) and five frontline book publishers were recently sued by the
Department of Justice (DOJ), for conspiring and manipulating e-book
The civil antitrust lawsuit filed in the District Court for the
Southern District in New York accused Apple, HarperCollins
Publishers Inc, Simon & Schuster Inc, Hachette Book Group,
Macmillan and Penguin Group of hatching a secret plot to inflate
e-book prices aimed at curbing
) dominance in the e-book market.
An Account of the Allegations
As per details available from the filing, the story goes back to
2007, when Amazon launched its e-book reader Kindle. Amazon began
to offer e-books at a lower discounted price ($9.99) much to the
ire of publishers, whose retail businesses suffered significant
market share loss. The move paid off for Amazon, as the company
grabbed 90% of the e-book market within a couple of years since the
launch of Kindle.
Amazon further miffed publishers when it proposed that authors
should directly sell their books to the company, bypassing the
publishers. Reportedly, Amazon promised a lucrative royalty of 70%
to the authors. Publishers feared that Amazon's entry into the
publishing market would ruin their businesses. Around the same
time, Apple was on the verge of launching its iconic tablet iPad
and was also considering an entry into the rapidly growing e-book
However, Apple feared Amazon's dominant position in the market
and believed that it would be difficult to compete against Amazon's
low priced business model. According to the DOJ, this bought the
two parties (Apple and publishers) together to fight a single
common enemy: Amazon. As per the DOJ's investigation, the next
phase comprised a number of secret meetings (also e-mail &
phone conversations) between the two parties in Manhattan and
certain parts of Europe.
Finally, Apple and the publishers agreed on an agency-based
revenue model, much different from the wholesale model practiced by
Amazon. As per the agency model, Apple became an agent (not
retailer as compared to Amazon) of the publishers, earning 30.0%
commission on every e-book sold. The publishers entered into a
contract with Apple, which ensured that both the parties would move
together to raise the retail prices of e-books.
The agreement also required that the publishers would not sell
the same books to any other retailer (Amazon in this case) at a
lower price than Apple. The DOJ alleges that the conspiracy
resulted in inflating e-book prices by an average $2.0 to $3.0 in a
three day period in early 2010, which resulted in consumers paying
millions of dollars more for e-books.
Most importantly, we believe that the move hurt Amazon's
dominant market position, since the company's market share dropped
to approximately 60.0% by the end of 2011.
However, Amazon's loss was gain for
Barnes & Noble
), which currently holds approximately 25.0% to 30.0% of the e-book
market share. Apple did not achieve the magnitude of success it had
anticipated, and to date, the company's e-book business contributes
a very small part of its total revenue.
Although Apple did not comment on the federal suit, the company
is known for maintaining a defiant stance over the issue. Recently,
in a class action suit, Apple rejected all claims of conspiracy and
argued that the company had vigorously negotiated with individual
publishers for all the agreements, and hence they were
Apple is also facing a couple of other lawsuits relating to the
same issue. Simultaneous to the filing of the DOJ case, a group of
16 U.S. states also sued Apple and the five publishers alleging
that consumers have lost more than $100.0 million as result of
inflated e-book prices. The European commission is also
investigating Apple and publishers in a similar anti-trust case.
Recently, the commission said that it has received settlement
proposals from Apple, Simon & Schuster, Harper Collins,
Hachette Livre and Macmillan.
Just after the DOJ case was filed, three accused publishers,
HarperCollins, Simon & Schuster and Hachette reached an
agreement to settle the case with the DOJ. As per the terms of the
settlement, the three publishers will terminate their agreements
with Apple and will also refrain from doing business on the agency
model for the next couple of years.
According to Reuters, HarperCollins and Hachette also settled
with a group of 16 states and agreed to pay $51.0 million as
penalty. However, Apple, Penguin and Macmillan were not a part of
the DOJ settlement and these parties have denied any
Following the filing of the DOJ case, Amazon announced its
intentions of lowering e-book prices. Barnes & Noble is
expected to follow suit.
We believe that Apple will vehemently fight off the anti-trust
allegations in the U.S. to protect its reputation among its loyal
customer base. Apple's defiant stance has already been successful
in garnering support from a number of publishers and book store
owners, since these parties stand to lose the most from the
low-priced business model followed by Amazon and Barnes &
No Near-Term Difficulties for Apple Shares
As lawsuits of this type tend to linger for a long time, we do
not see any near-term challenges for Apple. In any case, since the
e-book segment does not form a major part of Apple's business, we
believe that the lawsuit will not be an overhang to the stock going
We continue to believe that Apple remains the biggest growth
story in the tech sector, based on its superior product pipeline,
Apps, iCloud and iPhone 4S, the "new iPad" and Apple TV. Apple is
also well positioned to gain from its loyal customer base and
international expansion, in our view.
We have an Outperform rating on Apple over the long term.
Currently, Apple has a Zacks #2 Rank, implying a short-term Buy
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