On March 25, in collaboration with Goldman Sachs (GS) and MasterCard (MA) , Apple (AAPL) announced the Apple Card, a rewards card offering exclusive to Apple users. While the details of the offering are relatively well known at this point (2% cash back on everything when purchased with an iPhone, 1% using the physical card and 3% on purchases of Apple products/services), we don't believe the opportunity is being fully appreciated by the market.
To be clear, this isn't the most attractive card on the planet from a rewards perspective and depending on one's purchase categories there may be better offers out there (something members can gain better insight to here). Regardless, we believe the opportunity available to those companies involved is not being fully reflected in the stock prices of those names.
So, let's take a look.
To truly understand all the dynamics in play, let's first look at how a credit card works.
In the case of the Apple Card, there are three players, Apple, the company responsible for designing and marketing the card; Goldman Sachs, the financial institution responsible for extending the line of credit; and MasterCard the payment processing company responsible for ensuring acceptance everywhere you shop.
These three companies must work together to develop an offering that will convince buyers that this card is a "must have" -- and the incentives for each vary depending on which company you focus on.
With regard to Apple, the incentive to create an amazing experience is based on the following reasoning. If Apple can provide buyers with a better understanding of their spending habits and in turn help those consumers gain deeper insights into their financial decisions, and make that ability/experience exclusive to iPhone users, the company makes its ecosystem stickier. Remember, when it comes to consumer tech companies it's all about the ecosystem, which drives services adoption.
In turn this will make the switching costs -- think the decision to jump ship and buy an Android smartphone -- higher. Additionally, by offering attractive rewards and an increased level of cash back when using the Apple Pay app, Apple is able to further incentivize use of its digital wallet, which has its own revenue dynamic that we will discuss in more detail below.
As for Goldman Sachs, it's well known by now that the investment bank is making a big push into the consumer space via its Marcus operations. However, being that the firm has never released a credit card before, gaining market share and a presence in wallets (and digital wallets) around the world is no easy task and can be incredibly costly when taking into account the marketing expense. That is, unless you partner with a company that already has an installed base of ~1.4 billion and growing, as is the case with Apple.
Now, it is also worth noting that because Goldman Sachs is the bank extending the line of credit, the firm is also the one taking on all the risk. If a consumer defaults on their card loans, it's Goldman that takes the hit.
So, what do they get in return?
Well, for starters, access to the massive installed base we just mentioned. But in addition to that, Goldman gets to build out its consumer loan book, because every time the card is swiped and a consumer decides to run a balance on their credit card, Goldman gets to check that off as another loan extended and charge interest on those loans.
We should also note here that in 2018, Business Insider flagged a study from the National Bureau of Economic Research in which the researchers stated, "across all years in our data, no individual brand is as predictive of being high-income as owning an Apple iPhone in 2016," adding that "knowing whether someone owns an iPad in 2016 allows us to guess correctly whether the person is in the top or bottom income quartile 69 percent of the time." That's an attractive selling point for a bank like Goldman Sachs, which is already viewed as the premier financial institution for high-net-worth individuals and, again, is bearing all of the financial risk.
Finally, there is MasterCard, the payment processor. While MasterCard isn't responsible for marketing the card or bearing the financial risk, this is the company that ensures it is accepted, globally.
Every time there is a transaction, MasterCard process that payment and takes a few points off the top (its fee). The fee is simply a percentage of the transaction amount. Like Goldman, the reason to partner with Apple is because that massive installed base, coupled with the higher-earnings status associated with Apple users means that the partnership could aid MasterCard in boosting the gross dollar amount processed.
At this point it's worth flagging data from statistics portal "statista," in which research indicated that while Android users (via Google Play) download more apps that Apple users, Apple users spend close to twice as much money on apps compared to their Android counterparts.
Given that one metric, it makes sense that MasterCard and Goldman Sachs would want to partner with Apple. If MasterCard can be the primary processor of App store purchases, and Goldman Sachs the primary payment method (seeing as the Apple Card will sit in the Apple Pay wallet, which will be linked to the Apple App Store as a form of payment), both companies can gain another path toward growing gross dollar volume processed (or charged), in the app economy, which is in rapid growth mode as mobile commerce continues to become more prevalent.
