Mathew Ingram: Apple core becomes the sound of music

If any company is on top of the world right now, it has to be Apple. And the company's current success is all the more stunning because it was in such bad shape a few years ago that many felt it would never recover.

In fact, Dell founder Michael Dell famously said in 1997 just after Apple co-founder Steve Jobs returned to the company that if he were at Apple he would wind the company up and give the money to shareholders.

Jobs referred to that comment recently in an email to Apple employees, and if he gloated a little bit, that's understandable: on the day he sent the email, Apple's market value - its share price multiplied by the number of shares outstanding - had passed Dell's (although it has since fallen behind the PC maker).

At its current level of about US$72, Apple's share price is almost twice what it was a year ago, and has risen by more than 600 per cent in two years.

The engine behind all this growth is no secret. Over the past four years, the entire world has gone crazy for Apple's iPod in all its forms, from the original music player to the latest ultra-slim Nano and the video-playing iPod, and hundreds of millions of digital songs (and now TV episodes and videos) have been downloaded from its iTunes online store.

These two forces have helped to drive Apple's sales and profit up at an incredible rate. In the latest period, revenue rose 65 per cent to US$5.75 billion ($8.44 billion) and profit climbed by 92 per cent to US$565 million.

That worked out to 68USc - substantially better than the 49USc the company had told investors to expect. It shipped a staggering 14 million iPods in the quarter, up by more than 200 per cent from the year-earlier quarter. And sales of the company's Macintosh computers rose by about 20 per cent, with about 1.25 million shipped in the quarter. For many, this growth was further confirmation of the so-called "halo effect" - in which the popularity of the iPod rubs off on other Apple products.

There's just one problem with all this growth, however: some investors and analysts are wondering how much longer it can continue. The company is already the leader in digital music players, with about 90 per cent of the market for hard-drive-based players and more than 80 per cent of the market for MP3 players overall.

With that kind of stake, some wonder how much growth there is left. Apple no doubt has other products up its sleeve, but the stock has been trading based on the guaranteed growth the iPod has been producing. What will fill that gap in the coming quarters?

Despite the big numbers, there wasn't much celebrating in the wake of Apple's quarterly results. In fact, the stock fell by about 5 per cent after the announcement. In part, that is because the company's outlook for the current quarter was weaker than most analysts were expecting.

Apple said it expects to make a profit for the second quarter of about 42USc a share, but Wall Street was projecting a profit of about 51USc a share. A stock trading at the kinds of levels that Apple's has been - 35 times projected profit per share - doesn't usually react well to that kind of change in guidance.

Apple said the main reason for the cautious outlook was the shift it is making from using IBM processors in its laptops and desktops to using chips from market leader Intel. Some customers who are in the market for a new computer are likely to wait for the new models come out, analysts said.

"We did see what we think was a bit of a pause from some customers associated with the Intel transition," Apple's chief financial officer Peter Oppenheimer said after the quarterly report.

Some investors are worried about more than that. The main concern is that Apple's business still consists primarily of selling computers that have enjoyed fairly high profit margins, and produce lots of cash flow. Digital music and video players have become a much larger part of the company's business, but that market is much more competitive, and as a result the pressure on prices is much higher. Some analysts are worried about what that means for the future of the company's cash flow.

"Historically the Mac has been the primary revenue generator," analyst Nittin Gupta of Yankee Group said. "At this rate of growth, the Mac is not going to be their primary revenue driver."

Unless sales of Macs increase even faster than they have been, Apple could be trapped by slower sales of the iPod and lower profit margins. And investors who have been riding the soaring share price won't like that.

The only problem with being on top of the world, it seems, is that once you're there everyone starts worrying that you're going to fall off.