On Tuesday I described some reservations I have regarding the market's reaction to Apple's ( AAPL) iPhone.

While some have criticized my pricing and keyboard concerns, the real objection seems to be to my statement that Apple's shares have benefited from a nearly $20 billion incremental rise in equity capitalization from last week's MacWorld announcement.

In actuality, that was being conservative. I would say there was more than $5 to $10 of pre-announcement hype built in to Apple's share price, and then the stock rose another $10. With 870 million shares outstanding, those two pops represent $4.3 billion to $8.7 billion and $8.7 billion, respectively, which is how I arrive at nearly $20 billion in hype.

I believe those who have objected to my view are wrong. Here's why.

Were it not for the success of the iPod, Apple's growth rate would have plunged over the last two years. (You could argue that the iPod's growth rate, too, is decelerating, albeit from a lofty rate of growth.)

If you doubt my assertions on Apple's non-iPod growth, turn to page 54 in Apple's 10k, which highlights the dollar and unit sales contributions by product line and geographic region.

From 2004-2006, iPod unit sales rose from 4 million to 39.4 million, representing unit gains of 75% in 2006 over 2005 (69% in revenue) and gains of 409% in 2005 over 2004 (248% in revenue). During the same period, Apple's desktop sales rose from 1.6 to 2.4 million units -- a loss of 3% in 2006 over 2005 (-3% in revenue) and a gain of 55% in 2005 over 2004 (45% in revenue) while Apple's portable products unit sales rose from 2.6 million units to 4.05 million units, representing unit gains of 42% in 2006 over 2005 (+43% in revenue) and unit gains of 11% in 2005 over 2004 (11% in revenue).

Stated simply, over the past two years the sales growth in iPods and other music products was responsible for nearly 75% of Apple's incremental revenue of $11 billion (to a total company-wide sales figure of $19.2 billion last year).

In fact, if the iPod and other music businesses did not exist in the past two fiscal years, Apple's revenue would have only risen from $8.5 billion to $9.8 billion in 2006, a modest gain of 15%, and down from the 30% growth rate in 2005.

Before the iPod, Apple was essentially a stagnating personal computer company with modest market share. After the iPod, Apple's MacIntosh sales grew well in 2005 but that rate of growth dropped by a third in 2006.

Despite the protests of many, the iPhone has been hyped for at least the last 12 months as the next growth engine for Apple, intending to replace the iPod's significant contribution.

As someone wrote to me last night, without the iPhone's announcement "a stagnant or falling stock price combined with Jobs' involvement in the options backdating scandal would have made for a more hostile environment ... so it sure is a big help that Jobs can make an over-the-top iPhone announcement at MacWorld just two days before the press discloses further damning details of the options scandal. Without the iPhone announcement, MacWorld is a giant yawn ... so the iPhone is announced -- without even having the rights to the name -- months before it is ready to be shipped."

So one has to ask, as Alan Murray does in The Wall Street Journal today, why the iPhone was announced so far in advance of its actual introduction in June 2007.

Last Tuesday's announcement also runs the risk of both the smartphone and iPod markets freezing up over the next few months.

And looking beyond the wow! factor, one has to question many of the features of the iPhone product. I suspect that in the fullness of time there could be even more flaws than I mentioned in my article yesterday.

From my perch, the market's very favorable reaction to Apple's iPhone is yet another example of disbelief being suspended ... on the Street of Dreams.
At time of publication, Kass and/or his funds had no position in stock mentioned, although holdings can change at any time.

Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd. Until 1996, he was senior portfolio manager at Omega Advisors, a $4 billion investment partnership. Before that he was executive senior vice president and director of institutional equities of First Albany Corporation and JW Charles/CSG. He also was a General Partner of Glickenhaus & Co., and held various positions with Putnam Management and Kidder, Peabody. Kass received his bachelor's from Alfred University, and received a master's of business administration in finance from the University of Pennsylvania's Wharton School in 1972. He co-authored "Citibank: The Ralph Nader Report" with Nader and the Center for the Study of Responsive Law and currently serves as a guest host on CNBC's "Squawk Box."

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