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Time for another bite of Apple
The stock has slipped because some investors think the iPod craze can't last. But some experts see substantial upside, and in Apple's non-iPod lines as well.
By Michael Brush
iCame. iPod. iConquered.
That might have made a suitable motto for Apple Computer Chief Executive Steve Jobs in February as the shares of his company hit all-time highs north of $45.
Since then, however, Apple shares have iFlopped. Apple share were off more than 5% at one point today as traders fled the stock on fears that a new online subscription music service from Yahoo! (YHOO, news, msgs) would cut into Apples online music sales.
Investors had already knocked the stock down to $37 over the past two months because of worries about a slowdown in sales of the popular iPod line of portable music players.
Is it time to join them and shuffle this stock out of your portfolio?
Not at all. At these prices, it's time to buy.
"We view the pull-back in shares of Apple as a buying opportunity, given we do not anticipate the market share of the iPod will be meaningfully impacted by the emergence of Yahoo! and other music subscription services," Piper Jaffray analyst Gene Munster wrote in a note after the Yahoo! news broke.
What sellers are missing is that the new Apple Computer (AAPL, news, msgs) is about much more than iPod. There's a new operating system, beloved by reviewers, that promises to increase sales of the company's computers. Apple's laptops are about to get a boost, and there's the promise of the company making its mark in the world of cell phones.
At $35, Apple trades for 24.8 times expected earnings for the next 12 months, which is $1.41 per share, according to Thomson Financial. Thats not much more than the 22% consensus projected annual earnings growth.
Apple is reasonably priced for its growth rate, says Michael Sansoterra, a buyside analyst with Principal Global Investors, which holds Apple shares. He predicts growth will continue, even if doesn't accelerate from rates the company has seen in recent months.
Wall Street analysts and at least one value manager put price targets of $48 to $52 on the stock, 30% to 40% above the company's current price.
Related news and commentary on MSN Money
Heres a closer look at what may bring those gains.
Apple's products are cool, even when Apple isn't
Apple recently alarmed those who treasure free speech when it took aggressive legal steps against bloggers who leaked new product details -- acting a bit like the Big Brother Apple used to proudly proclaim it wasnt. The company also pulled John Wiley & Sons' books out of its stores after the tech publisher printed an unauthorized biography titled "iCon Steve Jobs." Not cool.
But when it comes to what the company produces, Apple remains the digital definition of cool.
It goes way beyond sleek designs and colors, or the popular iPod for that matter, says Darcy Travlos a digital technology analyst who follows Apple for CreditSights, an independent research firm.
To understand Apple, Travlos says, you have to see how its retooled itself to fit in with the decade of self-expression -- a time when people employ digital tools as creative outlets.
Online commentary can take the written form, via blogging. Or a broadcast form, via podcasting. Some are venturing into cinematography, or laying down tracks of original music in home studios, or simply producing slide shows of family photos. And, of course, theyre loading music onto iPods.
Apple has positioned itself as an important player by creating an ecosystem of computers, software, music players, and other devices that fit together nicely, says Travlos. Consumers have much more digital content to play with, and they want an integrated system to do this, she says. Thats what Apple offers.
What drove me to Apple was a change in my life in that I had kids, agrees Jim Grossman, manager of the Thrivent Technology fund (AATSX, news, msgs), which owns shares of Apple. I had to have digital pictures and I wanted them organized correctly. And I didnt want it to be too much work.
Apples most recent offering to the decade of self-expression: Tiger, an upgraded version of its Mac operating system. Among the new features is a tool called Spotlight that makes it much easier to find and organize files on your hard drive.
It is incredibly fast, says Rik Myslewski, the editor in chief of MacAddict magazine. And it is remarkably different.
Spotlight can search deep inside your computer's file storage and pull up, for example, all the photos you took with a specific digital camera. Another cool feature, says Myslewski, is the Dashboard Widgets. These are small tools you can program to regularly fetch and display stuff from the Internet -- like updates on stocks or the weather. Tiger is really a different way of interfacing with your computer, says Myslewski.
