Here's What Apple Investors Can Learn From Adobe

MarketsMotley Fool

It's been a brutal few months for Apple (NASDAQ: AAPL). After becoming the most valuable U.S. company ever, and briefly topping a $1 trillion market cap, things turned south. A growing trade war with China, a stock market in correction, and fears about slowing iPhone growth have taken the wind out of this highflier, which has lost nearly a third of its value.

A recent decision by Apple -- that it would no longer report unit sales figures for its iPhone, iPad, and Mac devices -- has many investors convinced that we've reached peak iPhone sales, dimming the company's prospects going forward.

Continue Reading Below

There is, however, an interesting -- if somewhat imperfect -- parallel that can be drawn to a change in strategy several years ago by creative software specialist Adobe (NASDAQ: ADBE), that holds an important lesson for Apple investors.

A lesson from the past

Back in 2012, Adobe made the somewhat radical decision -- at the time -- to offer a $50-per-month subscription to its suite of creative tools, alongside the more traditional sales of cellophane-covered boxes with a compact disk and a perpetual license for its software. Some customers were enthusiastic about the new approach and just one year later, Adobe made the controversial decision to discontinue its traditional software sales, moving solely to the cloud-based subscription model.

There was an immediate outcry from many core users, and more than 50,000 signed a Change.org petition, urging Adobe to reconsider the move. Shareholders took flight as revenue fell by nearly 8% year over year in 2013, and grew just 2% the following year.

In hindsight, of course, the move was brilliant. Adobe has achieved year-over-year growth of 20% or greater for 14 consecutive quarters, going all the way back to Q3 2015. That success is built almost entirely on recurring revenue, which now accounts for more than 90% of Adobe's total sales.

What's this got to do with Apple?

Apple has been trying to change the narrative for several years now. By early 2017, services had become a much more important part of its business. CEO Tim Cook hinted at the potential and made a somewhat ambitious pronouncement:

At the time of the announcement, services had generated $25.5 billion over the trailing four quarters and represented just 9% of Apple's annual revenue. Fast-forward to the fourth quarter of 2018, that has jumped to $37.2 billion and 16% of sales. Growth in the segment has been impressive, recently up 24% compared to the prior year -- while iPhone unit sales were flat.

More subscription revenue in Apple's future?

This correlation to recurring subscription revenue like Adobe may be closer than it appears at first glance. Apple has been increasingly hawking subscriptions to services like iCloud, Apple Music, and third-party services, and could potentially include an as-yet-unannounced video streaming service that could debut as early as next year.

Goldman Sachs analyst Simona Jankowski has suggested that Apple "launch a subscription bundle as a way to reinforce iPhone loyalty and leverage it into content." She calculates that by bundling numerous a la carte services like Apple Music and Apple TV into a streaming subscription that includes an iPhone, the company could generate an additional $19 billion in revenue by 2021.

Jankowski isn't the first to propose a bundle. Morgan Stanley analyst Katy Huberty calculated that an Apple media offering that included the company's video content, Apple Music, and its Texture news and magazine service could grow by 21% annually and generate $37 billion by 2025.

The wave of the future

While the analyst's ideas are merely guesswork, it's clear that Apple is pursuing recurring revenue in the form of subscriptions, much like Adobe did several years ago. Apple hasn't revealed the full extent of its plans, and investors don't yet know how it will play out, but the move could eventually be more lucrative -- over the long term -- than the iPhone itself.

Find out why Apple is one of the 10 best stocks to buy now

Motley Fool co-founders Tom and David Gardner have spent more than a decade beating the market. (In fact, the newsletter they run, Motley Fool Stock Advisor, has tripled the market!*)

Tom and David just revealed their ten top stock picks for investors to buy right now. Apple is on the list -- but there are nine others you may be overlooking.

Click here to get access to the full list!

*Stock Advisor returns as of November 14, 2018

Danny Vena owns shares of Adobe Systems and Apple. The Motley Fool owns shares of and recommends Adobe Systems and Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.