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16 January 2008

Stock falls as Apple seen merely ‘fiddling’ with existing product lines

Apple lovers everywhere look forward to the keynote of CEO Steve Jobs at MacWorld as if it were Christmas and their birthday all rolled into one, and Jobs rarely disappoints. But for investors this week, he has done just that, as they expected miracles and for Apple to unveil yet another world beater.

This week Jobs owned up to the weaknesses in the first Apple TV product, and fixed them, confirmed that virtually every major Hollywood studio is now ready to embrace either iTunes, or Apple TV or both, and saved the biggest gasps for his new super thin notebook, which is being marketed under the term ‘Thinnovation,’ at its fattest at three quarters of an inch, and thereafter tapering to a fine point where one side is a few millimeters.

The advertising for the new MacBook Air features someone pulling it from a large envelop which couldn’t possibly contain a laptop, and Jobs achieved the required gaps at his keynote by doing much the same.

While the comings and goings of MacBooks are not really our province at Faultline, the instant on, Flash memory based Air with 5 hours battery life, weighing just three pounds, with a touch screen, a camera for video conferencing, and no optical drive, does for the laptop what the iPhone did for handset design. It is priced at $1,799, has dual core 1.6 of 1.8 GHz processors, Wi-Fi N, 2 GB of main memory and either 64 GB or Flash or an 80 GB drive. If you miss the optical drive and want to load software, either buy an external drive, or install software wirelessly through a feature called Remote Disk using another computer’s drive.

Other announcements squeezed into the keynote included a wireless backup for a whole network of Macs, a simple hard drive on the network called the Time Capsule with a server-grade hard drive with either 500GB or 1 TB of storage for $299 and $499 respectively. Apparently it’s a single command to turn on wireless back ups and then just forget them.

But the two major multimedia announcements include the one that has been Apple’s poorest kept secret. We already covered the rumors that Apple has new deals with the studios, and that was confirmed by Jobs citing new deals for renting video through iTunes 30 days after the DVD sales window is open. This includes Touchstone Pictures, New Line Cinema, Lions Gate, Miramax, 20th Century Fox, Warner Brothers, Disney, Paramount, Universal, and Sony.

As of today the iTunes store can offer 1000 movies, and they work on PCs, Macs, iPods, and iPhones, and they are ready to start playing 30 minutes after you’ve begun downloading them. Jobs also said you can transfer them between devices and have 30 days to start watching, and then 24 hours before the rental ends.
In a way we’re surprised to see that Jobs has taken this deal. It makes online subordinate to DVD for the foreseeable future, but as the volumes rise, that can be re-negotiated and anyway the convenience of watching films at 30 minutes notice with a selection that begins at 1,000 and which will grow and grow over time, beats going out to Blockbuster on a cold night and choosing from maybe 400 DVDs, most of which you’ve seen. What it might not beat is belonging to Netflix and choosing between 6,000 video selections online, and 90,000 if you can wait for the DVD in the post.

So that’s what Netflix declared ahead of the Apple announcements, that all of its 7 million customers, except those on the lowest ‘2 DVDs’ a month service, will be able to use the online film streaming service as part of their online DVD rental service. We’re not sure how delighted that makes the owners of the 6,000 videos, or how Netflix shares revenue with them, but it is designed to undermine genuine online movie services. Of course this is just a streaming service to a PC, and pause, DVR and portable devices are not part of it, as they are with iTunes.

But the pricing for the iTunes service, $3.99 for new releases; $2.99 for older stuff is straight out of the Ark, and the entire deal is the same as Movielink and CinemaNow, which have ‘proved’ conclusively that this type of offering is not good enough to sweep the market. One of the big problems is only allowing 24 hours, instead of say 72 hours, to view the film once it is started. That extra viewing the following night, once you’ve realized how neat the film is, and invited your friends around, or placed it on your iPod and taken it to work, is perhaps the extra that this deal needs.

Also why is there a 30 day free window for DVDs? DVD revenue is falling, or at least settling, and a new format needs to be encouraged, not discouraged by a 30 day wait. But that’s the studios for you. It looks to us like this stuff was on the table a year or so ago for Apple, and that all that has happened is that it has gone back and said, ‘Okay we’ll take your terms.’

iTunes Movie Rentals if available immediately in the US but requires yet another iTunes upgrade and will emerge internationally later this year.

