When it comes to showmanship, there isn't a CEO alive who rivals Steve Jobs, ringmaster of the circus that has been Apple Computer (Nasdaq: AAPL ) for nearly three decades.
During the annual Macworld trade show, Jobs wowed the faithful by showing the Super Bowl ad that launched the groundbreaking Macintosh computer. But this time there was a twist: The heroine sports an iPod digital music player as she smashes the image of Big Brother. Fittingly, Apple kicked off its latest initiative with another Super Bowl commercial, this one produced in concert with PepsiCo (NYSE: PEP ) and featuring 16 teenagers who were sued for illegally downloading music.
The promotion? Apple and Pepsi are giving away 100 million songs over the next 60 days through the iTunes music store. The push is designed to help Apple defend its 70% share of the market for legally downloaded music as well as spur demand for the iPod and iPod Mini, announced at Macworld.
The rhythmic symbolism of both events is appropriate. But is the strategy behind the sales pitch enough to generate the growth Apple's valuation implies? Let's examine the possibilities.
Apple sold out of iPods during its 2004 first quarter, shipping 733,000 players and booking $256 million in revenue. That's nearly 13% of Apple's $2 billion in sales for the quarter, up more than 200% from the same period a year ago, when Apple sold $81 million worth of iPods.
Interestingly, demand probably hasn't come close to peaking. In early January, Apple inked a deal with Hewlett-Packard (NYSE: HPQ ) allowing HP to resell its own branded music player based on the iPod and to include iTunes with the nearly 16 million consumer-oriented personal computers it sells each year.
It is difficult to overstate the importance of this announcement. Apple's iPod and iTunes music store were doing well before HP came into the picture. In fact, Apple admits its first quarter -- which was already a huge success -- could have been better if it had adequately met global demand for its music players. Now, with its order backlog, the new Mini, and the new HP channel, it seems that anything less than 3 million iPods sold during fiscal '04 would be a major disappointment. Four million seems likely.
How would that translate into revenue? Let's do the math: According to its latest earnings report, Apple averaged $349 in revenue per iPod sold. If prices remain stable, 3 million iPods would generate more than $1 billion in revenue. Four million units could produce $1.4 billion in sales. Apple sold $345million in iPods during fiscal 2003.
Turning the dial to iTunes, Apple says that more than 30 million songs have been sold to date, with 17 million of those coming during the Christmas quarter. The Pepsi promotion should dramatically increase iTunes traffic. Add in the help from HP and paid downloads could pass 100 million during 2004. At that level, Apple should make a few pennies per song, up from zero now.
Clearly, Apple has to do whatever it takes to protect and expand its digital entertainment niche. But that won't be easy.
Deja vu all over again?
To begin with, longtime rival Microsoft (Nasdaq: MSFT ) is doing everything it can to own digital media, but, instead of focusing on consumers, the software giant is luring businesses into using its tools to create music stores to rival iTunes, with Best Buy (NYSE: BBY ) , and Wal-Mart (NYSE: WMT ) among them.
Microsoft's format, called Windows Media, is optimized for Windows PCs and is used by Roxio's (Nasdaq: ROXI ) Napster and a growing number of iPod clones. iTunes, on the other hand, works only with the iPod. Windows users can play downloaded songs on their PCs, but they'll need an iPod if they want to take their custom-made albums on the road. (Sound familiar, Mac users?)
That is certain to be an issue, especially now that Dell (Nasdaq: DELL ) has created an iPod clone called the Digital Jukebox, which sells for as little as $249, the same price as the iPod Mini. But Apple has a (small) cushion. Statistics show the iPod accounting for more than 30% of all MP3 players shipped, and more than 50% of revenue from MP3 sales.
Embrace and extend
The market share lead gives Apple an opportunity to redeem itself for past mistakes with the Mac, and Jobs seems intent on taking advantage. But he hasn't said how. Here's my suggestion: Embrace and extend Windows to fit the iPod and every other future Apple product designed for digital entertainment.
Indeed, Jobs may have signaled his intent to do just that during Macworld, when he introduced iLife '04. Calling it just like "Microsoft Office for the rest of your life," Jobs rolled out new versions of the suite's tools for managing digital content -- from music to photos to movies to DVDs and, with new software called GarageBand, to musical production.
Putting iLife on Windows could seed ground for growing market share with all kinds of new digital gadgets, such as an iPod movie player, or a digital hub for wirelessly connecting Macs and PCs with stereos and TVs, or an online iMovie store for distributing films from every studio, including Jobs' own Pixar (Nasdaq: PIXR ) .
But let's be honest: There's as much chance of Apple putting iLife on Windows as I have of pitching for the New York Yankees. (But that doesn't mean you shouldn't call if you need an extra arm, George. I may be old, but I can still bring it.) For one thing, making great software for a platform that isn't your own is hard. Mr. Softy spent years making mediocre software for the Mac. Only recently has Microsoft got it right.
Apple can't afford to make mediocre software. Its competitors are too big. With no room for error and a history of shortsightedness, it's hard to predict Apple the winner in digital entertainment.
It's all about the cash
But it's still hard not to like the company's stock over the short term. Wait a minute, did I just say short term? Yep, you heard me right, bucko. Apple's long-term prospects may be unclear, but the company could do well over the next year. If computer sales remain flat -- iMac and PowerMac sales are sliding while PowerBook and iBook sales are rising -- then the additional moolah from iPods and iTunes could grow full-year revenues by 22% over 2003 to $7.6 billion.
Foolish investors should also take a close look at Apple's balance sheet: Net cash (cash + short-term investments - debt) is $4.48 billion. That means Apple has more than $12 per share in cash on hand. Investors buying in now would get a slice of all of Apple's other operations for a little more than 10 bucks a stub.
Think about that: If Apple generates $0.40 a share in net income during 2004, lower than the Street consensus, then the stock trades at 26 times the forward earnings power of its operations. This for a company that is expected to double its income in one year.
That seems, uhm, illegal.
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