ozgurdonmaz
This week, Apple (NASDAQ:AAPL) held its Worldwide Developer Conference (“WWDC”), an annual event that usually showcases the company’s new software and APIs. This year, the event was quite a departure from previous ones. Focused primarily on generative artificial intelligence (“AI”), it generated a lot of hype. People expected a lot from the event and, going by the rave reviews it got, the event delivered.
The main reason why Apple’s event was so well received was because the company took a very different approach to AI than other companies had taken up to that point. Instead of launching one specific AI product (e.g. a chatbot), the company showcased the dozens of little ways AI would be integrated into its existing products. This approach differentiated Apple’s AI solutions from those offered by other companies. Until a few days ago, companies had been launching AI Chatbots that were mostly identical to ChatGPT. Apple took a different approach, integrating AI into every part of its ecosystem. The end result was a very impressive event.
It’s still several months before we can try out Apple Intelligence ourselves. However, we already know that Apple can materially benefit from this deal in several ways. First, there’s the nature of the deal with ChatGPT, which will be powering some of the AI features. There are no up-front fees charged to either party; instead, OpenAI will share revenue with Apple when users sign up for ChatGPT through Apple’s platforms.
Apple has made considerable sums of money this way in the past. For example, Google (GOOG) once signed a deal with Apple to share search revenue in exchange for Apple agreeing to make Google search the default on Apple devices. In the most recent fiscal year, this deal paid Apple $20 billion.
Also, the inclusion of ChatGPT in Apple devices could improve one of the company’s most widely-panned products: Siri. Siri has been in Apple devices for over a decade, and it has been perceived as one of the company’s worst features. Over the years, countless reviewers have complained that Siri’s feature set (e.g. voice recognition, intelligence) is far behind that of the competition. If the new Siri features announced at the WWDC are any indication, then the world’s least-loved digital voice assistant may soon become a lot more lovable.
When I last covered Apple, I rated the stock a hold on the grounds that it had gotten extremely expensive while having no growth. I put my money where my mouth was, too, as I unloaded my position in two lots: one at $184 and one at $192. After watching Apple’s WWDC event, I revised my opinion. Apple’s new AI features will not only increase the appeal of the company’s products, they will also generate new revenue directly in the form of ChatGPT revenue sharing. As a result, the company’s estimated future earnings are higher than they would have been had Apple not announced Apple Intelligence. Accordingly, I am upgrading my rating to ‘buy,’ even though the stock is more expensive than it was when I last covered it.
WWDC Undermined the Bear Thesis on Apple
Apple’s WWDC event significantly undermined the most common bear thesis on Apple–a thesis that I myself previously subscribed to. Most people who have been bearish on Apple over the last few months have been bearish because of valuation and growth concerns. Indeed, it was because of such concerns that I sold my shares. Based on Friday’s closing price, AAPL trades at:
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33 times earnings.
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8.5 times sales.
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44 times book value.
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29 times cash flow.
At the same time, its trailing 12-month growth rates were:
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-0.9% in revenue.
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4.7% in EBIT.
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5.2% in EBITDA.
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9% in diluted earnings per share (“EPS”).
So we have steep multiples combined with slow growth: not exactly thrilling stuff. Furthermore, until the recent WWDC, it was hard to see where future growth was going to come from. As I wrote in my previous article, growth is hard when you’re at a massive scale. Apple already does around $100 billion in annual profit, if it launched a new product doing $5 billion in revenue and a 30% margin ($1.5 billion), that would only increase net income by 1.5%. Such a launch would be a game changer for most companies. It would barely register for Apple. So, I figured that Apple’s dearth of meaningful new investment opportunities would hold back growth going forward. Indeed, I still think that. However, thanks to the terms of Apple’s deal with ChatGPT, it could generate new revenue with no incremental spend whatsoever. That, potentially, could be a game-changer.
Details of Apple’s ChatGPT Deal
The details of Apple’s AI deal with OpenAI are straightforward: the company pays nothing to embed ChatGPT in its products and services. In the meantime, it gets a cut of revenue if people sign up for paid ChatGPT plans through Apple devices.
How much new revenue can Apple generate through this deal?
There are two ways of approaching this:
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By looking at similar deals Apple made in the past.
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By analyzing how much ChatGPT costs and how many signups Apple could drive.
First, the similar deal approach. There is some precedent for Apple’s ChatGPT deal: its 2002 Google deal. In 2002, Google agreed to pay Apple a cut of its search revenue in order to remain the default search engine on Safari. It paid off even more to ward off a similar deal between Apple and Microsoft (MSFT). As of the most recent reports, Google’s deal was worth $20 billion. That’s definitely moving the needle for Apple: net income would be $20 billion less without it (Apple pays nothing so these royalties are pure margin).
This ChatGPT deal looks similar on the surface. First, ChatGPT is new, like Google was in 2002 when it started paying Apple. Second, the company is already fairly large, boasting 180 million users. Third and finally, Apple’s 1.5 billion users are a large audience that Apple could push toward ChatGPT. The end result could be a deal that, over time, comes to be worth almost as much as Apple’s Google Search deal (if not more).
Secondly, we can look at the potential based on ChatGPT’s pricing. ChatGPT (the most basic plan) costs $20/month, or $240 per year. According to MailChimp, 2% to 5% is a good conversion rate. Apple is known for its marketing prowess, so it can probably achieve conversions in that range. If Apple converts 2% of its customers into ChatGPT subscribers at $240 per year, it generates $7.2 billion in new revenue. If it converts 5% of its customers into ChatGPT subscribers at $240 per year, it generates $18 billion in new revenue. If the split is 50/50, then the potential revenue for Apple here is between $3.6 billion and $9 billion. Not quite as lucrative as the Google deal, but not nothing.
The AI Features Look Good
On a concluding note, I should add that the AI products Apple rolled out at WWDC were very unique. They included:
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Large language model (LLM) in Pages (Apple’s MS Word alternative).
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A re-writing tool that lets the user see the same text in different “tones.”
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A DALL-E based Emoji generator.
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A tool that ranks emails by urgency (how important Apple’s AI determines them to be).
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A related tool that prioritizes notifications by urgency.
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Automatic phone call summaries.
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An image playground similar to DALL-E integrated directly into messages.
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ChatGPT built into Siri.
Many of these features will certainly sound familiar to longtime Apple users, but the level of integration is something that hasn’t been seen before. For example, with the image generator being built directly into iMessage, people can send images the second they’re created. Plus there are all the “little details” like the notification ranking and emoji generation that make the integration of AI into Apple products all that more complete.
So, we have a model for $3.6 billion to $20 billion per year in new revenue per Apple, plus a host of new features whose exact benefits can’t be modeled, but may indirectly help Apple with customer retention and time-on-screen. On the whole, this collection of future benefits appears big enough to justify a re-rate. Accordingly, I now consider Apple stock a buy, despite it having run up since I last covered it.