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Apple just delaying the inevitable?
The company posted a blowout quarter. But eventually the amazing sales growth of the iPod will slow and its hard to see what will replace it.
By Robert Walberg
This was supposed to be the quarter that the wormed turned for Apple Computer, with sales of the companys hugely successful iPod digital music player finally starting to slow down. Going into last nights earnings report the stock had slumped 24% from its highs in January on just such fears.
But Apple investors can breathe a sigh of relief -- at least for now.
Bolstered by a 61% year-over-year jump in the number of iPods shipped, Apple delivered the second-best quarter in the companys storied history. Sales surged 34% to $4.36 billion, and net income rose by 41.4% to $410 million. To top it all off, non-GAAP earnings per share of 50 cents easily eclipsed the consensus estimate of 43 cents.
Will there ever be another iPod?
On the surface the numbers looked great. And for the most part they were, even if a few of them such as revenues and iPod shipments actually fell a little shy of inflated expectations. But Apples (AAPL, news, msgs) problem from an investment standpoint is that the company will be hard pressed to ever reinvent the success it has enjoyed with the iPod.
In just a few years, the digital music player has gone from product launch to industry domination. Apple reported that market share for the iPod jumped to 78% from 71% last quarter.
Meanwhile, the companys music store, iTunes, accounted for 87% of all songs legally downloaded in the U.S. Put it together and the iPod is now responsible for generating 39% of all Apples revenues. Expect that percentage to continue climbing in the quarters and years to come.
Unfortunately, with huge success come huge expectations. We saw that in the way the stock traded during the quarter and we saw that in a number of outlying, bordering on outrageous, forecasts on Wall Street. There were even some folks whining about the 39% sequential decline in iPod shipments from last quarter, even though the companys first quarter included the holiday shopping season. Disappointment over a 34% jump in sales also seems a bit ridiculous, but I guess thats why they call it the silly season.
Success with iPod, but not with iMac
The question for Apple now becomes how to build on its current base of success. Growth is expected to come in the form of new products and increased market share in the computer space now that the company has teamed with Intel (INTC, news, msgs) and has offered a way for users to run Microsofts (MSFT, news, msgs) Windows-based operations on a Mac. (Microsoft is the publisher of MSN Money.)
The company will also need to find new ways to generate excitement from the iPod franchise.
So far, there is little evidence that the companys success in selling iPods will translate into a meaningful increase in the market share for its iMacs. Though Apple shipped more Macs than expected last quarter, 1.1 million, its overall share of the computer market remains in the low single digits. The company is adamant that the consumer demand for iPods will translate into increased awareness and acceptance of Mac-based computers, particularly with younger buyers.
The halo effect might in fact work over time, but for the foreseeable future the company needs the switch to Intel processors and the opening up of its system to Windows to bolster share growth. And the jury is still out on whether that can work.
Cell phones to the rescue?
There is widespread speculation that the company will eventually unveil a cell-phone product that incorporates iPod features as well as others. Given the companys success in tapping into the consumer marketplace, it would be foolish to discount Apples prospects in the cellular market.
But competition there is much more established and much more intense. It is very unlikely that any new product in this area would create the excitement of the iPod franchise.
Which brings us back to the iPod itself. New variations on the theme combined with new uses should enable the company to continue growing the division at a high double digit rate for quarters to come. Pricing power is a concern, but even there Apple has managed to maintain margins above 20%, an impressive number given that competitors have been trying hard to steal share by discounting prices.
Unfortunately for Apple investors, growth in the iPod universe will inevitably slow as the revenue and market share base continue to expand. Its the law of larger numbers.
While slower iPod growth might keep the momentum money out of the stock, Apple is still an attractive play considering its strong management team, better-than-industry growth rates and a rock-solid balance sheet. After backing out the more than $10 per share in cash, Apple trades at roughly 26 times projected earnings of $2.10 per share.
Its not cheap. But considering the growth rate, its still attractive and could trade to the mid- to upper-$70s.
At the time of publication, Robert Walberg did not own or control shares of companies mentioned in this column.
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