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Apple Hits Hard Road

Shares are sluggish as the company's magic touch hasn't yet translated to the phone market.

Updated from 3:15 p.m. EDT




decision to slash prices on its iPhone has investors fretting that the do-no-wrong tech giant is taking its lumps in the bruising cell phone market.

Apple shares slipped again Thursday as traders tried to sort out the implications of Apple's move to lower the cost of the 8-gigabyte iPhone from $599 to $399 and to end production of the 4-gigabyte phone that was priced more affordably.

The stock was recently off more than 1% to $135.16.

Apple's price cut, announced Wednesday, came just two months after the iPhone debuted, and it overshadowed the

unveiling of its new lineup of iPods. Apple shares fell Wednesday by 5%.

"The iPhone news was clearly the biggest surprise" yesterday, says Darren Chervitz, director of research for the $102 million Jacob Internet Fund, a long-term Apple investor.

Investors hadn't expected that a price cut would happen before the holiday season -- or before the iPhone's launch in Europe. Many are clearly worried that timing of the price cut suggests that phone sales may be been less lofty than expected.

Later Thursday, Reuters reported that Apple would offer earlier iPhone buyers a $100 store credit.

The price cut also clouds the impact the iPhone will have on Apple's finances. Apple records iPhone sales piecemeal over two years, and reveals little about the financial terms of its exclusive deal with



. Analysts and investors say this makes it difficult to forecast Apple's earnings potential and, in turn, to place a reasonable price on its stock.

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The price cut further complicates these estimates. "The iPhone is the trickiest part of Apple's business to attach a value to," says Chervitz. "This can throw a wrench into valuation models."

Apple's apparent struggle may in part be due to the different market dynamics than the company typically encounters. Its iMac desktop computer is largely a niche product with an appeal that separates it from rival personal computers. And music devices from






pose little threat to the iPod's overwhelming command of the digital music market.

In the cell phone market, however, there are few niches where Apple can build a moat around its market share and profit.

Research in Motion's


BlackBerry remains the device of choice for businesses that want to arm employees with mobile email as well as voice calling. And the consumer portion of the market is flooded with alternatives from









On top of that, intense competition among cell phone players has incited successive rounds of price cuts that have played a role in lowering average selling prices for all of the major players in this market.

Analysts and some investors have argued that the iPhone is inexpensive when viewed as a device that combines a phone with an iPod and mobile Web browser. But it's unclear that customers are making this calculation when comparing the iPhone with alternatives that also offer Internet browsing, digital music players and photo sharing.

Investors have received mixed signals about consumers' interest in the iPhone this week. Apple CEO Steve Jobs said the price cut doesn't reflect slackening demand but is instead a move to juice sales during the holiday season. He also said the company is on track to sell 1 million phones this month.

Earlier in the week, market tracker iSuppli said

that iPhone unit sales should reach 4.5 million this year as Apple launches the device in Europe. iSuppli also said that unit sales should reach 13.5 million in 2008, ahead of Apple's target of 10 million.

Piper Jaffray analyst Gene Munster expects Apple to exceed near-term iPhone sales forecasts and to reach a broader range of consumers with its new price.

But this strategy invokes worrisome parallels with Motorola, which has suffered badly after aggressively discounting its Razr cell phone. The Razr took years to develop and was hailed as the sleekest, most innovative cell phone when it debuted in 2004. But successive price cuts aimed at picking up market share undercut the Razr's cachet as well as Motorola's profitability.

Motorola twice warned this year that it would miss earnings targets as its cell phone operation has gone into the red.

Apple should be able to avoid Motorola's fate if future iPhones are clearly superior and innovative devices, says Robert Stimpson, portfolio manager with Oak Associates, an Apple investor. Motorola stumbled, he says, by failing to provide compelling innovations to the Razr.

But this doesn't necessarily help Apple avoid another wrinkle in the Motorola analogy. Inexpensive Razrs cannibalized sales of the phones that Motorola hoped would replace it. If Apple enthusiasts snap up cheap iPhones rather than new models that come out in the future, Apple may be forced into the same cost-cutting trap.