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Analyst Addresses '22 Unanswered Questions on Apple'

TMO Reports - Analyst Addresses '22 Unanswered Questions on Apple'

by , 11:10 AM EDT, May 4th, 2006

Piper Jaffray analyst Gene Munster on Thursday released a research report in which he addressed 22 unanswered questions on Apple. He covered the gamut, from iPod- and iTunes-related queries to Mac questions, retail store speculation and general business operations.

Looking first at Apple's best-selling iPod, he said he doesn't think Apple will integrate an FM tuner in the iPod, "at least in the near term." He doesn't expect Apple to drop the iPod shuffle, nor add new features to the low-end MP3 player, as the former would give up the low end of the market to the competition, while the latter would cannibalize iPod nano sales.

Mr. Munster still believes there is a 75% chance Apple will release the fabled iPhone, a combination cell phone and iPod, within the next 12 months, despite the company's repeated insistence that it doesn't want to stray from standalone music devices. In addition, Apple is concerned about the impact on cheaper iPods, given the way camera cell phones attacked low-priced digital cameras.

While it seems like iPods are ubiquitous, the analyst believes only about 10% of the U.S. population has an iPod, assuming that 80% of all iPods have been sold in the U.S. and assuming an average of 1.2 iPods per iPod owner. He expects Apple to focus more on European markets this year, given the iPod's 21% share of the MP3 player market in Germany and 11% in France.

The iPod's extensive ecosystem of accessories, with over 2,000 on the market, has been an important part of the product's success, Mr. Munster explained. Apple's economies of scale with the MP3 player are also important, as it keeps competitors from undercutting the company's pricing. While the last quarter saw a seasonal downtick in iPods sold for the first time in three years, the analyst pointed out that the March quarters in 2004 and 2005 saw the introductions of the iPod mini and iPod shuffle, respectively, which kept sales strong coming out of the December quarter.

Finally, many industry watchers have wondered why Sony, the creator of the wildly popular Walkman, can't compete with Apple in the digital era. Mr. Munster believes the company "has done a poor job of marketing its MP3 players," including poor product names. He said that Sony has a hardware focus among its engineering team, which keeps the company from creating a compelling hardware/software experience comparable to iPod/iTunes.

iTunes

Moving on to iTunes, Mr. Munster said that he assumes Apple is selling around one million videos and 21 million songs on the iTMS each week, with the company seeing a "slightly better than breakeven" profit on the enterprise. He sees "a chicken and egg scenario," however, regarding full-length movies, wondering if they will come first or if a video iPod with a larger screen will initially debut, creating the demand for longer films.

He expects Apple to eventually offer theatrical films on the iTMS, but he doesn't believe it is a top priority for the company right now. He sees "a clear value proposition" in Apple offering TV shows because it gives viewers an opportunity to easily and inexpensively catch up on missed episodes.

While Napster.com's recent launch of an ad-supported free service created some talk of Apple selling ad space on the iTMS, Mr. Munster said he doesn't expect that to happen. "We believe Apple knows the value of an ad free experience and will not sacrifice long-term customer satisfaction for a near term pop in ad revenue," he wrote.

Macs

On the other side of Apple's business, the analyst's report said that he doesn't expect Apple to experience the same issues with an Intel-based iBook as the company saw with the MacBook Pro. He explained: "We believe Apple wanted to release the MacBook Pro in conjunction with Macworld '06 and, we believe, the company was, therefore, forced to announce the product before it was fully prepared. With the iBook, Apple does not have to manage around a set tradeshow date and can simply announce and ship the product when it is completely ready."

Mr. Munster expects Apple to continue to work to gain market share in the computer business "by making the highest quality product available and continuing to charge a premium price, assuming consumers will pay for quality ... We see the Street's fixation on market share as an overly simplified approach."

While he doesn't see Apple licensing Mac OS X, he does think that the release of Boot Camp created "a small chance that Apple will sell the Windows operating system either in its retail stores, or less likely, as an option when buying a Mac."

Retail and General Business Operations

Covering the retail sector, the analyst said that revenue in that area was down so much from the December to March quarters -- a 41% drop -- because of negative impact from the Intel transition. (The stores were up 2% from December 2004 to March 2005.) "Consumer awareness of the Intel shift was high," he wrote, "but there was virtually no availability of the MacBook Pro and limited availability of the iMac for 75% of the March quarter." He said that iBook sales suffered from the focus on Intel too.

The iBook should move to Intel processors soon, along with the Power Mac, which will help Apple store revenue as the year progresses. With the company adding 30 to 40 retail outlets this year, along with a new, more aggressive ad campaign comparing Macs to PCs, he expects that calendar year 2006 store revenue will be up compared to 2005.

The analyst added that Apple differentiates itself from other retail chains by "hoping the real relationship with the customer starts when the customer is buying the product and is at check-out, while with other retail stores, the relationship with the customer ends at check-out. The goal of the Apple retail store is to move customers from making a one time purchase into becoming ongoing participants in the store." He expects that a 50/50 mix of iPod and Mac advertising over the next 12 months, based on comments made by Apple CEO Steve Jobs at the recent shareholders meeting, "could have a positive impact on the halo effect."

Finally, Mr. Munster addressed Apple's potential uses of its just over US$8 billion stockpile of cash, which amounts to over $9 per share. He wrote: "The following uses of cash are underway or upcoming: $500m in pre-payment of nand flash, $350m stock buyback (essentially for sr. level management), and $50 million for a data center. Other uses of cash going forward: nand flash, new campus, and possibly a stock buyback. CEO Steve Jobs did specifically indicate at the company's recent shareholder meeting that Apple has no intention of paying a dividend."

Regarding Apple's new 50-acre campus in Cupertino, the analyst said that he expects 60-70% of it to be used to relocate employees who aren't currently working on the main campus, with the rest slated for company growth.

The analyst retained his "Outperform" rating on Apple's stock, with a $99 price target. At 11:12 AM EST on Thursday, the company's shares were selling for $72.10, up 1.35% for the day.


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