Initial reports suggest Tiger may be a hefty commercial success, as well. Larry O'Connor, president of Other World Computing, a Web site that sells Mac-related products, says he had more than 2,000 back orders for Tiger by the end of April. Prior Mac operating system upgrades saw relatively few back orders. For us, it is unprecedented, says O'Connor. The interest in Tiger is tremendous.
Steven Milunovich, a tech analyst with Merrill Lynch, believes Tiger will be popular enough to boost Apple computer sales, something other Mac operating system upgrades have failed to do.
This halo is real
One hope for Apple was that its iPods were so easy to handle that they would compel users to buy Apple computers. This was dubbed the halo effect by analysts.
And it seems to be working.
Apple shipped 1.1 million Macs in the first quarter, a year-over-year increase of 43% compared to growth of 26% in the prior quarter. That kind of growth probably wont continue, but its a clear sign the halo effect is alive and well. Youve got the beginnings of a new customer base, says Principal Global Investors Sansoterra.
A clever part of Apples strategy: 106 carefully located retail stores where shoppers can kick the tires on Apple products in a low-pressure setting. "Their stores are really showrooms more than stores," says Travlos. "They created a comfortable environment for people to test-drive their products."
Unlike Gateway (GTW, news, msgs) a computer maker that launched a chain of brick and mortar outlets that flopped, Apples retail chain turns a profit.
Luring new users with low prices
Another tactic that helps Apple convert consumers: Bargain prices for entry-level versions of its gadgets. Long considered a vendor of pricey niche computers appealing mainly to computer aficionados, Apple now sells stripped-down models for as little as $499. (In contrast, Apples high-end Power Mac sells for $2,500.) Apple has also rolled out a $99 iPod Shuffle version of the iPod, which normally sells for $299.
Some investors worry that lower prices will hurt margins. But Travlos sees this tactic as a way to build the foundations for higher revenue and margins down the road. The idea is that people tempted by low prices to bite the Apple will later trade up to pricier products.
Travlos thinks Apple computer sales could grow 21% in 2005 and 14% next year, compared to 10% growth overall for personal computers. She thinks sales of music-related products will increase 150% this year and 20% next year. Together, the lines account for most of Apples revenue.
Apple finance chief Peter Oppenheimer projects 15% annualized revenue growth over the next 10 years. But net income will grow much faster, says Needham & Co.s Charles Wolf, because revenue gains will be spread out over more-or-less fixed costs. Wolf thinks Apples net income will grow 29% a year over the next 10 years, and 41% a year over the next six years.
Next? Cell-phone iPods, laptop upgrades
Well likely see video and wireless iPods for the holiday season. And cell phones with iPod-like music capabilities are on the drawing board in a venture with Motorola (MOT, news, msgs). Chip technology in development at IBM (IBM, news, msgs) and Motorola, meanwhile, may finally overcome worries about overheating that have prevented Apple from upgrading its PowerBook laptop series, says MacAddicts Myslewski. Beyond that, Apples secrecy makes it hard to speculate on new products. But Jobs likes innovation as much as he likes privacy, so its a safe bet that new products are coming as the company tries to continue its recent run.
Despite the big run in Apple shares, even value investors like John Buckingham of the Al Frank fund (VALUX, news, msgs) arent abandoning the stock altogether. He originally recommended Apple shares at $7 in my April 2003 column. Hes sold two thirds of his position -- but hes keeping the rest. Apple is not cheap, but I think there is still substantial upside, says Buckingham. Buckingham is holding out to sell the remaining shares at his price target of $48.
Newton and the iPod killers
As good as Apple is at cooking up popular products, it doesnt have a perfect record. Remember the Newton? If not, its because Apple loaded too many features onto its personal digital assistant, making the Newton too expensive.
Apple competitors -- and doubters -- are constantly on the hunt for the iPod killer, a competing device that cuts into iPod growth. But no one has really come out with anything yet that is compelling, says CreditSights Travlos. So Apple maintains a firm grip on the market, with a 92% share in hard disc music players and a 65% share for digital players overall.
How much room is left to grow? Travlos calculates that Sony (SNE, news, msgs) sold 340 million Walkmans worldwide in the 25 years that portable music player ruled the market. So far, Apple has sold only 10 million iPods, despite its popularity. That suggests theres plenty of space for growth.
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