- While data on foreign adoption hasn't been as supportive and initial payment volumes are unmeaningful, there's still upside to growth.
- The adoption curve tends to elongate for financial products/services, so viewing results over a 12-month window could prove short-sighted.
- Also, when comparing the technological/ecosystem mix of Apple when compared to Android, Apple Inc. is still the clear winner in fin-tech.
There hasn’t been a lot of positive news on Apple (NASDAQ:AAPL) Pay other than reported figures on usage that aren’t exactly stellar. Despite the weak metrics over the short-term, we can walk away with a much stronger impression of Apple Pay when looking underneath the hood of comparative mobile payment technologies. Also, there's a long-tail to growth, meaning that once meaningful adoption takes hold, the rate of usage will likely increase and sustain at a healthy rate even off of a massive transaction base. This has been the case for many financial products historically.
The Slow Adoption Curve Of Financial Products
Bank of America introduced the first credit card in 1958, so cashless payment systems are quite old if not archaic. The cashless payment system is one of the biggest innovations in the financial sector, but adoption was slow and took decades for meaningful transactional volume to take place.
An even more extreme example of a slow adoption curve is the modern banking system. The oldest bank was founded in 1472 and it’s called Banca Monte dei Paschi di Siena, and it’s located in Siena, Italy. It took centuries before banking became a widely adopted service. Many centuries ago, the average person would hide their coin in the nooks and crannies of their cover boards or give it out to money changers in exchange for interest. Generally speaking, banking wasn’t a formalized concept until we hit the renaissance era and it took centuries beyond that point to develop a centralized banking system. The pace of adoption/development for new financial services tends to move at a snail’s pace, as modern banking took nearly a millennia before it became a successful mass market concept. When looking at a reasonable timescale for Apple Pay adoption, we should be thinking in terms of decades, not years.
Of Apple’s products and services, it’s not surprising that Apple Pay had such a slow start relative to other Apple products. Historically, financial products in general, have a very gradual adoption curve. However, the juxtaposition of finance is the sheer timescale of continuous compounded growth. In other words, successful financial instruments/services tend to snow ball continuously. Perhaps, the concept of infinite growth potential could be applied here even if growth were to moderate and become more gradual.
Source: Alex Cho, Capgemini
I approximate that non-cash volume for debit/credit cards grew at an average CAGR of 61% from 1956 to 2014. Of course, this is just an averaged exponential interpolation, so it’s not a perfect representation. The purpose of this illustration is to give us a way of comprehending 0 to 389 billion annual transactions over the course of 56 years.
To put Apple’s progress in comparison, after roughly a year into its launch, the company generated $10.9 billion in annual transactional volume, according to Timetric. The average transaction amount was $44.54 (what Visa reported in its most recent quarter), which translates to 244.723 million Apply Pay transactions in the prior year. To put this in perspective, it took the financial industry 40 years to reach a comparable transaction volume figure (rough approximation) for debit/credit cards combined.
So, when putting Apple’s first year into the context of historical growth rate for cashless payment services – Apple Pay was relatively successful. It didn’t hit the lofty expectations of Wall Street. Nor did Apple Pay have a meaningful financial impact in its first year. But, the duration of growth will likely sustain over a time span of decades similar to other financial services, which means that it’s a franchise likely to outlast many of Apple’s current consumer electronic products. Therefore, the durability of earnings and sales is what’s notable about this specific product when compared to others.
What is Apple Pay, Really?
The vast majority of money is imaginary with physical bills representing a small portion of all currency in circulation. Money is data stored across storage arrays that gets transferred at the speed of light from one data center to the next. It’s an endless system of record keeping that simply serves to remind us that we have tangible value.
It’s become apparent that we’re getting closer and closer to what futurists refer to as “blended reality.” Money is just an abstraction of the human imagination as it’s been rendered intangible. Much of our own reality is actually intangible, and what Apple owns is the most secure access point to currency, our data, and perhaps our lives. Data privacy is tantamount to maintaining one’s own identity.
Apple has developed a technological/durable advantage or a product that achieves what Pete Thiel labels in his book as the 100x effect. It’s so unique, and patent protected that I couldn’t help but delve further into the specific features of Apple Pay that make it so unique to competing ecosystems/services.
