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Sure, iPod sales are off and recession fears are rife. But Mac sales are scorching, and experts say Apple is well-insulated against a chill
Usually, on days when Apple Inc. (AAPL) reports earnings, giddy investors have a chuckle about the company's famously conservative forecasts and proceed to load up on the stock—confident that Apple's closely guarded pipeline of new products will keep sales and profits on the rise. But in a reflection of the gloomy mood on Wall Street over the prospect of a recession, investors found little to laugh about in Apple's latest forecast. After the company said earnings in the March quarter would come in 14% below analysts' expectations, the share price fell more than 11%, to $137.93.
Yet on closer inspection, there are signs that Apple can not only weather an economic contraction but emerge stronger than ever. Most important is the strength of its Mac business. Sure, Apple sold a few million fewer iPods than analysts expected, but Mac sales were scorching—particularly the desktop iMac, whose sales grew 53% in a market that expanded just 10%. "The Mac is on fire," says Needham & Co. analyst Charles Wolf, who notes that Mac sales rose by 200,000 units in a quarter when Mac sales are usually flat.
And strength in the PC business is much more of a positive than slightly disappointing iPod sales are a negative. For starters, the profit on one $1,500 iMac (roughly $500) dwarfs the $140 profit on an iPod Touch (assuming both products' profitability is close to Apple's overall 34.7% gross margin). And while Apple dominates the global $28 billion market for MP3 players, it still has less than 5% of the vast $258 billion PC market, says IDC senior analyst Danielle Levitas.
What's more, about 50% of the 500,000 or so Macs sold in Apple stores last quarter were purchased by someone who had never purchased a Mac before—in many cases the newbies are converts from PCs that run Microsoft's (MSFT) Windows operating system. That's not just a one-time boost, either, because history shows most Mac converts are likely to buy other Mac-compliant products, too—from iPods to iPhones to Apple TV set-top boxes. "Getting a Mac sale is arguably one of the toughest things, since you're asking the customer to make a big change" from Windows, says American Technology Research analyst Shaw Wu. "But once they do, there's great stickiness."
Good News Even in the Bad News
There's little question how Apple executives feel about the company's prospects. During a conference call for analysts and shareholders, Chief Financial Officer Peter Oppenheimer said: "I couldn't be more confident in what we're doing."
There's a silver lining in the iPod sales numbers as well. While the 22.1 million units were 2 million to 3 million shy of consensus expectations, Apple met Wu's revenue target for its famous MP3 line. That means the shortfall was mostly for Apple's cheapest, least profitable product, the iPod Shuffle, says Wu. So while consumers normally opt for cheaper models in nervous economic times, Apple's customers clearly see the value in the company's swankiest products. That's good news for Apple's well-rehearsed iPod strategy: Bring out a headline-grabbing gizmo at a high price and spend the next few years milking demand by maintaining that price for new high-end models while bringing out cheaper models to reach thriftier shoppers.
During the analyst call, Apple Chief Operating Officer Tim Cook remarked on the company's desire to establish the iPod not as a music player, like the iPod Shuffle, but rather as a "Wi-Fi mobile platform" that can handle various kinds of video as well. "We overwhelmingly met this goal," Cook said. "We may have traded off a bit of unit volume, but it was the right decision."
Chinks in the Armor?
To be sure, questions surround some Apple products. While iPhone sales are generally on target, it doesn't seem to have the unstoppable momentum the iPod had a few years back. And Apple didn't disclose early order numbers for the new MacBook Air or the refurbished Apple TV, both of which were introduced at this month's Macworld conference in San Francisco. Apple has occasionally disclosed such figures in the past.
And for Apple's video strategy to really take off, the company has to make good on promises to develop a richer library of movies and TV shows available through iTunes. Apple came to dominate the music business largely because millions of people ripped their CD collections into iTunes. Because movies and shows are largely protected by software and DVDs that limit reproduction, Apple's video strategy relies far more on the cooperation of the big movie studios.
" An Outrageous Buying Opportunity"
Those concerns aside, there's one thing no one questions: whether Apple will continue releasing innovative products to keep consumer demand jumping. Analysts say that while consumers may not buy the latest upgrade of their existing PC or iPod, they might fork over some bucks for something entirely different—say, an iMac with an iPhone-like touch screen, or an iPhone that works with faster 3G cellular networks. Both are possibilities for later this year.
All these reasons mean Apple is likely far more prepared for an economic downdraft than most other tech companies. Sure, many consumers may put off purchases of the latest iPod or iPhone if the recession hits hard, but Mac sales should hold their own, says Harvard Professor David Yoffie: "Apple sells to the least price-sensitive part of the market. While no company is immune from a recession, Apple is a little less vulnerable."
Analyst Wolf puts it another way: "I think this is an outrageous buying opportunity. It's not a cheap stock, but you're getting a company that can grow at 25% a year for who knows how many years, at 25 times earnings. To me, that's a steal—recession or no recession."