iPod Moving the Mac to the Mainstream?

If you purchased Apple stock at say, 20 bucks a share, sold when it hit 27 and then crowed when you made a cool 7 dollars per minus commissions right now you feel like a bit of a dolt. At least I do. Apple stock has been skyrocketing, reaching levels not seen since the dot com bubble burst way back in 2000. At some point you’ve got to wonder: Just what are people smoking to make them so deliriously optimistic about Apple’s future. The answer is pretty clear and the answer is “iPod.”

The success of the iPod is undeniable, so far more than six million of the hard drive based music players have been sold. That number was reached despite initial negative reactions and an “iPod killer” seemingly debuting every few weeks. Even with all the supposed competition the iPod clearly rules the market, exact numbers vary widely but reliable sources have put the number as high 92%. That is the kind of market share saved for Microsoft and the final episode of MASH. Still it is not enough to justify the recent run up in Apple’s stock price, the music player market just isn’t large enough at this point to justify a 25 billion dollar market cap. Of course stock traders are speculative types and they are counting on a lot of things to break Apple’s way.

What are the traders counting on? One thing they are sincerely hoping for is a substantial “iPod Halo” effect. The logic is (roughly) as follows: People use the iPod, they are impressed by the ease of use and quality construction. The joyful experience and exposure to Apple products results in a serious percentage of iPod owners considering Macs as a replacement for their Windows based commodity computers. Of course that is speculation and speculation without research is also called guessing. Fortunately there is some hope that this is a viable scenario, Piper Jaffray performed a study wherein they concluded that six percent of iPod users had already switched to the Mac while an additional seven percent of iPod users will likely switch from the PC to the Mac. While I found the some aspects of the study to be lacking (small sample size means large error bars) the results were encouraging.

So assuming that the research is somewhat correct then there is a large pool of switchers just waiting to jump to the Apple computing platform and, thus, the stock price is justified. Or is it? The study gives a ratio of Mac to Windows iPod users of roughly 75%. That is to say 75% of the people who own an iPod use Windows (obviously hard core Mac users don’t need to be switched). So with six million iPods in circulation you could expect, at most, 270,000 switchers.  That is a healthy number, in Apples most recent quarter they managed to sell some 800,000 thousand Macs so tacking on another quarter million would be a substantial boost. But the traders are hoping for a bigger increase than mere quarter million Macs, they’re hoping for much more. If you assume that the study performed by Piper Jaffray is accurate (a stretch) and assume favorable iPod sales you arrive at the conclusion that Apple will sell 25% more Macs in 2005 than they did in 2004. That would be a very substantial increase.

Of course all this is predicated on continued stellar iPod sales and people switching. Personally I’m skeptical about people switching in the numbers suggested by Piper Jaffray. The iPod sales figure is where everything becomes really murky because no one is really sure if the iPod trend is going to follow the most recent quarter or the longer sales trend. Here it is important to note that the sales of the iPod followed a fairly predictable line until the most recent quarter. The curve looks as follows:

What you see here is impressive steady growth. Actually what you see is very impressive growth.  But it is nothing compared to what happens in the most recently reported quarter:

That huge spike at the end is the result of iPod sales more than doubling. Turns out that in a single quarter iPod sales went from a respectable 860,000 units to a jaw dropping 2 million units.

The real question remains: Just what is the likelihood of continued iPod growth and subsequent switching? Looking at the first quarter of ‘04 we see that iPod sales more than doubled. So if we use that as an indicator then it would seem possible that the first quarter of ‘05 will see an astounding 4 million of the things fly off the shelves. And, again judging from previous performance, the number would stay fairly constant throughout the year. That is to say that Apple would sell about four million iPods per quarter for the 2005 fiscal year. People switching because of the iPod is harder for me to envision because one would think that there would already be a fairly significant upswing in Mac sales but if Piper Jaffray is correct there will Macs everywhere.

Of course that is a best-case scenario, it is like throwing a deck of cards in the air and hoping that they flutter down and assemble a fifty two card pyramid on just dumb luck. If any one assumption turns out to be erroneous the stock could be highly overvalued. And there are plenty of things that can go wrong: the first quarter of ‘05 may not see the anticipated doubling of iPod demand, or an actual iPod killer may show up. On the switching side the study may be flawed or Longhorn may roll out and be so incredibly good�well the Longhorn part is just crazy talk. If any of the other scenarios play out today’s jubilation could turn to a bad case of buyer’s remorse for the stock traders.