What Is the True Significance of This Federal Court Case?

Ryan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

A federal judge ruled on Wednesday that Apple (NASDAQ: AAPL) “facilitated a conspiracy” in conjunction with major book publishers to pump up the price of e-books, and in turn cost consumers millions. Handed down by U.S. District Judge Denise Cote in Manhattan, the decision marks a significant victory for the U.S. government and may have implications in the digital media market. As Judge Cote called for a new trial to determine damages in the case, Apple advocated its innocence and said that the company would appeal the decision.

In her 160-page ruling, Judge Cote wrote “the plaintiffs have shown that the publisher defendants conspired with each other to eliminate retail price competition in order to raise e-book prices, and that Apple played a central role in facilitating and executing that conspiracy.” The “conspiracy” was formulated through secret negotiations and hardball tactics utilized by five of the largest publishers in the world: Macmillan, Penguin, Hachette, HarperCollins, and Simon & Schuster, as well as Apple. These combined forces were intent on defeating Amazon’s (NASDAQ: AMZN) strategy of discounting e-book best sellers to drive sales of its Kindle e-book readers.

So what?

All five major publishers involved in the case have already settled, looking to avoid a long and costly trial. Combined, the five publishers were forced to pay out $166 million. Three of the major five publishers are owned by companies traded on foreign exchanges or private markets, though HarperCollins is a subsidiary of News Corp (NASDAQ: NWSA) while Simon & Schuster is a division of CBS (NYSE: CBS). When both HarperCollins and Simon & Schuster settled back in August 2012, HarperCollins was only obligated to pay $19.57 million, while Simon & Schuster paid $17.75 million. While these amounts are significant to the individual publishers, the amounts are miniscule in comparison to the massive size of their parent companies.

In terms of the effects on Apple, a new trial has already been called for by Judge Cote to determine the damages Apple owes. Projections do not place the sum Apple will have to pay as jeopardizing the overall financial health of the company, however, with the final amount most likely only reaching an eight-digit number. Because the publishers have already settled, they have also already worked out new contracts with e-book sellers which once again allow the sellers to discount certain bestsellers. This has allowed book prices to once again decrease.

In 2012, Apple’s iBook service grew 100% and the company maintained a 20% market share of the e-book market. The segment which includes the company’s e-book sales and app store produced $8.53 billion in 2012, representing only 5.45% of overall revenue. The e-book segment is still anticipated to operate profitably in the wake of the changes to the market. Effectively, the segment is still expected to grow as a result of consumers being “trapped” into Apple’s ecosystem and purchasing products from the company because it is simply convenient.

In respect to Amazon, it is only set to benefit from the ruling as the reintroduction of their reduced prices is highly likely to attract new customers. This will in turn lead to further acceleration in the sale of its Kindle products, with growth from 33.8 million units in 2012 to a projected 96.2 million by 2019. Presently, estimates place the company’s market share in the e-book market as being anywhere between 50% and 60%, a metric which is set to only expand in approaching years.

Now what?

Given the altered market conditions in the e-book industry, which of the companies presented offer attractive investment opportunities?

Apple’s top line is projected to rise from 2012’s $156.51 billion to 2015’s expected $195.01 billion, representing consistent 7%-8% year-over-year growth. Net income is anticipated to fall from $41.73 billion in 2012 to $40.46 billion by 2015, representing -1% growth annually. Presently, the company holds a price-to-earnings ratio of 10.14, and pays out a dividend yielding 2.87%. In total, Apple earns 5 out of 5 stars, and is a screaming buy on any considerable pullback.

Amazon’s top line growth is predicted to sustain in the 20%-25% range annually through 2015, with revenue increasing from 2012’s $61.09 billion to $108.53 billion by 2015. The bottom line for the company is expected to grow in the 60%-65% range annually through 2015, with net income rising from 2011’s $613 million to 2015’s anticipated $4.21 billion. The company presently holds a negative price-to-earnings ratio, and does not pay out a dividend. Overall, Amazon earns 3 out of 5 stars, and possesses tremendous fundamental growth but carries a premium valuation.

As a result of the recent split in News Corp into 21st Century Fox and the new News Corp, there is a substantial lack of financial information available on a company-specific basis so a deep fundamental analysis of News Corp isn't possible. News Corp’s primary holdings consist of 130 newspapers, sports programming in Australia, and book publishing services including HarperCollins. News Corp presently carries a market value of $8.66 billion.

CBS’s top line growth is predicted to sustain in the 3%-4% range annually through 2015, with revenue increasing from 2012’s $14.08 billion to $15.57 billion by 2015. The bottom line for the company is expected to grow in the 10%-11% range annually through 2015, with net income rising from 2012’s $1.57 billion to 2015’s anticipated $2.13 billion. The company presently holds a price-to-earnings ratio of 19.78, and pays out a dividend yielding 0.91%. Overall, CBS earns 4 out of 5 stars, and is a solid investment possessing steady growth metrics and a reasonable valuation.

The Foolish bottom line

The ruling in this case is a substantial victory for the federal government, but the loss is not monumental for Apple. If the company's appeal does not rid it of this annoyance, the fine that it will be forced to pay will not financially ruin the company. Meanwhile, Apple’s e-book segment will continue to grow well into the future.

Amazon is the real winner in this scenario, with the company being able to further accelerate the sale of its Kindle devices through discounted e-books. For the publishers, they will be forced back into an environment where sellers will be allowed to discount their products, an environment which they fought so hard to destroy.

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Ryan Guenette owns shares of Apple. The Motley Fool recommends Amazon.com and Apple. The Motley Fool owns shares of Amazon.com and Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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