By Tim Higgins 

The Justice Department's attempt to punish Google for its competitive practices in internet search could end up taking a major toll on a different tech giant: Apple Inc.

A multibillion-dollar deal in which Google pays to be the default search engine on Apple's iPhones and other devices is at the heart of the case the U.S. government filed last week against Google. That deal is also at the heart of Apple's services unit, which has been the biggest contributor to its growth over the past several years.

The government has pointed to the deal, whose history dates back 15 years, as an example of how Google, a unit of Alphabet Inc., uses its giant profits to block out competition -- a contention Google denies. For Apple, it has been a lucrative illustration of the value of access to the more than 1 billion global users of its devices. And while the outcome of the Justice Department's suit -- which could take years to play out -- is far from clear, analysts and investors say losing that deal could be a sizable blow to Apple, given estimates that Google's payments account for up to a fifth of the iPhone maker's overall profit.

"There's a risk, if you play it out, that there actually could be more financial impact to Apple than there is for Google," said Toni Sacconaghi, an analyst for Bernstein, said in an interview. He estimates that Apple's stock could fall as much as 20% if the deal with Google were to be eliminated entirely. At the same time, he and others say, any damage could be far less if Apple is able to offset it through other deals involving Google and its competitors, as many investors and analysts say could happen.

Investors seemed to shrug off the threat last week when the Justice Department's lawsuit against Google was revealed. Apple's shares rose that day.

Mark Stoeckle, chief executive of Adams Funds, which counts Apple among its largest holdings, says that it could be a long time before the legal case is decided, and questions whether what Google is doing with Apple is any different than a consumer-goods company paying a grocery store for better placement on their shelves.

"There is no question that if this arrangement were to end it would be a negative for" Apple, he said in an email, but at this point he thinks the risk for Apple is manageable.

Apple didn't respond to a request for comment on the Justice Department's lawsuit, which doesn't accuse it of wrongdoing. Google has disputed the lawsuit's claims, saying users turn to its search engine because it is the best and not because they can't find alternatives.

Last week, Kent Walker, Google's chief legal officer, said in a blog post that the Apple relationship is "no different from the agreements that many other companies have traditionally used to distribute software."

The two companies first struck a deal in 2005, when Steve Jobs was still Apple's CEO, to make Google the default in Apple's Safari web browser on Mac computers. The deal expanded with the arrival of the iPhone two years later, according to the government's lawsuit.

The companies have never made public the exact terms of the deal. Information about large payments from Google to Apple emerged in 2016 during an unrelated court fight involving the search giant, during which it was mentioned in court proceedings that Apple received $1 billion in 2014 as part of the arrangement.

The number grew sharply after that, analysts say, though they vary on its exact size. The government's lawsuit points to public estimates that Google pays between $8 billion and $12 billion annually for the arrangement, and said it represents 15% to 20% of Apple's profit.

Apple reported $55.26 billion in profit for the fiscal year through September 2019, a number analysts estimate grew slightly in the past year. The company is scheduled to report its fiscal 2020 results on Thursday.

Google also has much at stake if the government's antitrust action were to disrupt its Apple deal. Apple devices originated almost 50% of its search traffic last year, according to the government filing. Analysts including Mr. Sacconaghi have speculated that Apple might develop its own search business to compete for advertising dollars, perhaps through the acquisition of DuckDuckGo Inc., a small search engine that -- like Apple -- emphasizes privacy. Any such move would add a potentially powerful new competitor for Google, which overwhelmingly dominates search rivals including Microsoft Corp.'s Bing and DuckDuckGo.

DuckDuckGo didn't immediately respond to a question about Apple.

The revenue stream from its Google deal, which is essentially pure profit, has bolstered Apple CEO Tim Cook's effort to redirect the company as it has faced stagnating sales of iPhones, which make up about half of the company's revenue. The number of iPhones sold peaked in fiscal 2015, while revenue peaked in fiscal 2018 at $167 billion.

The Google deal accounts for a big chunk of Apple's so-called services business, which has soared to what analysts estimate to be $53 billion in the past fiscal year from about $20 billion in fiscal 2015.

Daniel Morgan, a senior portfolio manager who focuses on technology at Synovus Trust Co., which counts Apple among its largest holdings, said there may still be a way for Apple to collect some of the money in a scenario that might have multiple search engines paying for placement.

In Europe, for example, Google now gives users of Android phones the option of which search engine to use after losing a fight with regulators there.

 

(END) Dow Jones Newswires

October 25, 2020 17:05 ET (21:05 GMT)

Copyright (c) 2020 Dow Jones & Company, Inc.
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