BUSINESSWEEK ONLINE : JULY 31, 2000 ISSUE
COVER STORY

This Dip Makes Apple Look Even Riper
With the company's prospects ever brighter, the July 19 sell-off could be an opportunity for long-term investors

Mid-July may be a ho-hum time for computer sales, but it's usually a busy season for Apple Computer (AAPL). Each year this time brings not only an earnings report for the company's fiscal third quarter but the MacWorld trade show, at which rock star Chief Executive Steve Jobs invariably wows his fans with new products and software upgrades.

This year, to the detriment of investors, the two events came less than 24 hours apart. The company announced less-than-stellar quarterly results at 5 p.m. ET on July 18. The next morning, that news hung over Jobs as he delivered the MacWorld keynote address. While Mac fans were applauding as Jobs unveiled new products, investors were selling. The stock dropped 4 9/16 points, or 8%, to close at 52 11/16 on July 19.

Good news for long-term investors: The dip could well prove a buying opportunity. The sell-off, which affected many brand-name technology stocks, probably had as much to do with investors' desire to take profits ahead of Fed Chairman Alan Greenspan's July 20 appearance before a Senate panel as with any disappointment over Apple's prospects. Analysts will be weighing in with new earnings forecasts in coming days as they digest all the news -- and their meeting with management that followed the product launch. So expect the stock to jump around some more.

WAITING TO UPGRADE. But buy-and-hold investors shouldn't make too much of recent stock-price activity. To be sure, earnings weren't great. Revenue growth wasn't as strong as analysts expected. And the earnings number, while beating consensus estimates, wasn't as high as "whisper" numbers. Apple's profit from operations was $163 million, or 45 cents a share, for the three months ended July 1. That was better than the 44 cents analysts were calling for, but lower than the 47 cents some expected. Nonetheless, Apple's net profits were 43% higher than the same quarter in 1999.

Sales, the real disappointment, came to $1.8 billion, up 17% over the same quarter in 1999, but lower than the $1.9 billion most expected. That was mainly due to weaker-than-expected sales of the rainbow-colored iMac computer.

But it's hardly surprising that iMac sales flattened out. Apple has the kind of loyal customers who know that upgrades are coming and will wait to buy. Merrill Lynch analyst Steve Fortuna called the revenue shortfall, "not a big deal," and correctly anticipated that "the stock could overreact to the negative side" in a July 19 morning note.

In fact, revenue growth will be a strong point for the rest of the year, predicts UBS Warburg analyst Charlie Wolf. He thinks Apple will post sales growth of 50% next quarter (based on a very easy comparison, since the company was hurt by parts shortages last year) and 20% in the December quarter. That adds up to 30% revenue growth for the second half of this year.

Other analysts aren't quite so optimistic.

"GREATER CONFIDENCE." Standard & Poors equity analyst Megan Graham-Hackett expects only 20% growth for 2001, but she said in July 19 research note that seeing the "broadened and deepened product portfolio" at MacWorld gave her "greater confidence."

Margin improvement was the good news in the quarterly results that investors seem to have overlooked. Gross margins were 29.8%, up from 27.4% in the year-ago quarter. Wolf expects that Mac users who upgrade to the new OS X operating system will give margins a significant boost next year, since gross margins on the software will be close to 100%.

The bottom line is that the key factors that have brought about Apple's stunning turnaround are still in place. Apple has proven that slick design does matter with computer buyers. While earnings news kept the stock down, the products introduced at MacWorld, including a snazzy new cube-shaped desktop, a lower price of $799 for the iMac, and a high-tech new mouse, are exciting (see BW Online, 7/12/00, "MacWorld Expo: What to Expect When Apple Hits the Big Apple").

THE REAL KEY. This highlights one of the best reasons to invest in Apple: The company makes snazzy, innovative products that customers are willing to pay a bit extra for -- in a PC market characterized by eroding prices for commodity machines. But trendy products are only half the Apple story. Jobs is also credited with improving operating efficiencies -- the real key to Apple's turnaround in profitability and cash flow since he came aboard.

The big risk Apple faces now is that its new OS X operating system will be further delayed (its commercial launch is now expected in early 2001) or, worse, won't live up to customers' high expectations. Still, as any sea captain will tell you, the hard part is turning the ship around. Picking up speed is the easy part. Long-term investors should be thankful that Wall Street isn't yet convinced that the company has a lot more room to grow. It means they still have the chance to get into Apple at a decent price.

By Amey Stone in New York, with Peter Burrows in San Mateo

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