PiperJaffray analyst, Gene Munster provides a more elaborate explanation on the comparative advantages and disadvantage of the two mobile payment ecosystems:
First, iPhones running the A7 chip and beyond (post iPhone 5S) utilize a hardware technology called a Secure Enclave, which is a separate co-processor embedded into Apple’s A-series chips. The iPhone’s Secure Enclave handles both Touch ID authentication and enabling payments transactions to proceed. The Secure Enclave has restricted access and is encrypted. Apple does not receive any data from the Secure Enclave. Second, Apple Pay utilizes a secure element, which is a chip similar to the smart chips on modern credit cards, to communicate with the payment networks. For in-store transactions, the NFC chip on the iPhone enables direct communication between the contactless payment terminal and the secure element. The secure element only allows payments to be processed after they are authorized by the Secure Enclave.
Android - Host-Based Card Emulation Software Solution. Since Android devices are made by various manufacturers, the payments solutions and hardware have been varied in the past. Some previous Android devices utilized secure elements; however, in Android 4.4 (launched in late 2013; we are now on version 6.0), Google added host based card emulation (HCE). The main difference is that instead of having a separate hardware solution in the secure element to communicate with payment networks, the HCE enables the contactless payment terminal to communicate directly with the CPU on which applications run. The user’s personal information is stored in a cloud based secure element that acts as a virtualized version of its hardware equivalent and eliminates the need to store sensitive information on the device itself.
To put context behind that quote, Android utilizes some form of container-based virtualization that allows payments to be processed in a separate environment from other CPU functions and also does some of the payment processing within a private cloud. Basically, the interaction is done on a virtual machine within the OS layer, and data is only accessed via a VM to VM interaction via the internet. The design is less secure when compared to Apple Pay because it implies that the payment function isn’t isolated to specific hardware.
Apple intentionally uses an NFC or a secure element (for online transactions), which is read-only data and cannot be maligned. The NFC/secure element can only be accessed upon the input of verification via a thumbprint sensor, which gets processed on a separate CPU that’s dedicated to that specific process. The data is only accessed between the read-only memory, and separate CPU and interacts directly with the AmEx, Visa, and MasterCard inter-bank network. The data is encrypted making it even more secure.
The information is never passed on to the merchant, is never stored on the device and is even processed in a hardware defined environment that’s application specific. This means that a prospective hacker would need direct access to the hardware to alter the specific hardware function, which isn’t even possible. Hardware that’s application specific is not re-programmable by nature, so you can’t alter the function of Apple’s hardware thus making it a closed-loop system. The prospective hacker would also need to break through layers of encryption to gain access to the data, which is something the FBI has failed at repeatedly. With the transaction process done separately from the core OS and CPU, it creates further complications for would-be invaders, as it’s hard to access something that operates in an almost separate hardware environment from the core operating system.
Also, you can’t alter the data in the secure element, as it’s read-only, so you can’t alter the data sitting within the secure enclave either. The only way a person can realistically gain access to Apple Wallet is through direct interaction with the iPhone and replication of the thumbprint. This is a shortcoming that I believe Apple will eventually address through the inclusion of a retina scanner, and advanced AI algorithms that gain contextual awareness of the person accessing the account. Therefore, unless someone is as sophisticated as James Bond, there’s an extremely low possibility of data theft or unauthorized access of funds.
Apple owns both the ecosystem and patents to this technology, which makes this so interesting. After all, 20 years is ample time for Apple to further perfect and grow a payment business model. These features seem just as applicable 100 years or even a thousand years into the future. I’m sure Google would desire a more hardware defined solution, but with an unstandardized product ecosystem, and the prohibitive cost of designing custom silicon, it’s fair to say that Apple will maintain its edge here. Google would need to develop a separate method from Apple to make it comparable. For now, Android is an inferior alternative, but is still “good enough.”
While Apple Pay won’t move the needle on revenues for the next several years, I believe that the duration of growth for this specific category is more meaningful over a multi-decade timescale. Basically, we can assume that even if smartphones as a category becomes obsolete, the core Apple Pay service will likely have the staying power beyond a disruptive shift to new device. New financial products take significantly longer to move through the adoption curve but remain relevant for many years. Hence, Apple’s initial foray into the space may prove to be a massive success, years into the future.
I continue to reiterate my buy recommendation on Apple and $107.72 price target.