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Goldman Sachs just significantly slashed its price target for Apple, predicting 26% downside to the shares because of a “material negative impact” on earnings for the accounting method the iPhone maker will use for an Apple TV+ trial.
“We believe that Apple plans to account for its 1-year trial for TV+ as a ~$60 discount to a combined hardware and services bundle,” wrote Goldman analyst Rod Hall, in a note.
“Effectively, Apple’s method of accounting moves revenue from hardware to Services even though customers do not perceive themselves to be paying for TV+. Though this might appear convenient for Apple’s services revenue line it is equally inconvenient for both apparent hardware ASPs and margins in high sales quarters like the upcoming FQ1’20 to December,” Hall added.
Apple shares slipped 0.5% in premarket trading on Friday from its previous close of $223.09 a share. Goldman cut its 12-month price target on Apple to $165 from $187. The firm has a neutral rating on Apple’s stock.
Hall’s new price target is the lowest of the major Wall Street banks and the fifth lowest of all analysts that cover Apple, according to TipRanks.com.
Apple did not immediately return CNBC’s email request for comment. Goldman is not accusing Apple of improper accounting but believes that hardware profit margins will suffer as a result of this TV+ free trial and investors will react negatively.
Hall explained that Apple has taken “a very similar approach” to its accounting methods before, for so-called “embedded services” such as Apple Maps and its Siri artificial assistant. The Goldman analyst expects the free trial TV+ revenues will add 25% to Apple’s gross margin contribution, which, due to the lower product revenue, will result “in a negative calculated impact to EPS of 16%” for fiscal first quarter 2020, Hall said.
“We currently assume this is an introductory offer that runs for just one year. Should it run longer our out year forecasts would also likely need to be adjusted in a similar way,” Hall added.
Here’s an example of how Hall expects Apple’s accounting will work in this instance. You buy a new iPhone 11 Pro for $1,000 (Hall rounded the $999 price to make the example easier). Apple accounts for the purchase as a bundle, as you’re getting an iPhone 11 Pro and and a year of TV+, valued at $1,060. But the $60 discount for TV+ “is not solely apportioned to the TV+ revenue,” Hall said, and Apple instead proportionally divides the discount to both.
Hall believes the combined discount is 5.7%, or $60 divided by $1,060. Applied to the bundle, the iPhone is discounted to $943.40 (or 94.3% of $1000) and TV+ annual price discounted to $56.60 (or 94.3% of $60). As a result, and assuming the iPhone is not bought with an installment plan, Hall found that, while the iPhone has a lower average price, it also comes at a lower profit to Apple because the cost of goods is not affected by the company’s discount. However, at the same time, Hall expects the discounted TV+ revenue will be credited as “deferred revenue” and then “recognized on a monthly basis over the 12-month trial period,” he said.
“We calculate a possible ~7% negative impact on FQ1 and FY20 [average selling prices] due to this accounting treatment,” Hall said.
— With reporting by Michael Bloom