Thinking even bigger, we remind members that Apple did $265.6 billion in sales in 2018, roughly 4.5% of the gross dollar volume processed by MasterCard in 2018. And while that may seem like a small amount, it's important to remember that we're talking in billion/trillions of dollars, so every percentage point is significant in terms of absolute dollars.
As consumers adopt the Apple Card, a no brainer if you're already buying Apple products, the growth in Apple sales can become even more material as it relates to MasterCard's gross dollar volume processed and Goldman Sachs' ability to increase payment volumes charged to the card and as a result, interest fees generated off the resulting loans.
The takeaway from here, in our view, is that while Apple may have been the one to announce and brand the card, the real winner here is likely to be Goldman Sachs. While Apple has added an additional service that should increase the attractiveness of owning an iPhone and incentivize use of the Apple Pay app, Goldman is the company that could see the biggest impact to its bottom line as the card paves the way for Marcus to really start attacking the consumer market.
We believe MasterCard is also a major beneficiary, but the actual quantifiable benefit to the company will depend on how many customers it can bring on to its platform without cannibalizing the use of other MasterCard-branded cards. With that in mind, let's look at some of the numbers.
The Nitty Gritty
Ok, so now that we understand how the credit card business works for each of the players here and why these big names have come together to create this offering, let's see if we can quantify what all of this means.
First off, we must understand that the actual worth to all three companies ultimately comes down to consumer adoption. So, let's start there.
As noted above, Apple currently has an installed base of roughly 1.4 billion devices. However, given that many of these devices has been in use for several years, let's focus on the 2018 sales numbers; the thinking being, if you're going to buy an Apple device, you may as well sign up for the Apple Card and get your 3% cash back. This should help give us some idea of initial adoption potential in the first year or so.
In 2018, Apple sold 217.7 million iPhones, 43.5 million iPads, 18.2 million Mac computers and an undisclosed amount of Apple Watches, AirPods and other accessories. So, in aggregate, the company sold over 279 million devices in 2018 (and that's not accounting for Services or accessories sales whatsoever).
Even if we assume that there were four devices sold per credit card ( the thinking being we want to stay conservative and assume things such as consumers buying multiple devices or family plans where all the devices are purchased on a single card), we're still looking at a potential adoption rate of roughly 70 million (or 5% of Apple's 1.4 billion device installed base) -- strictly based on the assumption that buyers will jump for the card because it has no fee, is immediately accessible and saves buyers 3% on their Apple products purchase. And again, this is working off of what we believe to more conservative numbers.
Compare this potential 70 million membership number to Costco's COST (the third largest retailer in the world) 96.3 million total cardholders (up from 53.5 million in 2008, 75 million in 2014 and 87 million in 2016) across 52.7 million households (as of 2Q19 - up from 44 million as of 2016) and we begin to understand just how big the "Apple Club" really is. Once again, we believe we are being conservative in our 70 million estimate, especially over the long-term as the dollar amount spent on Apple Services (per person) increases as services are added and the incentive to pay for those services with an Apple Card grows as a result.
Interestingly, just for fun, we also ran a 24-hour Twitter poll asking people whether they had any interest in signing up for the card. As seen in the poll results below, while there was indeed a large amount indicating that there are, in some instances, better deals to be had (as we called out above) or hadn't even heard of the card yet, a solid 34% said they either would be signing up for the card or have already done so ahead of the summer 2019 launch.
If we were to apply these metrics to the quantity of new products sold in a year (34% of 279 million), we would be looking at potential signups of nearly 95 million. And while we realize that 1,213 votes is far from representative of the entire Apple customer base, we do believe it points to a solid level of interest in the new card. It also serves to increase our confidence that the cardholder opportunity available to the companies involved is significant and not properly being appreciated by investors as there is likely a "flywheel" effect associated with the signups, something we will dig into more below.
