In this offering to you, the home readers:

• Market Guy Mailbag
  • Apple Computer
  • The Bootstrap Entrepreneur

Market Guy Mailbag

Letter #1: Ozner in Barrhaven wants to talk about computers and music:

I’m interested in possibly taking a position in Apple Computer (AAPL-Nasdaq). With the recent introduction of their new G5 platform, and OS X software updates apple devotees will be happy, and although they have a very small market share percentage compared to other pc manufacturers such as Dell and IBM their latest inroads into the music file sharing arena seems interesting. In the short time that the Apple Music Store has been in existence they have sold over five million songs. Apple seems to have the recording industry on its side and music pay-for-service file sharing may be the wave of the future. Illegal file sharing options such as Kazaa are coming under more fire and scrutiny from record labels, and copyright law enforcement. I heard recently on MSNBC’s market wrap show that several law enforcement agencies are looking into prosecuting individuals who share copyright music through peer2peer file sharing programs. It may very well be time for a legitimate online music purchasing service. There are services available other than Apple’s, but their policy of allowing the song to be transferred, copied, and played on any device owned by the user is at this point unique. Apple plans to make their service available to all computer users in the near future, as well as internationally (currently it is only available to US Macintosh users). This market seems like it’s ripe for the picking, and these apple tress are definitely producing sweet fruit.

Thanks for writing in, Ozner. Great e-mail. Let’s begin with some background on my dealings with Apple. In the late 1980’s, three things were very clear. One: Miami Vice was over and I was going to have to come to terms, somehow, some way. Two: I really wanted Market Gal to go out with me. Three: Apple was making the coolest computers on the planet and I was definitely interested. After spending the next couple of years drooling over my friend’s Mac, I splurged and picked up an LCII (16 MHz processor, 40 megabyte hard drive, 4 megabytes of RAM). This was followed by an LC575, then a Performa 5200, and finally a PowerMac 7200. This may be gibberish to some, but among Mac users their computers are held in the same regard as a beloved pet. But in the late 1990’s, I angered many of my Mac-devotee friends and switched to a PC. Yes, I had lost faith. And who wouldn’t have? The company was dogged by flagging sales, poorly received products (remember the Newton handheld?), turmoil at the management level, and a public perception that we were watching a repeat of the Sony BetaMax story. I felt compelled to abandon the fruit.

Then along came some positive developments. There was a much-needed infusion of cash provided by none other than arch-rival, Microsoft. Co-founder and creative guru, Steve Jobs (the Apple Jesus) returned to the company. Then along came the iMac, signaling the company’s return to innovation. The coffers started to fill with cash and prospects brightened considerably. So where are we now?

What sound does an Apple make?
As Ozner suggests, there are a number of exciting upgrades and products in the pipeline. And in what can only be considered a coup, Apple successfully developed the most intriguing online music service to date. What makes the site so compelling, is the strength of the music catalogue. Many subscription music services have sprung up over the last few years (e.g., Pressplay, MusicNet, Rhapsody, MusicMatchMX, eMusic and assorted others). You pay a monthly fee that grants you access to a fairly limited number of music files. Apparently there are issues with this business model, as barely 300,000 subscribers have signed on. People aren’t very interested in subscribing to a service that offers so few songs. What about pay-per-track? Although you can buy individual tracks at places such as bestbuy.com, these catalogues are similarly limited and price points can differ greatly from song to song. Contrast this with Kazaa.com, the much talked about heir to the Napster throne, where music fans can download a seemingly unlimited amount of copyrighted music (albeit illegally) for free. Kazaa has managed to entice over 200 million registered users. That’s not a misprint.

Here comes Apple. Armed with an agreement with several of the top music companies, Apple develops a wide catalogue and an interesting pitch: any song you want for 99 cents ($US). What’s in it for the music companies? It provides a chance to test a new business model on Apple’s relatively affluent customer base. Given Apple’s miniscule 3-5% share of the computer market, there is very little downside. Plus, it’s a heck of a lot cheaper for them to sell their music online than to manufacture and move CD’s. What’s in it for Apple? First off, a considerable amount of buzz (i.e., free advertising). The product launch even made the evening news. Second, Apple is very strong in the digital music player space, with their iPod device commanding a quarter of the market. The arrangement with the music companies will keep those digitally hungry Apple customers satisfied and further committed to the Mac platform. Third, the company gets to once again differentiate itself from its competitors.

