'iPod nano Analysis Points to Solid Profits,' Says UBS Warburg

A breakdown of the cost to produce a 4GB iPod nano points to the belief "that nano margins should scale nicely over time," according to UBS Warburg analyst Benjamin Reitzes. Mr. Reitzesi latest research report, a copy of which was obtained by The Mac Observer, does not see "a meaningful dilution to the 20% gross margin range for iPods."

Mr. Reitzesi breakdown of costs for the 4GB iPod nano, which donit include labor, warranty and other charges beyond the price of the materials themselves, comes to US$164.10. The MP3 player sells for $249, which means that approximately 65% of its cost comes from the materials, including $114 for the flash memory, $8 for the LCD screen, $6.95 for PortalPlayeris audio system and $1.65 total for the click wheel. He expects Apple "to procure better NAND prices into 2006."

In contrast, research firm iSuppli reported last week that the 2GB iPod nano contains $90.18 in parts and costs $8 to assemble, leaving Apple with a gross margin of 50%. We should point out, however, that such estimates are largely subjective, given Appleis refusal to often even acknowledge its suppliers and the fact that no one quite knows how much of a discount Samsung gave the company for flash memory.

No Impact to Appleis Business Model

Meanwhile, Mr. Reitzes doesnit expect the iPod nano to affect Appleis business model, which he expects to result in the company reporting 28.3% gross margin for the current quarter, up from the year-ago quarter but down from the previous quarter "due to lower software sales."

However, he expects Appleis gross margins to drop to 28% and 27.8% in fiscal years 2006 and 2007, respectively, as the company moves away from the launch of Mac OS X v10.4 "Tiger," which favorably impacted gross margins in previous quarters, and as iPods, particular flash-based ones, become a greater part of the product mix.

Mr. Reitzes has also seen the same strong sales of the 4GB iPod nano, particularly the black one, as other analysts have reported. Wait times for 4GB iPod nanos are now one to two weeks on Appleis online store, which "backs growing momentum ... and will help fuel Appleis momentum into the holiday season."

iPod, Mac Sales Strength to Continue

Apple ends it 2005 fiscal year on Sept. 30, and in fiscal year 2006, Mr. Reitzes believes "iPod nano sales will account for just below 50% of total iPod units sold, or about 14.5 million of our total unit estimate of 31.7 million. We expect nanos to grow to more than 50% of total iPod units sold in FY07, or about 20.5 million units sold out of our total unit estimate of 39.6 million."

With the iPodis continued strength, Mr. Reitzes writes that the MP3 player is "still key to the investment thesis." He stresses that "Mac sales are more important" than iPod sales and sees momentum in that area too. He writes: "Our visits to retailers like CompUSA, as well as several Apple stores, indicate that the back-to-school season went well for Apple due to strong demand for iBooks and iMacs."

He adds: "We remain very optimistic about Appleis prospects for [market] share gains, with our forecast for unit growth of 41% for its fiscal 2005 looking conservative."

As a result of his bullish outlook, Mr. Reitzes raised his 12-month target price for Appleis stock to $64 and left his rating at "Buy 2." At 3:30 PM EST on Monday, Apple shares were selling for $53.61, up 0.77% for the day.

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