Apple (AAPL) will report its third quarter earnings after the bell on Thursday. While the company’s Q3 is generally its least interesting owing to the release of a next-generation iPhone in the coming quarter, this go-around is slightly different.
Apple is dealing with two major problems that are certain to be at the top of analysts’ and investors’ minds. The first is the long-awaited ruling on “remedies” related to the Justice Department’s antitrust lawsuit against Google (GOOG, GOOGL), expected sometime next month, which could cost Apple’s Services business an estimated $20 billion a year.
The second is Apple’s ongoing AI struggles. There’s still no clear indication when the company’s upgraded version of Siri will hit the market, and word that competitors are hiring away Apple’s AI talent isn’t helping investor sentiment.
“From a stock perspective, these execution issues raise a flag: Apple’s ability to drive future growth depends on delivering new capabilities and products on time,” BofA Global Research analyst Wamsi Mohan wrote in a note to investors Monday.
“If deadlines keep slipping, that potentially delays revenue opportunities and gives competitors a larger window to attract customers,” he added.
And getting through both roadblocks could prove to be especially difficult and costly.
Apple’s Google tie-up is under threat
Apple’s most pressing issue is the outcome of the “remedies” portion of Google’s antitrust lawsuit. Judge Amit Mehta of the US District Court for the District of Columbia ruled last year that Google operates as an illegal monopoly in the search space.
Now Mehta is set to decide how to address the matter. The Justice Department has argued in favor of forcing Google to sell its Chrome browser, provide its search data to its rivals, and end search exclusivity deals with smartphone makers like Apple. Google said it’s going to fight the original ruling, so Mehta’s decision could be moot in the long run.
But if Mehta gives the DOJ what it wants and Google fails in its effort to overturn the initial liability ruling, that could have serious consequences for Apple.
Under its exclusivity deal, Google paid Apple $20 billion in 2022 to make Google Search the default search engine in Apple’s Safari browser and across its Siri app, according to court documents.
That cash ends up as part of Apple’s Services revenue, which accounted for $78.1 billion. To put that into perspective, Google’s deal made up 25.6% of Apple’s Services business in 2022 revenue and roughly 5% of the company’s $394.3 billion in total sales for the year.
According to Morgan Stanley’s Erik Woodring, if Apple has to kill its deal with Google and instead opts to pick up deals with other search engine operators, it could face a 12% headwind to its full-year 2027 earnings per share. Using other search engine operators would also hurt the overall user experience, since customers wouldn’t be able to choose Google as a default search option.
If, instead, Apple decides to launch its own search engine, it could see a 20% downside to its FY 2024 EPS, though Woodring admits that scenario is the least likely outcome.
Apple’s AI headache
Outside of its immediate Google problem, Apple is also facing pressure from Wall Street to address its AI shortfalls.
Beyond its Siri delays, Bloomberg’s Mark Gurman reports that Apple is contending with AI researchers defecting to other companies. Four joined Meta in July alone, including the now-former head of its foundation models group.
Apple currently offers its Apple Intelligence service across its various devices, but it hasn’t been enough to impress investors.
“From a stock perspective, these execution issues raise a flag: Apple’s ability to drive future growth depends on delivering new capabilities and products on time,” Mohan wrote in his note.
Wedbush analyst Dan Ives, who wrote in an investor note that Apple is sitting on the sidelines of the AI race while its competitors are speeding by at 100 miles per hour, said the company should purchase OpenAI (OPAI.PVT) rival Perplexity AI (PEAI.PVT).
“Perplexity’s AI algorithms and technology are some of the most impressive in the tech AI world and the current investing round puts the valuation at roughly $14 billion,” Ives wrote.
“If Apple has to pay ~$30 billion, it’s a drop in the bucket relative to the monetization opportunity Apple can achieve on AI in our view,” he added.
But it’s difficult to tell whether a deeper AI push will goose iPhone sales among consumers who generally opt to upgrade their phones based on physical changes, such as better or bigger screens and improved batteries.
“AI is not yet a key sales driver for smartphones, and no one – neither Samsung nor Google – has cracked what a new AI user-interface really means,” Forrester principal analyst Thomas Husson wrote in an email commentary.
“However, Apple is perceived to be late in the game to the point that there is speculation that Apple could acquire AI native players, including French startup Mistral AI,” he said.
If the company is going to win over Wall Street, it needs to give some indication that it’s making moves in the AI space sooner than later.
Email Daniel Howley at dhowley@yahoofinance.com. Follow him on X/Twitter at @DanielHowley.
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