Technology

Students Will Help Save Apple


The tech company may look vulnerable to an economic downturn, but back-to-school shoppers should help it keep up a strong financial performance

Take a look around and it's hard not to get depressed by all the negative economic news. Home prices keep sliding. Credit is drying up. Inflation fears are on the rise. And consumer confidence is lower than it's been since the early 1990s.

You would think all of this would eat into the business at Apple (AAPL). The company's computers tend to be pricier than those from Dell (DELL) or Hewlett-Packard (HPQ), while its iPods and iPhones are the sort of discretionary purchases that consumers often cut out during an economic slowdown.

Paul Kedrosky thinks Apple is about to take a hit from the slowing economy. The Kauffman Foundation senior fellow who edits the business and economics blog Infectious Greed recently argued on Yahoo's (YHOO) Tech Ticker that since Apple's products are "aspirational," consumers can do without them and opt instead for cheaper alternatives from others, or bypass electronics purchases altogether. He's expecting Apple to miss its earnings targets for the current quarter and to lower its outlook for the quarter after that.

I think he's way off. So we've agreed to wager $50 on Apple's earnings announcement coming up in mid-October. He is betting that Apple will miss consensus estimates for the current quarter of $1.11 and say that gross margins for the next quarter will be less than 30%. I think Apple will at least meet the consensus and will keep its margin guidance higher than that. If Kedrosky is right on either metric, I'll write a $50 check to the National Resources Defense Council. If I win, he'll send $50 to the Susan G. Komen Breast Cancer Foundation.

Computer Sales Matter

Kedrosky's assumption seems reasonable until you start looking at what's really driving Apple. For all the attention the iPhone has been getting, Apple's performance in the quarter ending Sept. 30 will largely be determined by sales of its computers.

And in this back-to-school season, college kids are buying Macs in numbers never seen before. A recent survey by Student Monitor, a New Jersey outfit that tracks the buying habits of college students, found that 13% of all undergrads expect to buy a new notebook this fall. Of those, 43% say they plan to get a MacBook or MacBook Pro, nearly double those who said they expected to get a Dell notebook, and seven times as many as those who plan to buy from HP, says Eric Weil, the firm's managing partner. While students prefer Dell for desktop computers, that's small consolation: Students favor notebooks over desktops by a factor of nearly 5 to 1.

Ask among the college students you know and you'll probably find lots of new Mac-users like Joe Praetorius of Springs, Texas. The 17-year old is headed first to Houston's Media Tech Institute to study sound engineering, and then on to Boston's Berklee School of Music after that. I heard that the Mac was best for sound engineering and editing, he says. Gina Elliott, of Bronxville NY, who's headed to Georgetown University got her first Mac earlier this year after finding Windows, which she'd used for her entire computer-using life, irritating. I was really frustated with Windows. Things were difficult to find and it took a long time to figure things out. Just this week, she convinced her Mom to switch.

Back-to-school time has always been important for Apple. In 2007 the company sold nearly 2.2 million Macs in its fourth quarter ended Sept. 30, up 34% from the year-earlier period. Those computers brought in $3.1 billion during the 2007 quarter, half of all the company's revenue.

Another blowout quarter is in the offing: Analyst Gene Munster of Piper Jaffray (PJC) wrote in a research note on Aug. 25 that the latest numbers from market researcher NPD suggest Apple could sell as many as 2.9 million Macs this quarter. That would mean a surge of 34% from the same quarter a year ago. On the iPod and iPhone front, NPD data, Munster says, suggest sales in the ballpark of 11 million and 4 million units, respectively. Add it all up and you have the makings of a quarter where Apple could beat Wall Street consensus numbers by 8¢, and report earnings per share as high as $1.19. Advantage me.

Getting "Help" from Microsoft

Moreover, Apple has of late been defying trends in the computer industry. It has been winning share of the personal computer market, reaching 8.5% in the U.S. behind Dell and HP, according to the most recent Gartner (IT) report. In the second quarter, it saw its year-on-year growth rate in unit shipments hit 38%. That's three times the rate of growth at Dell, seven times faster than HP, and nine times faster than the PC industry as a whole.

And what is fueling that growth? Microsoft (MSFT) is certainly doing its part. The perception that Windows Vista is a buggy mess, fueled by Apple's "Mac vs. PC" TV ads, are causing Microsoft some damage. As The Wall Street Journal reported on Aug. 21, it's about to try to fight back with a $300 million ad campaign that will include appearances by celebrities including Jerry Seinfeld, Will Ferrell, and Chris Rock.

Students want to buy products that are cool, and the perception about Windows at the moment is anything but. The iPod tends to entice people from Windows over to the Mac, and the iPhone will only add to that trend. In 2006, Needham analyst Charles Wolf conducted a survey (BusinessWeek.com, 6/15/06) that demonstrated that Windows users who were also iPod owners were nearly twice as likely to consider a Mac as their next computer. This trend came to be known as the iPod Halo Effect. The Mac's ability to run Windows via Boot Camp or virtualization software such as Parallels or Fusion (VMW), he found, only increased their intent. Selling 45 million iPhones, as some analysts expect Apple will do by the end of 2009, will only compound this trend, and now that the phone is available in 44 countries, it will widen the Mac's potential international footprint.

Guarded on Guidance

Finally, I'd be remiss if I didn't address the negative guidance that Apple gave last quarter. Gross margins, Chief Financial Officer Peter Oppenheimer said in July (BusinessWeek.com, 7/22/08), will be lower than before, dropping below 32%. The reason? A back-to-school promotion that takes place every year, and a mysterious "new product transition." Kedrosky expects Apple to repeat that guidance when it next reports earnings in October, but with "more gusto."

New products at Apple always drive new sales. The conventional wisdom suggests that a new line of notebooks, and maybe a new version of the iPod Nano, is on the way, perhaps as soon as the second week of September. Kedrosky thinks that's too late for the back-to-school crowd, but I disagree. While many schools will start on Sept. 2, classes at lots of state schools don't get under way until late September. I think there will be plenty of freshmen armed with financial aid and scholarship checks headed to the bookstore to order a new notebook during the final three weeks of the month.

We'll see who's right when Apple reports its quarterly and full-year earnings in October. I feel pretty confident Paul will be the one writing the check.


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