We would also note that from a security standpoint, the Apple offering sets itself apart from the competition as the physical card will come with no identifiable marks other than the cardholder's name (no CVV, number, expiration date, etc.). This helps to reduce the ability for thieves to go on an online spending spree (where all the necessary information is generally available on the face of most cards), though these metrics are all available on the digital app, which by the way, also allows cardholders to freeze their card or order a new one in the event of loss or theft.
From a customer service perspective, Apple is also looking to make support as easy and hassle free as possible by enabling members to message support directly from their phone via text.
The intangible that we haven't accounted for in this adoption estimate is the status symbol associated with a titanium, Apple/Goldman Sachs credit card. Even if you never use it, that's a card that many people would no doubt like to see in their wallet, especially given that there is no annual fee for holding it.
We have included the following table (based on 2017 numbers) to better illustrate what this opportunity could mean to Goldman Sachs relative to competitors.
Source: ValuePenguin by lendingtree
Ok, now that we have an idea of the adoption potential and factors such as security, support and status that should further aid cardholder uptake, let's look at how the new card can reasonably be expected to impact sales and earnings.
How Apple Makes Money
While we believe the stickier ecosystem is a huge factor in Apple's motivation to revamp the credit card experience, there are several ways the card can lead to increased services revenues -- the "flywheel" effect we mentioned above.
First, there is the fact that a 3% instant cash back reward on Apple purchases serves to make everything in the App Store 3% cheaper, instantly. With lower prices, generally comes higher demand, so the discount factor alone can result in an uptick in user spending in the App Store and other service offerings.
Additionally, as noted above, there is the Apple Pay dynamic. Apple charges 15 bps (or 0.15%) for every purchase made with Apple Pay, the company's digital wallet application (regardless of the actual credit card used). While this does not directly tie into the Apple Card, the launch of the new card, which again provides 2% cash back ONLY when used in conjunction with Apple Pay, can certainly lead to increased use of digital wallet, and therefore an uptick in the fees paid to Apple as consumers seek to prioritize use of the Apple Pay app in pursuit of the full cash back reward.
The final piece to keep in mind is that by funneling Daily Cash rewards back into the Apple Pay wallet, users will be forced to again utilize the wallet in order to spend their rewards, leading to additional transaction volumes.
Source: Morgan Stanley Research
How Goldman Sachs Makes Money
Now that we have an idea of the adoption opportunity and how Apple stands to see the new card boost its Services business, let's consider what this could all mean for Goldman Sachs.
The tricky part here is figuring out what kind of yield Goldman Sachs may be able to generate off the Apple Card. Since the bank has never issued a branded card before, we don't have an existing portfolio to work off. However, since we're looking at Apple and the Apple Card from the perspective of a club and the Costco Club card is currently backed by Citigroup (C) , let's use that as our comparison, a solid choice given Citi's fantastic consumer business that Goldman would no doubt love to emulate.
According to Citigroup's 2018 10-K, Citi-branded card purchase sales (think gross dollar amount charged to Citi-branded cards) totaled $344 billion. From this, Citigroup ultimately loaned out $88 billion (the aggregate amount of dollars that consumers racked up on their cards and did not pay in full, i.e. borrowed from Citigroup). This in turn, led to $8.6 billion in revenue being generated by Citigroup off their branded card business, resulting in net income of $1.58 billion on branded cards alone.
While we don't expect the same dynamic to be instantly available to Goldman Sachs, as Citi's branded card business includes multiple partners in addition to Costco, such as Home Depot (HD) , Sears (SHLD) , American Airlines (AAL) , AT&T (T) and more), it starts to become apparent that this deal is potentially worth hundreds of millions of dollars annually to Goldman Sachs' bottom line -- depending on adoption, and the balance consumers choose to let run on their credit card.
If Apple can capture just half of its annual sales on the Apple Card, we're already talking about purchase sales to Goldman of nearly $130 billion. And this does not include those made outside of Apple using the credit card (such as transportation, which is a massive addressable market that we will discuss in more detail below), which consumers will be incentivized to do because in addition to 2% cash back, the reward is instantly credited to their digital wallet as "Daily Cash," an especially enticing offer for those who do run a credit card balance, as cards like the Citi Double Cash Card (which also gives 2% cash back on all purchases) provides the reward in two parts, 1% when you buy and 1% when you pay.
