Why Apple needs the iPhone (and the Mac): iPod growth slows

January 17, 2007, 3:13 PM UTC

ApplejobsApple (AAPL) announced its first-ever $1 billion profit quarter today, an impressive milestone that’s a testament to the rise of iPod and the resurgence of the Mac. But the most important number for investors might be the slower holiday sales growth of the iPod compared to the year before.

Mac fans will pummel me here for being overly critical, but these financial figures require a critical eye.

Let me be clear here: iPod revenues are still growing quite a lot. In holiday 2006 they were up 50 percent (to 21,066,000) over the same quarter in 2005. But get this: In holiday 2005 iPod sales grew 207 percent (to 14,043,000), in holiday 2004 they grew 525 percent (to 4,580,000), and in holiday 2003 they grew 235 percent (to 733,000). Dropping to 50 percent is a dramatic slowdown.

[Update: The raw unit numbers above are included to underscore the point that many readers are making about iPod growth. Note that the quarter’s unit sales growth dropped from nearly 10 million units in 2005 to 7 million in 2006. This is not to suggest that anyone should have expected Apple maintain the previous growth level, merely to point out that the growth has slowed.]

Why does it matter that iPod sales growth is slowing, if Apple sold 21 million of the things in calendar Q4 alone? Because stock price is all about momentum. The iPod has driven Apple’s growth to this point, and if Apple’s stock price is to move higher at a rate similar to how it has in the past, its sales will have to grow at a similar rate. So if the numbers aren’t coming from the iPod, where will they come from?

Here are some possibilities, and some risks:

The Mac.
Mac sales were up 28 percent in the holiday quarter of 2006, compared to 20 percent in 2005, 26 percent in 2004, and 12 percent in 2003. So Mac sales are up notably, if not dramatically – Mac sales grew three times faster than the overall PC market. Apple has the next version of OS X, Leopard, coming this spring, and Apple said it expects sales of its professional Macs to improve when Adobe Systems (ADBE) releases its Creative Suite in the second calendar quarter of this year – also the spring. But Microsoft (MSFT) Windows Vista is a wild card. Apple is growing Mac sales by winning Windows switchers, and it’s not clear whether people will be so eager to switch when there are brand new Windows toys out there to play with.

Apple TV.
Steve Jobs unveiled it at Macworld, and when an analyst asked Chief Operating Officer Tim Cook whether it’s a niche product or mass market, he said, “We see this as the DVD player of the 21st century, so clearly this is not a niche.” But will sales be enough to offset a slowing iPod? No commitments there. Cook said to wait until the launch for a sense of that. My take? Apple TV doesn’t look like a volume play on the same scale as the iPod; it’s unlikely to achieve the same cult status.

That leaves the iPhone. No one knows what its impact will be, and whether it will prove as popular as the music player – though it must be noted that the iPhone is more expensive than the priciest iPod, and is sure to come with a commitment to an pricey service plan. Assuming the iPhone does extraordinarily well – and there’s no reason to believe it won’t – it will sell fewer than 5 million units in 2007. (Remember, Steve Jobs targeted sales of only about 10 million iPhones in 2008, when Apple plans to have distribution in Europe and Asia as well as North America. Even if he hits that number a year early on U.S. sales alone, that’s just 5 million units.)

So by my math, it might be hard for even a wildly successful iPhone to make up for the slowdown in iPod growth rates. Apple sold 21 million iPods this holiday quarter, and would need to sell the equivalent of about 10 million more in the same quarter of 2007 just to maintain the 50 percent growth rate. iPhone, Apple TV and Mac sales might help, but won’t get Apple all the way there.

Is that cause for investor alarm? Not necessarily. Every company that’s had a hit product goes through a cycle like this, when that product matures and a new one is coming to market. And Apple is well positioned to weather the transition, having built up its war chest of cash to $11.9 billion, after adding $1.75 billion last quarter alone.

Given the iPod sales growth numbers though, I wouldn’t expect an uninterrupted upward slope on that stock chart.