Apple WWDC First Look: Why Streaming Music Will Dominate

First of all, Merrill Lynch has a Buy rating for Apple, but that was not the point of this call. The firm also has a price objective of $145.

In the current model, iTunes runs on a pay-to-own model that transfers rights of ownership to customers who purchase the song or album. With Apple Music, the brokerage firm expects Apple to retain the ability for customers to pay for and download songs, but to lean more heavily on subscription-based streaming.

Apple has the chance to differentiate itself by having people curate songs, signing exclusive deals with artists and providing artists with more visibility to their fan base. At the same time, it provides a social media platform for interaction with their fans.

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In the report, Merrill Lynch detailed:

Revenue from music downloads has declined from over 80% of iTunes revenue to around 50% masked by the growth in the App store up from 20% to about 50% of iTunes sales. We attribute a part of this decline in music downloads to the growing popularity of streaming audio. At WWDC 2015, we expect Apple to launch a new streaming music service “Apple Music”, which unlike some competing offerings will require a paid monthly subscription vs. having a free advertising-supported version.

The firm estimates the earnings per share impact from Apple Music to be roughly $0.40 for every 100 million subscribers. There are over 1 billion iOS devices sold, but Spotify has only about 15 million paying subscribers.

For the most part, Apple’s stock does well heading into the conference, but it typically declines 2% to 3% on the day of the event, and then does well 30 days out. During the keynote, in addition to the launch of Apple Music, Merrill Lynch expects an update on the Apple Watch potentially allowing third party apps to run natively on the S1 chip. There is also the possible launch of an Apple TV service and an updated Apple TV set-top box that will allow third party apps, although recent media speculation points to a delay.

Merrill Lynch described its investment thesis as follows:

We rate Apple Buy on: 1) strong iPhone product cycle 2) development of new revenue sources like Apple Pay, Apple watch, home/health kit etc, and 3) optionality provided by a significant cash balance that can help accelerate innovation into new markets.

Shares of Apple were down 0.6% at $128.65 on Friday’s close. The stock has a consensus analyst price target of $148.75 and a 52-week trading range of $89.65 to $134.54.

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