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The Death of Rumors? Let's Hope Not

January 15, 2005

By Eric J. Savitz
Barron's

APPLE HAD A STUNNING YEAR IN 2004, tripling in price on the huge demand for its iPod music players. And it could have further to run. Last week, at the annual MacWorld trade show, CEO Steve Jobs introduced a pair of intriguing products, a $99 flash-memory-based music player called the iPod Shuffle, and a $499 box called the Mac Mini.

The day after the product announcements, Apple checked in with stunning financial results for the fourth quarter, beating revenue expectations modestly but with profits far above even the most optimistic projections. Apple shares, which had fallen sharply after the MacWorld announcements, largely on the company's failure to match the most optimistic rumors about December quarter iPod sales -- see, rumors strike again! -- soared higher after the earnings report. The stock, which had traded as low as 63.30 on Wednesday, finished the week with a gain of 95 cents, at $70.20.

Perhaps the most interesting aspect of Apple's fourth-quarter numbers was the jump in Mac sales -- for the first time in years, the company seems to be gaining some market share in personal computers, where its share has shrunk to about 2%. Some analysts have been arguing that a pick up in Mac shares would almost surely follow the strong iPod shares, in what the Street calls the iPod halo effect. But there are other forces at work, as well.

Michael Shulman, director of research at ChangeWave Research, says a survey by his firm found that among those people intending to buy an Apple computer in the next 90 days, the most significant reason cited for choosing a Macintosh is a lack of viruses, spyware and pop-up ads. In a research note, Shulman said that 13% of respondents planning to buy a desktop personal computer in the next 90 days plan to buy a Mac -- more than quadruple the level seen in any previous ChangeWave survey.

So is there really more upside for the stock from here? Yes, say some of the Street's savvier computer analysts. Steve Milunovich, computer hardware analyst and technology strategist at Merrill Lynch, thinks the stock can hit $85, which would give Apple an enterprise value-to-sales ratio of about two times. It helps that estimates have been ratcheting up dramatically: Milunovich pushed his September 2005 fiscal year forecast up to $2 from $1.45, while boosting his fiscal 2006 projection to $2.50 from $1.80.

Andy Neff, the longtime hardware analyst at Bear Stearns, has a similar target, $87, reached by placing a multiple of 25 times on his estimate on 2006 operating earnings, then adding in the company's cash position. Neff says he uses a more aggressive valuation approach for companies like Dell and EMC which have more predictable earnings. But Apple, he says, has been harder to pin down. The company, Neff notes, has topped analyst expectations for seven quarters running -- after 11 straight quarters in which the company hit numbers, then lowered guidance.

What makes some people nervous about Apple is that the company is so driven by product cycles. "In a sense, Jobs has two movie companies, Pixar and Apple," Neff says, noting that both rely on a series of hit products, driven by innovation. (And sequels: Pixar has Toy Story 2. Apple has the iPod, the iPod Mini and now the Shuffle.)

So what will Apple do next? Who knows. "Asking that question about Apple is like asking what movie Pixar should make next," says Neff. What we do know is that whatever Jobs and Apple do next, there will be a standing-room only crowd at the Moscone Center next year waiting to see it.