It is here that Steve Jobs owned up to the failure of Apple TV, and offered a new version which does not need a PC, which he thinks will fix it. Attach the Apple TV 2.0 to your TV, and attach that to the internet, and you can select, buy and view movies direct and with a hard drive, store them for viewing later also. It can still get video from your PC but you can order DVD and HD quality movies direct as well.

Jobs typified this as the 125,000 video and audio podcasts, plus photos from Flickr and .Mac. and over 50,000,000 YouTube videos, but what the audience was probably most buzzed about was being able to rent HD movies for $4.99 and an initial 100 movies and 600 TV shows straight away. You can also take the content from iTunes, and there is a neat feature that your PC or Mac gets a copy automatically, from the Apple TV.

The price of the new Apple TV 2.0 will be $229 rather than the $299 Apple TV 1.0 cost and the software upgrade and new Apple TV start shipping in two weeks.

Jobs then started with news about the iPhone, which he says has sold four million devices so far, ahead of schedule he says. He then goes on to talk about the market share for smart phones in the US, claiming second place with a 19.5% market share against the Blackberry’s 39%, beating out Palm, Nokia, Motorola and everyone else. The truth is that there are no smart phones in the US, or at least not many, and the rest of the world market share is what counts, and only on 3G devices really.

The graph for the 3rd quarter of 2007 below, from Canalys demonstrates the global shape of smart phones when split by operating system and it shows how US centric the iPhone is so far, and why it is likely to remain much the same in the near future. Apple is the purple patch at the top of the North American column.

The great bulk of those big orange Symbian chunks are Nokia, Samsung, and Sony Ericsson, but that doesn’t deny that Apple has made a great start to its career as a handset maker, just that its statements about market share will only be taken seriously by people that don’t have a clear global view.

His other news about the iPhone were improvements in location services and maps, an ability to customize the home screen and to send multiple SMS at once.

The location system allows users to bookmark locations ( and therefore maps, like a web page), using Google maps in the back end. Maps uses a combination of wi-fi triangulation from Skyhook Wireless and Google’s cell phone tower triangulation to find where the user is. Which mostly work only in the US, which means that once again Apple will have to find another way of doing this in other countries (once again, why not work with Nokia that has all this taped with its Navteq purchase).

Skyhook Wireless has moved its coverage to Europe and Asia this year taking in the top 50 European metropolitan areas and the top 15 Asian cities, but then again, why not just put a GPS chip in the handset like 180 million other handsets did last year.

Jobs then went on to talk about iPod improvements, especially for the impressive iPod Touch, making it more and more iPhone alike, adding mail, a stock ticker, maps with locations, and notes, all in a $20 upgrade.

But as much as Jobs piled on all these announcements, the Apple stock has been over-hyped, and clearly he cannot launch an iPhone class revenue opportunity every year. Shares in Apple dropped $10 by the time the keynote was over, from $179 to $169, taking over 5% off the share value of Apple on the day, but at a market capitalization of $148 billion, it can afford that we think.

In our view Apple has to work out what it wants to be, and there are many possibilities. It could dominate consumer electronics, but perhaps the margins in that business long term are unattractive; it can look for discrete device opportunities like the iPod or the iPhone, and keep itself purely operating at the high margin end of multiple markets- in the end a recession will come along and eat most of its profit if it adopts that approach ‘ or it can become a handset company, in which case it needs a few years to bed down its iPhone, pushing on to 3G this year, WiMAX the next and LTE the following year, and driving up volumes, improving its logistics and distribution channels globally.

Then it will find itself on a hard slog to drive down the costs of what it builds, while retaining its design cachet, and it will have to put itself into a position where it can compete head to head with Nokia, Motorola, Samsung and Sony Ericsson on a global basis. Our feel is that this will take too long, and given that the US investor public still think Apple is quite rightly worth MORE than Nokia, given their respective market capitalizations, if Apple went this route, it would be perceived as an also ran. Perhaps it should buy Motorola and run it as an arms length handset maker (at $32 billion market cap, that’s not so crazy as it sounds).

But with the current level of investment expectation on Apple, all the design and execution in the world will not keep investors happy, and Apple has perhaps just turned into a stock that is ripe to sell, at least for a short while until its value is more sane.