Another Music Phone? Yawn…

What if Apple made a cell phone and no one cared? Talk of the elusive iPhone heats up again, but analysts see marketplace obstacles

by Olga Kharif

Today, the iPhone is talked about in roughly the same tone that people use when they're speculating about life on Mars. Sure, it's possible, even probable, that Apple (AAPL) will introduce an iconic cell phone. But the iPhone seems to have become the stuff of folklore, partly because of patent filings and veiled executive comments, and partly because the product introduction has been said to be imminent for so many months. Is it about to become real?

Rumors that Apple will introduce an iPhone rose yet another notch (if that's possible) this week, when Prudential Equity Group analyst Jesse Tortora penned a note saying that Apple is readying a music phone—and a separate, combination video and music phone. He expects Apple to introduce the devices in January at Macworld, a conference for Mac enthusiasts where the company typically debuts new products. At least one of the phones will offer Wi-Fi connectivity, he says, and both will become available in the March quarter of 2007.

Analyst Skepticism

Contrary to expectations, the news doesn't have Wall Street doing cartwheels. Apple shares fell after the Prudential report came out on Monday and before the company's strong earnings report on Wednesday evening. Why? Even Apple seems less than confident about the iPhone's prospects. One line of Tortora's report: "Our checks indicate that Apple will produce these phones in limited quantities initially due to concerns over market acceptance and battery life." An Apple spokesperson refused to comment on rumors and speculation.

But the fact is the iPhone looks less like a slam dunk than it's been made out to be. Most financial analysts aren't expecting a huge uptake, at least initially. "In my opinion, it's not going to be a huge market," says Charlie Wolf, an analyst with Needham & Co., who believes the next big seller for Apple will be a Mac computer preinstalled with Windows operating software. Other analysts instead point to iTV as Apple's next big thing (see BusinessWeek.com, 9/14/06, "iTV: Here's Our 2¢").

Many analysts are skeptical on the appeal of an iPhone. Wolf believes an iPhone would first find buyers among today's 50 million or so iPod users. But even if all those people bought an iPhone right at its release, that would still trail the 78.1 million cell phones handset market leader Nokia (NOK) shipped in its most recent quarter. And, of course, initial iPhone sales will be far lower: After years of touting the iPod, Apple shipped only 8.7 million iPods in its latest fiscal quarter, according to results released on Oct. 18 (see BusinessWeek.com, 10/19/06, "Apple's Big Mac").

Inadequate Margins and Demand

In the handset market, that's a drop in the bucket. And like other low-share players trying to muscle their way in, Apple is sure to feel margin pressure. Even today, most handset makers reap only single-digit margins—a radical, unusual business position for Apple, which reported 12.6% overall operating margins in its latest quarter.

Meanwhile, even iPod aficionados might turn their nose up at the new device. Today, more than half of Americans with music-capable phones also carry MP3 players. That's an indication that "it's a nice feature to have, but people aren't that interested in it," says Bill Hughes, an analyst with consultancy In-Stat. That's a disquieting prospect for any new Apple phone, given that much of the iPod's user base is in North America.