will effectively lower its fees in the region by about 15%. On the earnings call, the company outlined the App Store EU accounts for about 7% of total App Store revenue. In other words, the EU App Store accounts for about 0.5% of overall revenue. While this region is too small to matter for overall revenue, regulation pressure related to the App Store globally has been increasing. Those changes could become a headwind to growth.

In the US, the company will soon allow developers to promote paying for apps outside of Apple’s paywall, which could further pressure the effective take rate in the US.

The bottom line is the App Store accounts for about 8% of overall revenue (Deepwater estimate), and 15% of company profits. Declining take rates over the next several years will dampen earnings growth. My sense is this dynamic will slow Services growth by about 1% per year for the next few years, which translates to a headwind to Apple’s overall revenue of about 0.2% per year and a 0.4% headwind to earnings. For example, if Apple were growing its top line at 5% with no changes to App Store take rates, the revenue growth with the changes to take rate would be 4.8%.


Apple and generative AI

Tim Cook did something he has never done before: he mentioned generative AI in his prepared remarks. While he stopped short of giving details, it was a milestone moment given how tight-lipped Apple is about upcoming products. Essentially Cook pre-announced that they will have a generative AI model sometime this year. WWDC in June makes the most sense to formally announce the model.

I believe this foundation model will take the form of an enhanced Siri. The near-term use case is having Siri respond to texts and emails. Long-term the company is in the best position of any Big Tech company to win in personalized AI because privacy and security are central to Apple’s brand. While personalized AI does not exist today, the concept is to ask Siri to complete a multilayer task, like organize a meeting, book a flight, or take action on how to improve a credit score. That will supercharge how we use generative AI.

It’s unlikely Apple will have the best LLM given their privacy policy limits the available data for training. That stands in contrast to Google, Meta, and x.AI which all have 10+ years of proprietary data to train on.

What is likely is Apple will have one of the best consumer implementations of generative AI given their ability to integrate the experiences into both Apple hardware, software, and services. I envision it will be AI that just works.


The spatial computing paradigm begins

Innovation is alive at Apple with the world of spatial computing launching with Vision Pro. The reviews have been consistent, groundbreaking tech with limited use cases.

On launch day, the platform already has over 600 apps available, more than the 574 apps built over the past three years for Meta Quest. Importantly, Vision Pro’s developer momentum is pointed in the right direction with about 60% of those apps outside of gaming, compared to about 30% on the Quest platform. Apple’s goal is to motivate developers to ensure Vision Pro goes beyond gaming to make the device mainstream.

For 2024 the product will appeal to developers and tech enthusiasts. The reason is it’s crazy expensive (7x more than Quest 3) and by my measure, it’s crazy powerful (30x more than Quest 3 when comparing display, cameras, interface, and compute).

The central question for the success of Vision Pro: Will developers get behind it? I believe the answer will be yes.

As for how big can Vision Pro get? I estimated the Vision segment would account for about 15% of total Apple sales in 2030, or about $74B. This estimate is based on assuming Apple grows its top line by an average of 5% per year through the end of the decade, totaling $550B.


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