Apple joins Google, Meta, and Amazon as Big Tech that currently are working through cases with the DOJ.

While the DOJ is taking a unique approach to each case, they all share the common thread that the government doesn’t like the power that they have all accumulated over the past decade. This position stands in contrast to consumers’ view which is mostly positive on the value they get from Big Tech.

Specifically, the complaint against Apple is focused on five topics, four of which I see as impacting Services.

• Blocking of Super Apps. If they were allowed it would make it easier to switch between iPhone and Android by purchasing a new phone, signing into your super app, and then you’re off and running.
• Blocking cloud-based video game apps. Apple offers its cloud-based game platform, Arcade, but blocks third party cloud-based games.
• Blocking Cross-Platform Messaging Apps. Some of the features of iMessage are limited to iPhone to iPhone.
• Block some functionality of third-party Watches. For example, you can’t use a Samsung smartwatch to find your iPhone.
• Blocking third party digital wallets. For example, Venmo cannot launch with a double tap of an iPhone button.

Services have been a gold mine for Apple. The segment has averaged an annual revenue growth rate over the past five years of 17%, ahead of the average product growth rate of 7%.

If you exclude 2021 from that average, because the Product business had a 35% jump in sales from the pandemic, the gap widens. Using four of the past five years yields average annual Services growth of 14% compared to Products which were flat.

On top of that, while Services account for about 22% of sales, the segment accounts for about 40% of gross profit.

In other words, I believe the DOJ is mostly taking aim at the Services segment, which is the juiciest part of Apple’s profit profile.

Making it easier to move your apps and contacts cross-platform from Apple to Android could have a negative impact on iPhone upgrades as users would not be as locked in. The flip side is also true, allowing these super apps that transport your device profile between iPhone and Android would also make it easier for Android users to switch to Apple.

While tech investors have become number to the threat of regulation, the unknowns will be a headwind to AAPL’s earnings multiple for the next few years. Over the next couple of weeks, Apple investors will be focused on guessing the impact of the DOJ complaint.

I expect investors will quickly focus on iPhone and Services growth rates in the March quarter, what they are doing in AI, commentary about the competitive dynamic in China, and the company’s response to the move by the DOJ.

Given the unknowns related to key levers in Apple’s business now in play, we should expect the topic to remain at a low level in the background.

And as a rule, investors don’t like unknowns.

Apple’s response:

“At Apple, we innovate every day to make technology people love—designing products that work seamlessly together, protect people’s privacy and security, and create a magical experience for our users. 

This lawsuit threatens who we are and the principles that set Apple products apart in fiercely competitive markets. If successful, it would hinder our ability to create the kind of technology people expect from Apple—where hardware, software, and services intersect. 

It would also set a dangerous precedent, empowering government to take a heavy hand in designing people’s technology. We believe this lawsuit is wrong on the facts and the law, and we will vigorously defend against it.”

Taking a step back: The DOJ is doing its job and trying to keep big companies in check, and it’s not just tech, just ask JetBlue and Spirit Airlines.

Apple is not alone in these fights, just ask Google, Meta, and Amazon.

In the end, I believe little will happen for two reasons.

First, it’s hard to regulate a company. Twenty-five years ago it looked like Microsoft was going to get broken up, and in the end little changed.

Second, consumers love Apple products. The company gets endless recommendations from its users about how they want Apple to make their lives even better. That’s important because it adds political pressure to maintain the status quo. One view into how consumers feel about Apple products is to track the growth of active devices.

In the Dec-23 quarter, the company 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 installed base, reaching over 2.2B devices. That marks a step up in growth from 2022 when the base grew by about 8%.

The DOJ thinks Apple is coercing its customers to remain customers. This is painting Apple as the bad actor, but in reality, their users are happy with Apple’s products just as they are.

Disclaimer