Here's why Apple's upcoming streaming video service won't rescue it from plunging iPhone sales (AAPL)

tim cook

Apple's impending video service is getting a lot of hype.
But even if it's smash hit, the video service won't be able to make up for Apple's declining iPhone sales, Jefferies analyst Tim O'Shea shows in a new report.
In a best case scenario, a video subscription service would only provide about 5% of Apple's revenue, according to O'Shea's estimates.
And there are reasons to think Apple could have a tough time luring customers to its video service.

Apple's upcoming streaming video service won't do much to boost the company's flagging financial fortunes, even if it's wildly successful.

That's the assessment of Tim O'Shea, an analyst who covers the iPhone maker for Jefferies. In a research report late Thursday, O'Shea estimated that if Apple's video service had 250 million subscribers in 2023, it still would account for only about 5% of the company's revenue that year — and wouldn't make up for its declining smartphone sales. By point of reference, after offering streaming video for 12 years, Netflix has 139 million subscribers.

"It's going take a long time for this type of service to really move the needle," O'Shea told Business Insider.

To figure out the potential of the video service, which Apple widely expected to launch next month, O'Shea estimated that Apple would charge customers $15 a month for the offering and would take a 30% cut of the revenue, giving the rest to video production partners.

If the service was extremely successful and hit 250 million subscribers, it would yield $13.5 billion in revenue for Apple. That's nothing to sneeze at. After all, Netflix's total sales last year were $15.8 billion.

But in the context of Apple, such a figure would be just a drop in the bucket. In fiscal 2018, the company posted revenue of $265 billion. Although O'Shea and other analysts expect Apple's sales to drop sharply this year before slowly recovering in coming ones, $13.5 billion would still represent only a small fraction of the company's revenue.

Apple could have a tough time in the video business

Apple has shown with its Apple Music service that it can grow such offerings relatively quickly by tying them closely to iOS, the software underlying the iPhone, O'Shea said. Apple Music now has 50 million paid subscribers and reached that total much quicker than market leader Spotify, he said.

But it's likely that Apple will have a tougher time in video, O'Shea said. The iPhone maker is just one of numerous companies that have or will launch streaming video services in the near future. And it's unclear how many services consumers will sign up for.

Apple's spending a fraction of what Netflix is spending on original shows and movies, meaning that at least at first it will likely be far more dependent than the streaming video giant on third-party content. But the company's plans to take a 30% cut on revenue may not sit well with many Hollywood studios and networks, he said.

"It's hard see how those economics fly," O'Shea said.

Even before the launch of Apple's video service, Netflix has been trying to avoid having to pay the similar commission Apple charges app store developers for subscriptions that come in through their iPhone apps. Netflix instead has been encouraging customers to sign up for its service via its web site.

Apple could find it hard to sign up customers to its own video service if too many production companies balk at offering shows and movies through it. Already Netflix has balked at being a part of Apple's service and HBO has yet to commit to it, CNBC reported.

"There are only a handful of players that make content that matter," O'Shea said. "If you lose one or two of them, it makes your service much less attractive."

The decline of the iPhone business is really hurting Apple

But even if Apple overcomes such obstacles, it faces an even bigger problem — the iPhone. Apple's smartphone sales accounted for $167 billion in sales last year, and the iPhone may be the single biggest product business of any company ever, O'Shea said.

Because it's so huge, even a small percentage drop in its sales can more than wipe out big gains in other parts of Apple's business. And that's exactly what O'Shea and other analysts are expecting to happen this year after Apple saw a 15% drop in iPhone revenue in its first fiscal quarter. For his part, O'Shea expects Apple smartphone sales to fall to $135 billion this year, a drop of more than $30 billion.

Read this: One of Apple's best-known analysts says an all-time low iPhone upgrade rate is going to cause more pain than investors realize

O'Shea is optimistic about Apple's services offerings in general. In addition to Apple Music and the upcoming streaming video business, the company's services include its app store business, the licensing revenue it gets for making Google the default search engine on the iPhone, and its iCloud storage offerings.

The services business "is big, real, and growing," he said. "It's going to be big over time."

But right now, the deterioration in the iPhone business is overwhelming everything else.

"These iPhone declines are by far the dominant trend," O'Shea said, continuing, "Services at this point are not big enough to offset that pressure."

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