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Zen Master
Creative Technology, maker of the Zen, may not be an iPod killer. But the stock is worth a look.
January 20, 2005: 3:42 PM EST
By Paul R. La Monica, CNN/Money senior writer

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Now and Zen: Shares of Creative have surged during the past two years thanks to strong sales of its MP3 players.
Now and Zen: Shares of Creative have surged during the past two years thanks to strong sales of its MP3 players.
Creative's Zen Touch has a battery that lasts twice as long as an iPod's.
Creative's Zen Touch has a battery that lasts twice as long as an iPod's.

NEW YORK (CNN/Money) The MP3 player wars have begun.

Sure, Apple is the undisputed heavyweight champion of the digital music player market. The company sold nearly 4.6 million iPods in its latest quarter and has received a lot of buzz for its new iPod Shuffle flash player.

But Creative Technology, the Singapore-based maker of the Zen and MuVo brands of music players, has emerged as a strong number two.

Creative, which reported its fiscal second quarter results Thursday morning, said that it sold 2 million MP3 players in the quarter. Not too shabby. The robust digital music player sales helped Creative post a 50 percent year-over-year increase in total revenues.

What's more, Creative said it expects revenues to increase another 50 percent in its fiscal third quarter. The company also makes the popular Sound Blaster line of audio cards as well as speakers and Web cameras.

So with that in mind, are shares of Creative (Research), which trade on the Nasdaq, worth a look?

Despite the healthy results and outlook, shares of Creative fell more than 11 percent Thursday. The reason? Even though sales were strong, earnings took a hit, falling 10 percent from a year ago, due largely to increased marketing costs for its new Zen Micro player, it's multi-colored alternative to Apple's iPod mini.

Spending too much on ads?

Therein lies the problem for investors. It's encouraging that Creative plans to compete aggressively with Apple (Research). But will the fight be too costly?

The company has said it plans on spending $100 million this year on marketing and it took out a $175 million, five-year loan in November to fund much of this promotional blitz.

I think this is money well spent. Apple, after all, has a huge edge in the "coolness" factor. The iPod has a brand name cachet that other companies can't hope to approach unless they get their name out there in front of the public eye.

"Apple has tremendous support from resellers and customers and has created more buzz. It's going to be hard for Apple's competitors to match that momentum," said Bill Fearnley, Jr., an analyst with FTN Midwest Securities.

But Creative has buzz-worthy features of its own. For one, the battery life for its Zen Touch, which is comparable to the regular iPod, is 24 hours, double the iPod's battery life. It's also easier for people who don't buy music from Apple's iTunes to transfer songs bought at online stores like Napster (Research), RealNetworks' (Research) Harmony or Microsoft's (Research) MSN Music to a Zen.

So with that in mind, I think Thursday's dip appears to be a healthy pullback for a stock that, like Apple, has ridden the digital music craze during the past two years. Before Thursday's plunge, shares of Creative were already up about 10 percent in 2005. And that's on top of 50 percent gains in 2003 and 2004.

Market is big enough for iPod and Zen

Of course, there are risks with this stock. The company is relatively small (a market value of about $1.2 billion) and is not based in the United States. As such, no U.S. based analysts follow the company and there is not as much institutional support for the stock.

But for what it's worth, there are 11 analysts outside of the United States that cover Creative, according to Thomson/First Call. And based on their consensus estimates for this fiscal year, which ends in June, Creative trades at a P/E of about 20 and slightly more than 1 times projected revenue.

Apple, by way of comparison, trades at 35 times this year's earnings estimates and a price-to-sales ratio of more than 2.

Now does Apple deserve a premium to Creative? Certainly. But when push comes to shove, Creative doesn't have to supplant Apple to prove that it's a worthy investment.

"Both Apple and Creative are doing well and it is not necessarily at the expense of each other. It's not a zero-sum game," said Shaw Wu, an analyst with American Technology Research. "This is a good market to be in."

So if Creative can stay ahead of other companies in the digital music player market, such as Sony (Research), Samsung, Dell (Research) and iRiver, then that would be sweet music to investors.

There's nothing wrong with being the Pepsi to Apple's Coke.


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