Thinking Different about Apple's Stock


Here's the basic Wall Street rap on Apple Computer (Apple fans, prepare to cringe): Sure it has some nice products, but its market share among computer users is falling anyway. With just 5% of the U.S. consumer market and 3% worldwide, according to International Data Corp., it has lost the battle against the Windows juggernaut and -- even if it hadn't -- personal computer makers are lousy investments these days anyway.

"We owned Apple (AAPL) many years ago," says Erick Maronak, director of research at investment firm NewBridge Partners. "We sold when it was apparent the [Windows] model was really going to take hold." Although impressed with Apple's new products, he doesn't think they'll provide a serious long-term boost to sales and profits. Besides, he says, "We're less than lukewarm on the whole PC industry."

A look at Apple's stock price for the past year confirms the general lack of interest. All through volatile 2001 it traded between 15 and 25, and at $22 on Jan. 18. Adjusted for a split in the summer of 2000, it's right where it was three years ago. At that point, the stock was about to start a two-year ascent to $70 ($140 pre-split). But then Apple's growth, along with the bull market, stalled in mid-2000. The stock plummeted like the fruit that hit Issac Newtown in the head, landing in the $20 range, and got stuck there.

WILLING CONSUMERS. That's the history. But recent developments at Apple are pointing to a potentially brighter future. Several new products, including its hit iPod digital-music player and the attention-grabbing iMac, which launched in early January, look like winners. That could mean a climb in sales and -- most important -- gains in market share.

Plus, while corporate buyers are still holding back when it comes to technology spending, evidence is building that consumers are ready and willing to plunk down some cash for a hot new machine. Holiday sales of PCs were stronger than expected. And on Jan. 17, Dell (DELL) upped its financial guidance, noting that its consumer business was up 50% in the fourth quarter over the third quarter.

Since Apple's sales are more weighted to consumers than other PC makers' are, the iMac, which is packed with easy-to-use new digital-entertainment features, could wind up in lots of homes. "They are banking on the right trends," says Eric Kintz, who heads the San Francisco office of Roland Berger Strategy Consultants. "One of the very few growth areas that we see in coming quarters is home entertainment."

IMMEDIATE APPEAL. Much of Apple's success going forward rests on the iMac, which has already reaped many glowing reviews -- and a Time magazine cover story. The space-age flat-panel screen swinging on a stainless-steel pivot arm that emerges from a half-melon-shaped base has immediate appeal for many buyers. More important, the machine comes at a price that -- for once for Apple -- is very competitive with Windows-based PCs.

Here's where much of the current controversy over the stock lies: The iMac's lower price point should spark sales and result in market-share gains. But will Apple be able to meet the demand? Probably not, at least at first. And will it be able to maintain lofty profit margins? The iMac's high-end components are more expensive, and Apple is using costly air freight (rather than cheaper ocean shipping) to move the product from Taiwan. Analysts already expect gross margins to fall several points from the 30.7% reported for the quarter ended in December.

One reason for optimism that Apple can keep margins at least near, if not at, the 30% mark is its new retailing strategy. At the end of the quarter, it had 27 stores, which attracted 800,000 visitors in December alone. It expects to open more. Sales through the stores have the potential to carry higher margins than those through other retailers -- once Apple gets through the startup costs.

DIVIDED OPINION. In the last quarter of 2001, the stores brought in $48 million in sales but lost $8 million, according to Salomon Smith Barney analyst Richard Gardner, who believes they'll become profitable as early as the quarter ending in September, 2002. Still, analysts remain divided on the store strategy. Merrill Lynch's Steve Fortuna argues that they add expense to Apple's already high cost structure and points to Gateway's failure to generate profits from stores as proof of how difficult retail outlets are to manage.

Despite the ongoing controversies over its strategy (one would expect no less from Apple), the company's first-quarter profits, reported Jan. 16, are another cause for optimism. Revenues of $1.38 billion were a little light, compared to analysts' projections of $1.43 billion in sales, likely a reflection of deferred purchases as customers waited for the new iMac. But Apple sold more than 125,000 iPod music players in its first two months on the market and said demand for the new iMac is exceeding its own expectations. Profits came in at $38 million, or 11 cents a share, meeting estimates but down from $66 million in the prior quarter, and the stock rose nearly $2 on Jan. 17 -- an 8% gain.

Since much of Wall Street continues to dismiss the company, investors who are willing to bet that Apple can manage a fumble-free transition to its new product line have an opportunity -- but hardly a sure thing. Mark Specker, an analyst with Soundview Technology Group, titled a Jan. 17 report: "AAPL: Greater Opportunity and Risk."

"PREFER TO WAIT." Salomon Smith Barney's Gardner is one of the few analysts to really get behind the stock following the earnings report. He upgraded his rating from neutral to buy and raised his price target to $27 on Jan. 17. "We are especially encouraged by Apple's decision to price the product aggressively," he wrote.

Merrill's Fortuna, however, stuck to his neutral rating, noting that the quarter was better than expected but that plenty of risk remain for the quarter ending in March -- when Apple has to actually deliver all those iMacs it's taking orders for now. "We would prefer to wait and see for a while longer before getting more positive on the stock," he wrote in a Jan. 17 note to clients.

The case for waiting before jumping in is a good one. But Apple has the original iMac to thank for dragging its stock out of the doldrums when it launched in late 1998, and history may repeat. With some investors and analysts just starting to perk up and pay attention to Apple once again, intrepid fans might want to "think different" and get there first. By Amey Stone

in New York


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