One other aspect that can't be stressed enough is that while all the numbers noted above already provide a nice overview of the opportunity, none of it accounts for the fact that this offering is not simply a financial play, it's a fintech play.
As members know, we are huge fans of the rapidly growing digital payments space, which according to Dan Schulman, the CEO of PayPal (PYPL) , could ultimately prove to be a $100 trillion (yes trillion, with a "T") total addressable market. And this really is where Apple's, and as a result, Goldman Sachs' edge comes into play.
Not only does the card offer all the rewards and status noted above, but perhaps more importantly, Apple has coupled it with a robust digital experience that provides users with a better understanding of everything from purchase activity, to the amount of interest they will pay based on how fast they work down their balance.
We should also note that Goldman Sachs has a similar offer that looks to go beyond the analysis of one credit card's activity and provide users with a full financial profile via its Clarity Money app. As a result, we would not be surprised to see further collaboration on the digital front, a factor that should serve to further increase the stickiness of the Apple ecosystem while at the same time increasing the attractiveness of Goldman's consumer offering, Marcus.
Goldman's Consumer Opportunity
Regarding the benefits this partnership brings to Marcus (the consumer arm of Goldman Sachs) specifically, while Goldman has done a lot to grow the business, including offering up some of the best savings account and credit deposit rates in the industry, the one thing it has lacked until now is a card (credit or debit). That one hole in the business has held it back because while the interest rates may be attractive, consumers looking to have an account and charge to that account at bricks-and-mortar locations have, until now, been unable to do so; i.e. money into the account is no problem, but spending that money has required a third party since no credit/debit card means nothing to swipe and no numbers to use when entering card information online.
Simply put, the lack of a Goldman card has until now meant that customers needed to sign up for an offer from a separate institution, be it a credit card provider or digital service such as PayPal (all of which would be netting profits that could otherwise go to Goldman). The ability for Goldman to now offer a more complete banking service coupled with a credit card, means consumers can now look to the bank for nearly all of their needs, be it spending or saving.
To better illustrate what this means to Goldman's bottom line, consider this scenario. Until now, if you were to have an account with Marcus and credit card with, say, Citigroup, while you could link the Goldman account to the card to pay off the balance, any loan amounts left on the card and the interest associated with that card would completely bypass Goldman, going instead to the financial institution behind the card. The Apple Card solves this problem by allowing Goldman to be the supplier of the loans associated with the running balance and collect the interest fees on that balance. And as we noted above, this can be worth potentially hundreds of millions to the bank's bottom line, even before accounting for additional consumer cash inflows as Marcus becomes a more widely recognized and viable option versus traditional consumer banks such as Citi, Chase (JPM) , Bank of America (BAC) or Wells Fargo (WFC) .
That said, the one thing we would still like to see from Goldman is a checking account and debit card. However, additional account features aside, we believe this to be a significant upgrade to the bank's offerings as it enhances accessibility from a spending standpoint. This is the partnership Goldman has needed to really jump start Marcus and we don't think that aspect is being fully appreciated in the still beaten down share price.
Implications for MasterCard
While we touched on the benefits to MasterCard above, we chose not to further speculate on the amount of new business created as there is a cannibalization factor to be considered, making the numbers nearly impossible to estimate without more data. The thinking here is that although millions may sign up for and use the Apple Card, that means they aren't using another card potentially backed by MasterCard. For example, the Citi Double Cash Card is also a MasterCard and as a result jumping ship from one card to the other would likely not net out too much of a gain for MasterCard. That said, this is a major win for the company as it can potentially help to solidify the company's standing as it relates to Apple products and services purchases (recall, the App Store metrics noted above) and provide an opportunity to steal share from competitor Visa (V) .
Our view is if consumers jump from one MasterCard to another, it's no gain or loss to MasterCard, but if they jump ship from anywhere else, be it American Express (AXP) or Visa, then they're stealing share, something that should make shareholders very happy.