In the short term, the results have been very impressive. Since the April launch, several million songs have already been downloaded. But will people continue to pay? I teach first-year students and one evening during the class break, many of them were talking about online music options. Here’s what they decided: Free is cheaper than paying $1 a song. If a CD holds 15 songs, that will cost $15. Free is cheaper than $15. And $15 buys 15 boxes of Kraft Dinner. In other words, $1 a song might as well be $10 as song. All they know is that anything more than free is not free. Unethical as all get out, but you can’t argue with the logic. Plus, they usually mention that free music has become somewhat of an expectation. So this is what the music industry (and by extension, Apple) is up against. Appeals to morality and threats of prosecution seem to be falling on deaf ears. Not everyone steals music, but enough do to leave the recording industry in serious trouble.

Fine, but what about the stock?
As always, the essential question is, can we make money here? Well, since January 1st, Apple shareholders and their 36% return have been laughing all the way to the bank (currently trading at $19.85). No way did I see this coming. However, the most important thing for investors is not where the stock has been, but where it’s headed.

Let’s compare Apple’s valuation with that of the 800-lb computer gorilla, Dell (NYSE ticker: DELL). A useful starting point would be to compare their respective price-to-earnings statistics. Have a look at the following table (info obtained from www.globeinvestor.com and First Call):

Based on expected earnings for this year, Apple is considerably more expensive than Dell. But what about next year? Same situation. Fine, but if Apple is growing at a much faster clip, then perhaps the premium valuation is justified. As the table makes clear, Apple’s earnings are expected to grow at a slower rate than Dell’s. In fact, it’s expected to grow slower than even the S&P 500 index.

Maybe it’s not fair to compare Apple with Dell. I mean Dell’s market share is roughly 6 times greater than that of Apple’s. Perhaps it’s more useful to analyze Apple with respect to a broader range of competitors. Well, even when using this approach, Apple comes out pricey. The technology hardware sector is expected to grow at an annual rate of 11.5% over the next five years and yet trades at a lower multiple than Apple.

Sure, but as we learned during the tech meltdown a few years ago, earnings estimates can be a moving target (watch for Apple’s quarterly results on July 16th, by the way). Perhaps there is some catalyst that will propel Apple forward and justify the current stock price. The online music division? Maybe when they open up the service to international Mac users and even Windows customers, they might have something. But I’m guessing by the time we get to that point, there will be a considerable amount of competition. Needless to say, people in both the computer and music industries are watching this little experiment with great interest.

Maybe there will be a ramp up of purchasing from one of Apple’s traditional markets: education. Demographically this makes sense, with all those baby boom echo children in school (according to David Foot, these are the kids born between 1980 and 1995, to all those baby boomers). However, there’s a big problem with this idea. The overwhelming numbers of state and local governments are in deep financial trouble and hardware upgrades don’t help at election time. Am I missing something here?

What’s the punch line?
Nothing would please me more than to see a stronger Apple. I think their products are easy to use and fun to look at. However, loving the company and its products is not enough for me to purchase the stock. The Apple juice comes at Dom Perignon prices. Sorry, Apple. I have betrayed you once again.

The Bootstrap Entrepreneur
Letter #2: Loyal reader Mike at Brymark Promotions (aka Mike in Kanata) wanted to let Market Guy readers know about an event taking place on Thursday, July 17th. It’s the Exploriem.org First Annual Symposium: The Bootstrap Entrepreneur. The keynote speaker will be Dr. Terence Matthews, founder of Mitel, Newbridge, and March Networks. I couldn’t help but notice that among those also heading to the podium will be Jeff Hunt, owner of the Ottawa 67’s, and Dr. Bruce Firestone, founder of the Ottawa Senators. These guys know how to get it done. The symposium is being held at the Brookstreet Hotel in Kanata (nice digs).

For more information, contact Mike at mike@brymark.com.

The non-member price of admission is $120 plus GST. Wanna get in free? For some reason known only to him, Mike actually likes this column. So he’s making one free ticket available to a lucky Market Guy reader. Just send a note to the Market Guy and I’ll randomly select a winner to receive one free admission. I only wish I could go…damn that full-time job! Well, that’s it. I’m simply going to have to retire early.

The Market Guy is an Instructor with the Department of Psychology at Carleton University. He’s not a professional advisor. He’s just a guy who loves investing and talking about the markets. He’s currently trying to figure out what kind of sprinkler to use on his lawn. So many choices: oscillating, impulse, spike, turret. Geez. Sprinkle a little something atmail@marketguy.ca