Morgan Stanley: China’s App Store headwinds will pass

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From a note to clients by analyst Katy Huberty that landed on my desktop Monday:

According to data compiled by Sensor Tower, Apple’s App Store generated $8.4B in payments to developers in the September quarter, implying App Store net revenue (what is recognized on Apple’s P&L, net of payments to developers) of $3.6B (+23% Y/Y), a quarterly high (Exhibit 1) but below our forecast of $3.8B (+30% Y/Y originally, +32% Y/Y after Sensor Tower restatements; Exhibit 2).

Assuming our estimates for the other Services line items are in-line, these results imply September quarter Services revenue of $9.8B (+15% Y/Y or +24% Y/Y on a normalized basis, excluding the $640M favorable one-time payment from the September 2017 quarter), below our current estimate of $10.0B (+18% Y/Y, +28% normalized) and below current consensus of $10.1B (+19% Y/Y, +28% normalized).

Coupled with slower Chinese gaming approvals, decelerating gaming/luxury brand growth in China, and implications of a potentially escalating trade tensions, we see China exposure as the biggest near-term risk. However, we believe that many of the App Store blemishes we cite below are more temporary in nature and as a result, continue to believe in the longer-term sustainability of App Store growth, which plays a meaningful role in our bullish Services thesis.

Cue the bar charts:

app store headwinds

app store headwinds

Click to enlarge. 

Maintains Overweight rating and $247 price target. 

My take: Huberty’s $247 price target reflects her base case. Her bull case, in which services revenue per device accelerates to 10%+ growth annually, carries a $363 price target. (Her bear case price target? $151.)