On March 21, Apple (AAPL -0.35%) fell 4.1%, marking the worst single-session drop since it fell 4.8% on Aug. 4, 2023. The sell-off last August was in response to Apple's fiscal 2023 third-quarter earnings. But this latest sell-off had nothing to do with quarterly financial reports.
The U.S. Department of Justice (DOJ) filed a civil antitrust lawsuit against Apple for monopolizing smartphone markets. Here's what the DOJ said and why it's yet another piece of bad news weighing Apple down.
Image source: Getty Images.
Under a microscope
Big tech companies like Apple are no strangers to antitrust threats. However, as Apple has grown in value, it has become a bigger target.
The DOJ's 88-page document is chock-full of helpful context, including how Apple purposely built a system to protect itself from competition. "If you read our lawsuit, what you'll see is that our concerns are not necessarily with what Apple is doing with Apple's products; our concerns are with restrictions when Apple tells others what they can and can't do with their products. That is our primary area of concern and that is the primary area of focus in our lawsuit," said Jonathan Kanter, assistant general for antitrust, in an interview with CNBC on March 22.
To quote the seventh point from the DOJ's report:
Apple's smartphone business model, at its core, is one that invites as many participants, including iPhone users and third-party developers, to join its platform as possible while using contractual terms to force these participants to pay substantial fees. At the same time, Apple restricts its platform participants' ability to negotiate or compete down its fees through alternative app stores, in-app payment processors, and more.
Whether you agree or disagree with the suit, the danger is that it targets Apple's high-margin services segment, which has been the saving grace of an otherwise low-growth period for Apple.
Slowing down Apple's growth engine
Apple has expanded its services offering to fuel growth despite sluggish product sales. The company still relies heavily on selling devices -- particularly iPhones. But the business model is still effective as long as Apple is adding users across devices and boosting engagement with services to enhance the Apple ecosystem. Services include iCloud, Apple TV, Apple Music, Apple News+, Apple Podcasts, Apple Pay, and more.
For its fiscal 2024 first quarter (ended Dec. 30, 2023), Apple reported 11.3% year-over-year growth in services revenue but just a 0.1% increase in products revenue. The high-margin services segment contributed to all-time-high diluted earnings per share and a 10-year high quarterly gross margin of 45.9%.
Despite the strength of its services, Apple would be nothing without app developers. Just imagine if Meta Platforms' Instagram wasn't on the iPhone. This absence would degrade the utility of an iPhone, but because of Apple's dominance, it would be even worse for Meta Platforms.
Apple's best argument is that developers need Apple more than Apple needs them. But overall, Apple can't succeed without third-party developers. There are valid points that Apple is overcharging for its services. A good example is Apple Pay. To quote the DOJ report:
Apple also uses its smartphone monopoly to extract payments from banks, which need to access customers that use digital wallets on iPhones. Since Apple first launched Apple Pay -- long before it achieved meaningful adoption -- Apple has charged issuing banks 15 basis points (0.15 percent) for each credit card transaction mediated by Apple Pay. Payment apps from Samsung and [Alphabet] Google are free to issuing banks. Apple's fees are a significant expense for issuing banks and cut into funding for features and benefits that banks might otherwise offer smartphone users. The volume of impacted transactions is large and growing.
In some ways, Apple is a victim of its own success, but that's the nature of antitrust suits. Apple provides more value to its users than ever before, but it will continue to face scrutiny the more it enters new industries like mobile payments.
An uphill climb
The DOJ lawsuit is yet another thorn in Apple's side, especially because it targets the highest growth segment of Apple's business. The lawsuit doesn't break the investment thesis. Still, it could eventually lead to margin compression for Apple.
Apple's other key issues right now include slowing global growth, particularly in China. Apple has also failed to make a splash in artificial intelligence and has largely missed out on the gains that have rippled throughout the tech industry as a result of that theme.
If Apple stock were crushing the market and expensive, then there would be cause for concern, but that simply isn't the case.
Apple is down over 11% year to date compared to a 9% rally in the Nasdaq Composite -- a substantial underperformance considering Apple is the second-largest component in the Nasdaq behind Microsoft. Zoom out further, and Apple is down over the past six months and up less than 10% over the last year.
Apple's price-to-earnings (P/E) ratio is now just 26.6, a discount to the S&P 500's multiple of 28.4. Apple has its challenges, but it's too good of a company to have a lower valuation than the broad market.
Given its challenges, Apple stock could remain pressured in the short term, so there's no rush to dive headfirst into the stock. However, Apple has the qualities of an excellent long-term investment for patient investors, so it's worth opening a starter position, holding, or at the very least, adding to the top of your watch list.
