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reports after the close on Wednesday, Jan. 18. Following Steve Jobs' comments at the Macworld Expo last week, estimates have moved up sharply. Jobs guided to $5.7 billion in revenue for the December quarter, and analysts who have adjusted their estimates are tightly clustered around this figure. There was no specific guidance on EPS at Macworld, so these estimates are more varied. The range is from 59 cents to 69 cents per share, up about 10 cents from before Jobs' speech. Estimates have risen sharply for fiscal 2006 as well. The range of EPS estimates is now $1.95 to $2.53, up about 30 cents at the midpoint. Revenue estimates for 2006 range from $19.4 billion to $22.3 billion, up $2 billion to $3 billion.
I think the big question mark for the December quarter is, how good were margins on the incremental $700 million in revenue AAPL booked relative to prior estimates? Fourteen million iPod shipments accounted for the positive surprise, as Mac shipments actually may have been 100,000 units under expectations. Recently, average selling prices, or ASPs, for Macs have been running around $1,400. Therefore, if units were 100,000 short, this might imply a revenue shortfall of $140 million in this unit. If so, that would mean that the extra iPod unit sales made up closer to $800 million in revenue.
At 3.5 million units, that implies an average revenue per unit of $228 for incremental iPods. That feels a bit high to me, but I think the math suggests that sales of the new 30GB and 60GB iPods must have been quite strong in the December quarter. These units earn higher margins than the 2GB and 4GB nanos, which were also strong sellers during the holiday season. The range of analysts' estimates is most likely a function of how the mix of iPod sales is viewed along with the level of Mac sales that carry different margins than iPods.
To view a video preview of Wednesday's call, click here.
Regarding the slight shortfall in Mac units, analysts seem unconcerned, given the earlier-than-expected introduction of desktop and laptop Macs powered by
chips. I get the impression that analysts feel there may have been some lost sales to customers waiting for an Intel-based machine. I think the shortfall was likely due to the overwhelming demand for iPods. Apple Stores were mobbed at Christmas, and I think there was just less of a focus on selling computers and more of a focus on getting iPods out the door. For example, each store set up a separate table just to ring up iPods.
Beyond the quarterly numbers, the questions for AAPL relate to future iPod and Mac demand. Analysts bumped up their iPod shipments for every quarter in 2006 and are expecting another year of big growth. Reports of unmet demand at many consumer electronics retailers have led to the assumption that a backlog in demand still exists at the consumer level. Given the strength in sales at the Apple Stores, I wonder how much of that supposed demand has already been met. That said, with 42 million iPods sold, we are far from saturation. At most, U.S. penetration is around 10%, and the rest of the world lags well behind. Also, AAPL did not introduce iPod upgrades at Macworld, suggesting that plenty of demand remains in the current form factor. It also leaves the ability to drive demand with further upgrades certain to come later this year.
AAPL also seems more focused on supplying its own iPod accessories. Accessories were a big seller during the holidays, and Macworld Expo accessory
introductions -- such as the iPod FM Remote and iPod A/V connection Kit -- tell me that AAPL wants to capture more of the multi-hundred million-dollar revenue stream in accessories. Typically, accessory purchases carry higher margins, so this could be a source of upside surprise in the future, if my theory is correct.
As for Mac demand, I think the Intel transition and the halo effect will prove quite positive during 2006. AAPL has always had great success with new Mac introductions due to the willingness of its loyal customer base to upgrade. Credit Suisse First Boston analyst Robert Semple has published some excellent research on this phenomenon and notes, "
In the five major form factor upgrades since 2001, according to our criteria, Apple has averaged a 129% sequential increase in unit shipments along with a 26% ASP increase." Add in the much greater awareness of AAPL products today, and this transition could be among the best ever. Plus, I continue to believe that, in the consumer market, the shift toward using computers for broadband Internet and digital media has reduced the importance of the operating system and increased the importance of the application software. AAPL has a big edge in digital media applications, so the leveling of the playing field against Windows makes a pickup in market share for Macs a real possibility.
With all that as background, being long AAPL, I do worry that we could get a sell-the-news reaction to the earnings report, particularly as it relates to margins and guidance. Heading into this week, AAPL is already up 19% this year after more than doubling off the summer low. My confidence in predicting the short-term reaction to AAPL's first-quarter 2006 earnings report is low. However, based on my belief that demand for iPods and accessories will remain strong and Mac sales will boom, I think downside is limited. Based on what I know now, I'd be a buyer below $80, where I think 20% upside would exist for AAPL shares over the next six to nine months.
At time of publication, Birenberg was long Apple and long Intel in very select client accounts, although holdings can change at any time.
Steven Birenberg is president and chief investment officer of Northlake Capital Management, LLC. Northlake specializes in managing equity portfolios using a combination of exchange-traded funds and special situation stocks. Prior to forming Northlake, Birenberg was a principal, director of research and portfolio manager at Gofen and Glossberg, LLC. Prior to that, he was a trust investment officer at Star Bank in Cincinnati, Ohio. Birenberg has managed portfolios and researched stocks for more than 22 years. He earned his bachelor's degree from Miami University, Ohio. From 1987 through 1992, Steve taught at the CFA preparatory program the Study Seminar for Financial Analysts in Windsor, Ontario. Birenberg appreciates your feedback and invites you to send it to