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Sour Apple?
Fears about iPod inventories, a legal settlement and a switch to Intel chips have some worried.
June 6, 2005: 3:25 PM EDT
By Paul R. La Monica, CNN/Money senior writer
Do the shuffle: There is speculation that Apple may soon unveil an iPod Shuffle with as much as 2GB of memory.
Do the shuffle: There is speculation that Apple may soon unveil an iPod Shuffle with as much as 2GB of memory.
Cored or juiced? Apple's stock is up sharply during the past year but has taken a notable hit lately.
Cored or juiced? Apple's stock is up sharply during the past year but has taken a notable hit lately.

NEW YORK (CNN/Money) - Some worms have started to dig their way into Apple.

Last week, there was news that the company was extending warranties and offering $50 store credits or $25 in cash to buyers of early versions of its popular iPod as part of a legal settlement. The company was sued by customers claiming that Apple misrepresented how long the battery for these iPods should last.

There were also rumors that demand for the iPod, which has been a must-have tech gadget since its release in 2001, may be starting to slow. Unsubstantiated reports of rising iPod inventories sparked a 4.5 percent drop in the stock on Friday.

Finally, Apple (Research) announced Monday that beginning next year, it will begin selling versions of its Macintosh computers that will use Intel (Research) processors, sparking concerns about how risky a transition might be for the company.

Apple CEO Steve Jobs made this official Monday at the company's Worldwide Developer Conference in San Francisco. Apple has been using chips made by IBM (Research) and Freescale Semiconductor (Research).

The company said that it will make available a transition kit to developers so they can prepare software that will run on Macs that operate on both Intel chips and the PowerPC chips made by IBM and Freescale. Apple added that all of its Macs will run on Intel chips by the end of 2007.

iPod worries overblown...

What's this all mean for the stock? Shares, which finished the first quarter of this year up nearly 30 percent, have cooled off dramatically in recent months and are now flat for the year. The stock is about 16 percent below its 52-week high.

But some of the concerns appear to be overdone, particularly about the iPod.

Bill Fearnley, Jr., an analyst with FTN Midwest Securities, said that he has not noticed any iPod inventory problems.

If anything, he said Apple has done a better job lately of shipping the appropriate level of iPods in order to avoid shortages. So he thinks investors could be worrying unnecessarily.

"Investors have gotten used to Apple being out of stock on some of their hottest products. Now they have them in stock. And the good news is that they are still selling through," Fearnley said.

There's also the fact that the second quarter of the calendar year tends to be not as strong for Apple and other makers of consumer electronics and computers. Sales usually pick up towards the end of the summer during the back to school shopping season.

"The reaction to the inventory reports was overblown," said Darcy Travlos, an analyst with CreditSights. "Apple stock has been trading on iPod expectations but this is seasonally the weakest quarter."

The settlement of the battery lawsuit is also expected to have a minimal impact on the company with most analysts estimating that it may cost Apple between $100 million and $150 million. Apple has more than $7 billion in cash and investments on its balance sheet.

Apple may also be set to soon unveil new iPods, which could boost sales in the summer months. For example, there has been speculation about a 2 gigabyte version of the Shuffle, which uses cheaper flash memory chips instead of a hard drive for storage, and an iPod mini with a color screen.

Shaw Wu, an analyst with American Technology Research, said that an iPod mini with a color screen in particular could be a big hit. Some rivals, such as iRiver and Creative Technology (Research), which makes the Zen Micro, have similar products with color screens.

"A color screen would be a positive," Wu said. "Doing that could spur some people to want to upgrade."

...but shift to Intel could be a headache

But the switch to Intel chips is a notable risk, which could weigh on the stock. Despite the buzz about the iPod, sales of Macs still make up nearly half of Apple's total revenue.

Wu notes that since Apple has marketed its computers during the past few years as being technologically superior to those that run on the so-called "Wintel" platform -- Microsoft's Windows operating system and Intel processors. So it may not be easy for Apple to convince its loyal user base why it's now reversing course and embracing Intel.

"A transition to Intel is technically possible but from a marketing standpoint it could be more challenging," Wu said. "Why ruin something that's doing well?"

Even though switching to Intel processors could lead to lower costs for Apple in the long run, it could cause significant cost increases in the short term, since Apple software programs would likely need to be redesigned in order to work with Intel chips.

"Plainly, under any reasonable scenario (barring one that is accomplished overnight), such a platform shift can be expected to cause some transition risk," wrote SG Cowen analyst Richard Chu in a report Monday.

With all this in mind, analysts said shares of Apple could muddle along for the foreseeable future.

The stock, trading at 29 times earnings estimates for fiscal 2005, isn't cheap, although analysts are projecting earnings gains of 20 percent annually for the next few years.

But Apple is clearly expected to do more than simply meet expectations. Any slight hiccup could cause momentum investors to bail on the stock and the move to Intel chips adds an element of uncertainty that investors hadn't been counting on.

"Apple is fairly valued but there's a lot of work that needs to be done if they switch processors," said Fearnley. "There are a lot of details that need to be fleshed out."

Still, for longer-term investors, the Intel news could be a positive.

CreditSights' Travlos thinks that Apple will benefit from having Intel chips in its Macs because more consumers are comfortable with the Intel brand name, particularly when it comes to chips for notebook computers, which have become more popular than desktops. And that could be good because even though Apple's Mac users may be intensely loyal, the company's overall market share of the PC market is still small.

"Consumers and investors had been equating Apple with the iPod. But now Apple will have the chance to get in front of more consumers in a credible way in the computer business," Travlos said.

For more about personal technology, click here.

For tech commentary, click here.

Analysts quoted in this story do not own shares of Apple and their firms have no investment banking relationships with the company.  Top of page

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