Apple could shock the naysayers

January 24, 2008: 9:21 AM ET

Apple executives are fond of talking about seven years ago, the last time Wall Street seriously underestimated the company. Faced with an economic slowdown that saw his tech industry peers slashing staff and cutting projects, CEO Steve Jobs proclaimed that he and the rest of Apple would instead "innovate our way" out of the slump.

Jobs made good on that promise. Soon after, Apple (AAPL) unveiled the iTunes Store, the iPod took off, and … well, the rest is history.

This week, you can bet the true believers around Apple's Cupertino headquarters are thinking back to 2001, while loading up on some suddenly discounted shares. Talk about an after-Christmas bargain: Apple stock is trading at about $140, 30 percent off its December 28 high of $202.96. That's about the same place where Wall Street valued the stock six months ago, before it became clear that the new iPhone would sell nearly 4 million units in 200 days.

iPod touch
Apple executives have begun touting the iPod touch as a wireless handheld computer rather than a simple media player. If consumers and developers embrace that concept, it could lead to innovation and sales for Apple in 2008. Photo: Jon Fortt
Apple 1-year chart
Apple was a stock market darling in 2007, but economic jitters in 2008 have some investors doubting its growth prospects.

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The most recent ding to Apple stock came Wednesday, after the company turned in the best quarter in its history. The stock dropped nearly 11 percent. Depending on whom you ask, the stock got hammered because of soft iPod growth, tepid revenue guidance, or plain old investor fear.

Honestly, there's plenty to be afraid of; with the U.S. subprime mess threatening to become a global financial crisis, 2008 looks less investor-friendly than 2007. Last year Apple shares more than doubled, starting at $85 and ending at $198. In between Apple became possibly the most talked about stock on the planet, fueled by rising Mac sales, iPhone hype and digital tussles with Hollywood.

Apple has taken a less cocksure stance in 2008, possibly to fix relations with Tinseltown. Last year Jobs tried to muscle the major studios when he launched Apple's iTunes movie download store, expecting that Hollywood bosses would give in and let Apple sell their movies and TV shows on Apple's terms. (Jobs predicted, wrongly, that many studios would eventually come on board during 2007.)

In the end Jobs failed to win their cooperation, his effort to create the "DVD player of the future" with Apple TV failed, and he even lost NBC as a partner for TV downloads. (The lack of high-quality video options might have been one reason U.S. iPod sales were flat in the holiday period.) This month Jobs is showing a new willingness to compromise, giving Hollywood bosses the iTunes video rental option they had been clamoring for -- but it's still not clear whether Apple and the studios can get along.

Meanwhile, the 2007 run-up in Apple's value wasn't always based on real numbers. The stock began shooting higher on iPhone anticipation before analysts knew how many Apple could realistically sell, or how Apple would account for iPhone sales on its balance sheet. (Revenues are spread over two years.) Price movements could be wild. In the space of a couple of hours in May, the stock dropped more than $4 billion in value on a rumor that the iPhone launch would be delayed four months, and quickly recovered. (Distraught Apple investors, take note: If the stock's rise wasn't always based on numbers, why should we expect its fall would be?)

But there's also plenty of reason to believe Apple can innovate through this downturn like it did the last.

First is stability. Apple has stockpiled more than $18 billion in cash, giving it more than enough cushion to think big, take risks, and make mistakes (like Apple TV). Apple's PC market share gains also help to add a source of recurring revenue. If this year plays out as usual, this summer the company will announce updated Mac software packages for tasks like video and audio editing, word processing and spreadsheets. If Apple adds attractive new features to those bundles, it will bring even more profit to the company.

Second is the iPhone. Like the iPod before, it's a hit -- even though it is solely distributed through AT&T (T) in the U.S. and through other exclusive carrier arrangements abroad, it seems to be gaining traction. During his Macworld keynote a week ago, Jobs announced that Apple has sold 4 million iPhones; and within those numbers was a gem of a detail. On the earnings call, Apple said it sold 2.3 million iPhones during the quarter -- do the math, and it seems Apple sold about 300,000 iPhones in just the first two weeks of 2008. If that pace keeps up -- and it easily could as Apple expands the iPhone's availability in Europe and Asia -- then Apple could sell as many iPhones this quarter as it did during the holidays, an impressive feat.

Last is the iPod touch. Largely glossed over in Apple's earnings announcement was the executive team's emphasis on the fact that the company doesn't view this thing as just an iPod -- it's a wireless computer. And the iPod touch will fully come into its own at the end of February, when Apple opens the door for outside developers to build software for it. What the iPod touch becomes then is an open question. Will Apple invent a way for it to become a viable gaming platform? Will clever engineers come up with cooking programs, GPS attachments, video recorders, or other ideas to spark demand for the gadget?

If so, watch out. Sales of the iPod touch and iPhone might just push the stock price higher again -- and if so, Apple executives will relish the chance to tell the story of how investors, once again, underestimated Apple.

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