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Apple Off-Key on iTunes

Katie Dean

Apple (AAPL Quote - Cramer on AAPL - Stock Picks) shares hit a monthly low Tuesday after a report on slowing song sales in the iTunes Music Store apparently tempered investor enthusiasm, but even the author of the report said Apple shouldn't worry too much.

Shares of the Cupertino, Calif.-based computer maker slid $2.61, off 2.9% to close at $86.14. Shares changed hands at heavier-than-normal volume.

For its digital music report, released Monday, Forrester Research analyzed 2,791 U.S. iTunes debit and credit card purchases between April 2004 and June 2006.

The report found that iTunes sales steadily increased from the beginning of the survey date to January 2006, but tapered off in the following months.

The number of monthly transactions rose from just two per 1,000 households in April 2004 to almost 17 in January 2006. At the same time, the average amount spent per purchase nearly doubled to $6.69.

But since January, the number of transactions fell 58%, Forrester found, and the size of each purchase declined 17%, resulting in a 65% drop in monthly iTunes sales.

"With only two years of full data, it is too soon to tell if this decline was seasonal or if buyers were reaching their saturation level for digital music," Forrester analyst Josh Bernoff wrote. "During the previous year, iTunes revenue fell after the holidays but rose significantly in May."

For its part, Apple spokeswoman Natalie Kerris says "the conclusion that iTunes sales are slowing is simply incorrect."

Apple does not provide any financial details related to its online music store, but says 1.5 billion songs have been sold in the store.

Kerris added that iTunes sales are 6% of all music sold in the U.S., making it the fourth largest music retailer.

Forrester also found that iTunes shoppers tend to make "small 'impulse' buys," with the median transaction hitting $2.97. One-third of total transactions hit $1.08 or less, and 75% of purchases cost $9.99 or less.

"Apple's iTunes proves that 99-cents micropayments for digital music can lead to substantial revenue; buyers spent an average of $35 at iTunes over the past year," Bernoff wrote. "With half of all transactions costing $3 or less, though, transaction fees threaten to make iTunes unprofitable."

Using data from Apple press releases and public statements by Steve Jobs, Forrester analyzed total global sales and found that "Apple has been steadily selling just 20 iTunes tracks for each iPod sold, suggesting that even at 99 cents, most customers still aren't sold on the value of digital music."

In an interview, Bernoff said that even though song sales are down, it's the number of songs purchased per iPod that should have the music industry, not Apple, concerned.

"Apple is going to keep selling iPods, that's where all the profit is for them," he says. "Not in the iTunes Music Store."

"I don't really think this [report] is bad news for Apple but I do think this is challenging for people who sell music," Bernoff says, referring to the music labels like Vivendi's Universal Music Group, Warner Music Group (WMG Quote - Cramer on WMG - Stock Picks), Sony's (SNE Quote - Cramer on SNE - Stock Picks) BMG and EMI.

Buying music online hasn't replaced the CD-buying habit, Bernoff says. Listeners are ripping their CDs to their iPods, downloading music for free, or burning CDs and sharing them, which is "done by more people than any other form of piracy."

He added that online music stores are "no prescription" to save the major labels. The companies need to find additional revenue from ringtone sales and selling unprotected MP3s, for instance.

(Microsoft (MSFT Quote - Cramer on MSFT - Stock Picks), for one, has already made concessions to the music industry and will pay interested labels a cut of every Zune player sold.)

Even if the report doesn't spell doom for the iPod maker, it provoked the second notable ding to its stock this month. Shares dipped to $86.90 last week after CIBC World Markets analyst Ittai Kidron released a note speculating that the widely anticipated iPhone will launch later than many expected.

Meanwhile, Apple iPods continue to sell well at online retailer Amazon.com (AMZN Quote - Cramer on AMZN - Stock Picks), holding eight of the top ten spots in the MP3 player category.

Rounding out the list are two SanDisk (SNDK Quote - Cramer on SNDK - Stock Picks) players, which have moved up the list to hold two of the top five spots.

Microsoft's black Zune is at No. 19.