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Apple at the crossroads
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September 29, 2000: 4:57 p.m. ET
Computer maker struggles to appeal to users beyond its loyal customers
By Staff Writer David Kleinbard
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NEW YORK (CNNfn) - Apple Computer, long an orphan in a world dominated by IBM-compatible personal computers, stands at a crossroads.
One day after Apple (AAPL: Research, Estimates) warned that its fourth-quarter earnings and revenue would fall below expectations, investors decided it was no longer a core holding, and investors sliced its value in half. In late afternoon trading Friday, the stock was down $27.50 at $26, a 51 percent plunge. The market's reaction caused Apple to lose about $10 billion of market value in one day. Trading volume was more than 20 times Apple's daily average.
"We've clearly hit a speedbump, which will result in our earning, before investment gains, approximately $110 million rather than the expected $165 million for the September quarter," said Steve Jobs, Apple's CEO, in a statement. "Though this slowdown is disappointing, we have so many wonderful new products and programs in the pipeline -- including Mac OS X early next year -- and remain positive about our future."
Most of the analysts who downgraded Apple Friday said that the revenue and earnings shortfall was a company-specific problem, not a sign of a slump for the entire personal computer industry.
"In our opinion, investors should not read this Apple blowup as evidence that PC demand is weak," said Merrill Lynch analyst Steve Fortuna in a research note. "Apple is, in many ways, a market unto itself."
Apple benefits from having an extremely loyal customer base that verges on the fanatical. However, to keep growing, the company needs to sell products and services beyond its current installed base, converting computer users from the "church" of IBM.
"They are primarily selling into their installed base and are not expanding their markets," said Kevin Knox, a research director at the research firm Gartner in Stamford, Conn. "Design innovation only gets you so far. It's hard to continue growing if you keep selling into your installed base."
"The important question the shortfall raises is whether Apple will be able to attract new users to the Macintosh platform to continue to grow its market share," said UBS Warburg analyst Charlie Wolf in a research note. "The shortfall raises ominous questions about whether it can."
Wolf lowered his fiscal 2000 earnings estimate for Apple to $1.71 per share from $1.86 and his fiscal 2001 estimate to $1.80 from $2.10.
Balance sheet is strong
No one is worried about Apple's solvency. The company has had 11 consecutive profitable quarters and intends to be profitable in the fourth quarter also, although those profits will be below previous expectations. In addition, Apple finished the quarter with a healthy $3.8 billion in cash and short-term investments.
On the other hand, Apple's share of the computer market is in the low single digits. If the company loses what little share it has, software developers may stop writing for the Apple platform, and dealers may stop selling the machines, analysts said.
"It's very difficult when you have as low a market share as they do to get dealers interested," said Bruce Tognazzini, who worked at Apple between 1978 and 1992, ending up with the unconventional title of Human Interface Evangelist. "A dealer has to sell a Mac, whereas he doesn't have to sell a Windows machine, since the Windows machine is a known quantity."
"Steve Jobs has done a good job of selling, and the Apple interface is still superior, but he doesn't have critical mass," said Tognazzini, who now is one of the partners at the computer design firm Nielsen Norman Group.
In addition, Apple's announcement on Thursday was especially troubling because it noted that the company's sales have been weak in the education segment, a part of the market Apple historically has dominated.
"We do not see this as a one-quarter phenomenon for Apple, but rather as the beginning of many tough quarters ahead," Merrill's Fortuna said.
Company was saved by innovative design
As recently as December 1997, Apple was at the brink of ruin. The company had an operating loss of more than $1 billion that year, and its stock was below $7 by December. In 1997, Steve Jobs returned to Apple, after having been cast out of the company in 1985. In the ultimate form of vindication, Apple paid more than $400 million for Next, a company Jobs started after being expelled from Apple.
Jobs brought Apple back from near death with the trendy-looking, colorful iMac and PowerBook lines. The iMac -- which now comes in colors such as indigo, ruby and sage and starts at about $800 -- has shipped about 3.7 million units since its introduction. Apple also was helped in August 1997 when Microsoft (MSFT: Research, Estimates) agreed to invest $150 million in Apple and continue making its Office suite for the Mac. As part of the deal, Microsoft's Internet Explorer became the default browser for the Mac operating system.
Apple's most recent major innovation was the G4 Cube, a machine so elegant that many observers said it deserved a place in the Museum of Modern Art in New York.
"The G4 is about the nicest industrial design that I have seen anywhere," Tognazzini said.
While the G4 is powerful, easy to upgrade, and less than one-fourth the size of most PCs, it has been criticized for being too expensive at $1,800 and for shipping with too little random access memory. In its press release issued Thursday, Apple said that sales of the G4 are off to a slower-than-expected start, providing no detail on why.
"We believe that the Cube is too pricey at $1,799 to appeal to consumers in volume, while few professional users are going to opt for the Cube based on its award-winning design," said Merrill's Fortuna.
No compelling reason to upgrade
Aside from the G4, Apple hasn't introduced new products recently that give its customers a compelling reason to upgrade, analysts said.
"I don't see anything next quarter that will result in massive upgrades," said Gartner's Knox. "Coming out with new colors is not going to drive a substantial number of upgrades. Going from blueberry to ruby is not a good reason to replace your machine."
"Apple has a lack of any real new products to drive strong year-over-year unit growth," Fortuna said in a research note. "Its existing products are getting stale."
Knox said that Apple needs to derive more revenue from sales "outside the box" -- products and services outside of the computer itself. Apple needs to follow the lead of Gateway Computer (GTW: Research, Estimates), which has been successful at generating profits from extra services, such as Internet access, he said.
"Bragging about megahertz and megabytes is a thing of the past," Knox said. "They need to look at solution sales. Gateway is a great example of that approach."
The Microsoft factor
Apple's eventual salvation or death could come at the hands of software giant Microsoft. There are many analysts who believe that Microsoft has chosen to keep Apple alive to avoid having further scrutiny from the Justice Department, which, along with the attorneys general from 19 states, is pursuing a sweeping antitrust case against Microsoft.
Microsoft's willingness to continue producing its Office suite for the Apple platform is considered key to Apple's survival. Office serves as a cross-platform application, since an IBM-compatible PC running Word can read a document created in Word on a Mac.
"Gates has kept Apple alive to get the Justice Department off his back," Tognazzini said. "All he has to do is stop making Office for the Mac and that is the end of Apple. He keeps Apple alive, but very weak." 
-- Click here to send e-mail to David Kleinbard
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