$AAPL Defends App Store Model in Federal Court

05/03/21 10:27AM EDT

Editor's Note: Below is a complimentary research note written by Senior Telecom-Media Policy analyst Paul Glenchur. To access our Telecom-Media Policy research please email sales@hedgeye.com.

$AAPL Defends App Store Model in Federal Court - 5 3 2021 8 53 12 AM

Today, Epic Games (the creator of Fortnite) and Apple will square off before Federal Judge Yvonne Gonzalez Rogers in a California District Court, commencing a multi-week trial to determine whether Apple violates the antitrust laws in its operation and administration of the iOS app store. 

We expect the trial to wrap up around the end of May and a decision could come down by late summer.

Going into the trial, we give the edge to Apple in this monopolization case brought under Sections 1 and 2 of the Sherman Act as well as California antitrust laws. 

We think Epic is facing an uphill fight to convince the court that app store distribution -- as a consequence of Apple ecosystem lock-in -- should be treated as a single-brand product market, excluding from the competition analysis consumers' access to in-game Fortnite transactions through gaming consoles, computers, web applications and other devices or playing options. 

Strategically, if Epic can prevail on its assertion that the relevant antitrust market is confined to the iOS App Store, monopoly power can be assumed as Apple clearly maintains 100% control of its app store, foreclosing all other app purchasing options for iPhones and iPads.

Keep in mind, however, that monopoly market power and the charging of monopoly rents are not prohibited under the antitrust laws.  Liability stems only from the maintenance or acquisition of monopoly power through conduct that excludes competition without established pro-consumer justifications.

The issue of market definition is critical. Epic is attacking the App Store distribution model generally, not just in the context of Fortnite or other games. 

A good part of the trial could focus on the validity of expert economic testimony when applying traditional antitrust market analysis to multi-sided platform markets like the App Store.  A recent Supreme Court decision requires a net competitive assessment of market impacts on both sides of a two-sided transaction platform, likely complicating the analysis in this case.

Epic's Basic Complaint  

Epic, mirroring similar complaints from Spotify (SPOT) that have triggered EU enforcement action, complains that Apple abuses its app store control by foreclosing alternative distribution of iOS-compatible apps (sideloading), and forcing reliance on Apple's in-app payment system (enabling Apple's imposition of 30% commissions on large developers and 15% commissions on smaller developers for digital products and services). 

Epic contends Apple's security, privacy and reliability justifications for iOS app distribution exclusivity are pretextual and do not promote consumer benefits justifying current app store practices.  Epic reinforces its contention by highlighting Apple's allowance of alternative Mac OS app distribution for iMacs and Apple laptops.

Epic is not seeking damages. It requests an order forcing Apple to allow and support iOS app distribution outside of the App Store and a prohibition on apple's in-app payment requirements.

Apple Fights Back

Apple promotes a narrative suggesting "if it ain't broke, don't fix it." 

The company points to the billions of dollars of wealth created on the iOS app distribution platform and the "unclean hands" with which Epic brings this lawsuit, i.e., a deliberate, scripted breach of the Apple developer agreement as a highly-publicized prelude to the antitrust case filing.   

Apple asserts consumers have substantial options to access and play Fortnite outside of App Store downloads, even on Apple devices (via the Safari browser), rejecting monopoly market share claims as well as asserting its pro-consumer justifications for existing App Store policies. 

Apple also attacks the scope of Epic's remedial requests, objecting to the forced licensing of its iOS intellectual property to accommodate Epic's preferred business plan.

Moreover, Apple points to the burdens of court-supervised enforcement of a remedy that mandates changes to Apple's IP licensing as well as its business relationships with all developers. 

The company suggests it would modify its business model for IP compensation if forced to do so as a consequence of this litigation, likely burdening the court with complaints asserting remedial circumvention or other complex technical and administrative disputes beyond the reasonable competence of federal courts.

Reasonably Plausible Scenario

Again, absent settlement (i.e., acceptable changes in App Store commission rates or policies), the case will be decided on the evidence.  Going into the trial, we sense some reluctance by Judge Gonzalez Rogers to accept Epic's definition of the relevant antitrust market. 

She also seems reluctant to accept Epic's illegal tying claims (App Store distribution coercively tied to Apple's in-app payment mechanism).  Further, the court seems to recognize the substantial and potentially disruptive impact of "dismantling" the App Store model. 

Although the trial testimony and documents will be critical to the outcome, it appears that Epic Games faces the larger challenge in achieving a favorable judicial result.

If, by late summer, the court rules in favor of Apple, ongoing scrutiny of App Store policies could be handed to regulators at the FTC. 

We assume FTC nominee and big tech critic, Lina Khan, will win confirmation to a seat on the Commission, installing -- at least temporarily -- a 3-2 Democrat majority on the Commission.  One of the current FTC Democrats, Rohit Chopra, awaits full senate confirmation as head of the Consumer Financial Protection Bureau.  His confirmation is not a slam dunk (the Senate Banking Committee tied 12-12 in reporting the nomination to the floor). 

Accordingly, upon confirmation of Prof. Khan, the FTC could have a brief or sustainable working majority to advance aggressive competition policy actions against the major tech platforms.  If Comm. Chopra wins CFPB confirmation, the FTC will remain in neutral until President Biden can fill the open Democratic seat.  That could happen by this summer.

As we've noted, however, the FTC seems to be emerging as the venue posing the greatest immediate threat to the leading tech platforms. 

The current and nominated FTC Democrats unanimously agree that the FTC has the power to issue rules that define "unfair methods of competition," and the authority for such regulations flows from the FTC Act, not the antitrust statutes at issue in the pending Apple, Facebook or Google cases. 

Taking a cue from the EU, we would expect a fully-staffed FTC to explore the regulation of "digital platform gatekeepers," considering obligations and requirements on such platforms, including Amazon, designed to level out relative bargaining power between these platforms and users who depend on them.  More affirmative requirements could flow from this approach, including demands involving data portability and platform interoperability.

The legal authority for an aggressive regulatory approach is heavily disputed, but proponents of FTC intervention worry that litigation and subsequent appeals will take too long to resolve and Congress will struggle to win a consensus for major antitrust reform legislation. 

Forcing the issues at the FTC likely represents the most expeditious approach for altering the competitive landscape for big tech within the current term of the Biden Administration.

* Note: This analyst holds shares in AAPL subject to Hedgeye's personal trading policy.
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