Antitrust action is being considered against Apple (AAPL) for its alleged monopolistic practices in its App Store, raising more red flags for shareholders.
Apple's litigation issues on home soil are remaining quieter than concern over Qualcomm (QCOM) on Monday, as a myriad of bad news from Beijing pours in for the Tim Cook-led company. As the company draws about 18% of its revenues from mainland China, the apprehension is justified, and shares have reacted accordingly.
Yet the implications of the antitrust action considered under Apple v. Pepper, which heard opening oral arguments just two weeks ago, poses a larger problem for the company that continues to move away from being simply a hardware company.
The litigation, which has been progressing slowly over recent years, threatens to create competition and constrain services revenue that recently reached $10 billion in the company's fiscal fourth quarter.
The case began with a filing by Robert Pepper and three other iPhone users in 2011. The users were disgruntled about Apple's terms of service and essential monopoly on apps, which they contended had driven app prices higher.
The case has gone back and forth through the courts with Apple winning a decision before that was overturned by the U.S. Court of Appeals for the Ninth Circuit.
Following that decision, an appeal by Apple has left the case at the feet of the highest court in the land.
Services Size-Down
Apple's services segment, which includes App Store, Apple Pay, iCloud, and Apple Music, has become a serious thesis for investment in Apple amidst its challenges, especially as revenue has reached record levels.
The company has also set even higher targets for 2020, creating a bullish feeling around Apple's non-hardware offerings in recent quarters.
"This is exactly why I am in the name. Subscription services," long-time NYSE trader and Real Money contributor Stephen Guilfoyle wrote in his column on Monday morning, summing up the sentiment.
Guilfoyle echoed the sentiment of Morgan Stanley analyst Katy Huberty, who proposed that services will act as a mooring through the shaky waves of iPhone sales.
While the company does not break out the revenue of each component of the segment, the 30% cut the phone giant takes on all first year apps and the 15% cut on sales of apps with more than one year under their belt, the revenue available is assumed to be a remarkable one.
As such, the App Store plays a central role in Apple's revenue acceleration amid deceleration in phone sales as it can act as a way to keep phones up to date amid longer user cycles for the actual phone hardware.
What the current Apple v. Pepper case being heard in front of the Supreme Court at present would mean is a breakdown of the company's stranglehold on the app market and an almost certain deterioration of the company's exorbitant app distribution pricing model.
Where We Stand Before the SCOTUS
Apple, not keen to see its App Store knocked out of its dominant position, has chased the case up to the Supreme Court on the argument that only app developers are in a direct relationship with Apple, not iPhone users.
The case draws from the Illinois Brick Co. v. Illinois case which was ruled on in 1977 which established that indirect purchasers of goods or services along a supply chain cannot litigate for antitrust actions committed by the manufacturer or service provider. If accepted, the plaintiffs would have no case.
Unfortunately for shareholders, recently published transcripts from the Supreme Court do not paint a promising picture for Apple.
Justice Elena Kagan explained her reasoning during opening arguments on November 26 as follows:
"When you're looking at the relationship between the consumer and Apple, that there is only one step. I mean, I pick up my iPhone. I go to Apple's App Store. I pay Apple directly with the credit card information that I've supplied to Apple. From -- from my perspective, I've just engaged in a one-step transaction with Apple. And when I come in and say Apple is a monopolist and Apple is charging a super-competitive price by -- by extracting a commission that it can only extract because of its market power, I mean, there's my one step."
Judge Stephen Breyer joked that given his octogenarian status, there were many words in the filing that he did not quite understand. He simplified the problem through analogy:
"If Joe Smith buys from Bill, who bought from the monopolist, then we have something indirect. But, if Joe Smith bought from the monopolist, it is direct. That's a simple theory."
Justice Sonia Sotomayor also appeared firmly in the corner of app consumers, chiding Apple's arguments:
"More generally about Illinois Brick...That was a case of a vertical monopoly: A concrete block person, manufacturer, monopolizes the next intermediate market who then sells to a customer... This is not quite like that. This is dramatically different. This is a closed loop."
Perhaps only Justice Neil Gorsuch offered any support to the Illinois Brick contention, though he even questioned the very precedent of the decision itself, making his endorsement of the argument an unstable one.
So, while much of the market is eyeing China and its courts' impositions on the company, there may be bigger legal problems that lie in wait.
