A forgettable year is drawing to a close for Apple (AAPL 2.38%) investors, who have faced the broader stock market selloff despite the company’s resilient performance amid a weak smartphone market. But 2023 could turn out to be a much better year for the tech giant, as one of its key businesses is likely to step on the gas.
We know that Apple gets most of its revenue by selling products such as the iPhone, the iPad, MacBooks, and other devices, but its services business is paying off in a big way for the company. In fiscal 2022 (which ended on Sept. 24, 2022), Apple reported services revenue of $78 billion. The segment’s revenue jumped 14% year over year and accounted for nearly 20% of the company’s top line.
Apple looks set to sustain the terrific growth of its services business in 2023. Let’s see why that may be the case and how the segment’s growth could help the company’s bottom line.
The services business is moving the needle significantly for Apple
Apple had a massive installed base of 1.8 billion active devices at the end of the first quarter of fiscal 2022. Though the company hasn’t updated that number lately, CEO Tim Cook did point out on the October earnings conference call that Apple set “another record on our installed base of active devices, thanks to a quarterly record of upgraders and double-digit growth in switchers on iPhone.”
So it won’t be surprising to see the company sitting on an installed base of 2 billion active devices, given the healthy demand for iPhones and other devices. A bigger base of installed devices means that Apple can sell its services to more users. This explains why the company’s services revenue has been growing faster than its product revenue.
In fiscal 2022, Apple’s product revenue was up just 6% year over year. But the growing adoption of the company’s wide-ranging services (apps, music, games, TV, cloud, and others), allowed it to finish the fiscal year with 7.7% revenue growth over the prior year. What’s more, Apple reported 9% year-over-year growth in its adjusted earnings per share to $6.11 per share, outpacing its revenue growth thanks to the higher-margin profile of the services business.
More specifically, Apple’s services business delivered a gross margin of 70.5% last quarter. That’s more than double the product gross margin of 34.6% and significantly higher than Apple’s overall gross margin figure of 42.3% last quarter. So the growing influence of Apple’s services business should translate into solid bottom-line gains in 2023 and beyond.
The good news is that Apple’s installed base of active devices could keep growing at a nice clip in 2023, and that should positively affect the services business.
Why the services business could keep growing in 2023
IDC estimates that 233.5 million iPhones may be shipped in 2023, which would be a slight increase over this year’s estimated production target of 220 million units. This also suggests that the installed device base is set to increase once again next year.
However, a new product from Apple could give its installed base a significant boost in 2023 and beyond. Supply chain gossip indicates that Apple could launch an augmented reality/virtual reality (AR/VR) headset in 2023. Rumors suggest that the tech giant could make 500,000 units of its mixed-reality headset in the new year, with each unit expected to be priced at around $2,000.
Assuming Apple can sell all these rumored headsets, it could generate a billion dollars in revenue from a new product line next year. But the bigger play for the company would still be the services business. The company is reportedly working on delivering 3D content through its headsets, according to Bloomberg, with one job listing suggesting that it may be developing a virtual environment akin to the metaverse.
So a mixed reality headset could add another dimension to Apple’s services business. The device will help the company mark its presence in a market that’s expected to take off nicely in the long run. A third-party estimate forecasts that the mixed reality headset market could generate $19.5 billion in revenue by 2026 as compared to an estimated $5.6 billion this year. The growth in sales of mixed reality hardware should open the door for the likes of Apple to sell more services next year.
All this indicates that Apple’s services business is built for long-term growth. It won’t be surprising to see this segment get closer to $100 billion in revenue in 2023, per a Morgan Stanley estimate. That could help Apple overwhelm Wall Street’s expectations in the new year and send its shares soaring, which is why investors may want to take advantage of the 25% decline this tech stock has witnessed in 2022 and buy it before it breaks out.
Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple. The Motley Fool recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.