We would also note that Visa currently has the Amazon account, so getting the Apple account -- and as a result exposure to a likely significant portion of Apple Pay transactions -- is a huge win for MasterCard. It provides MasterCard with strong exposure to eCommerce and mCommerce (mobile commerce) thanks to the growing acceptance of Apple Pay, in apps, online and at bricks-and-mortar locations.
Another Path to Growth
Finally, it's always fun to consider new growth opportunities. We'll focus on Goldman Sachs for this as the real value to Apple from any initiative is simply to increase the utility and stickiness of its ecosystem and anything that benefits Goldman inherently means an enhancement of the Apple ecosystem. In other words, if through our analysis we can determine benefits to Goldman Sachs, we are by default acknowledging that these benefits come as a result of consumers sticking with or switching to Apple products and increasingly turning to the Apple Pay app, which, as noted above, provides Apple with 15bps on every transaction.
Given that Apple already told us that contactless transportation payment systems are on their way later this year (they already in use in select cities including Chicago and Portland, and starting to pop up in New York as testing commences) this feels like a realistic and logical addressable market to dive into. For the purposes of our analysis, let's consider the impact to Apple when the new system makes its way to New York.
According to the New York City MTA's website, in 2017 total subway ridership was just over 1.7 billion, transit bus ridership was just over 600 million and bus ridership was roughly 120 million. So, in total there were over 2.4 billion MetroCard swipes, in 2017, in New York City alone. This led to a total of $6.17 billion in passenger fares.
Source: Comprehensive Annual Financial Report for the Years Ended December 31, 2017 and 2016
So, in New York City alone, Apple has an opportunity to disrupt over $6 billion in transaction volume via its contactless payment initiative. And while the ability to use an iPhone can certainly further aid in making the platform "stickier," the implications for Goldman Sachs are even greater.
If we consider that the MTA's MetroCard will essentially become a digital account on the iPhone, then we can also assume that it will be reloaded via a payment method found in the Apple Wallet, with Goldman Sachs clearly looking to be that default payment method. Therefore, the bank is potentially setting itself up to take on a decent amount of the billions of dollars (again this is just New York City) in transaction volume. Should even a small percentage of those purchases result in running credit card balances, Goldman could be looking at another avenue towards hundreds of millions in loan interest profits.
Additionally, to get an even better idea of the transit opportunity available domestically, we note that according to the American Public Transit Association (APTA), "public transportation is a $68 billion industry" with riders boarding public transportation "35 million times each weekday," amounting to 10.1 billion trips in 2017 alone. The opportunity only becomes more impressive when we consider that Apple is a global company with the ability to disrupt transit payment systems in countries around the world thanks to the mass adoption of the iPhone.
That said, we must keep in mind that ride-sharing services such as Lyft LYFT and Uber do pose a competitive threat to mass transit. However, from Apple's, Goldman Sachs' and MasterCard's perspectives this should prove largely immaterial as ride-sharing apps exclusively utilize digital payments and therefore provide an opening for Apple Pay. Either way, the growing use of digital/mobile payment options available in the transit industry, be it mass transit or ride sharing, plays to the benefit of those companies with exposure to the potentially $100 trillion digital payments market (when accounting for all forms of payment slowly shifting to digital, not only the transit associated ones).
The Bottom Line
The payments industry, especially as it relates to digital payments is in secular growth mode. We believe that although there is significant competition in the space, Apple and Goldman Sachs are right to team up and attack the industry head on as the purchase volumes are only expected increase, globally. While we do not view the space playing out in a winner-take-all scenario, we believe that thanks to the premium branding, consumer loyalty and differentiation provided by Apple's digital wallet app and Goldman Sachs' Clarity Money app, the two companies are now in a prime position to become dominant forces in the rapidly growing industry.
Source: Nilson, 2019
All in all, this is a massive opportunity for all the companies involved and one that we believe will become more appreciated by the market over time as we approach the launch later this year (summer 2019).
As a result, we continue to view Apple as an "own, don't trade holding" and believe Goldman Sachs to be massively undervalued, with little credit (no pun intended) being given to its budding consumer business, which thanks to this partnership is set to ramp. In addition, we are closely eyeing shares of MasterCard, which is a Bullpen name, for an opportunity to initiate on weakness.