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iPod: How Long Will It Reign?

By Chris Burba You don't have to look around for long to see that Apple's (AAPL

; S&P investment rank, 3 STARS, hold; recent price, $67.21) iPod digital music player has made waves in pop culture. You've seen the TV ads: Silhouetted, plugged-in dancers whipping themselves into a frenzy to the sounds of iconic rock band U2. The two-story Apple store in downtown Manhattan looks more like a high-tech art gallery than a retail outlet and draws enviable crowds. The design of Sony Ericsson's new T630 mobile phone has iPod echoes. There's even the "iPod nod," a silent, cool-affirming exchange between strangers sporting the tell-tale white earbuds.

The music player is also having an impact on Wall Street. Apple shares have more than tripled thus far in 2004 and received another boost on Nov. 22 from Piper Jaffray analyst Gene Munster, who raised his $52 target price to $100.

HEAVYWEIGHT ENTRY. Munster cites what he believed to be signs of a "halo effect": Computer owners, thrilled with the iPod experience, decide to extend their loyalty into another realm by switching to Macs from Windows-based PCs. Days after the Piper Jaffray note, UBS Financial, Banc of America, and Merrill Lynch each raised their price targets on the stock.

Amid the hype, Standard & Poor's equity analyst Megan Graham-Hackett thinks there's reason for caution. First, competing products are coming out, and she thinks they look impressive. Sony (SNE

; 5 STARS, strong buy; $36.32) has launched its new Network Walkman in Japan, finally embracing the MP3 format as well as its proprietary Atrac technology. The Japanese giant's first launch of a digital player earlier this year didn't take off, largely because it limited users to Atrac files. Graham-Hackett believes Sony's decision to release a device with MP3 technology poses more of a competitive threat to iPod.

Elsewhere, Gateway (GTW

; 3 STARS; $6.75) has released its MP3 Photo Jukebox player. Along with storage and playback of music files, Gateway's device displays color photos.

Dell (DELL

; 3 STARS; $41.11) also offers an MP3 player, the Dell Digital Jukebox, and has partnered with Musicmatch to provide users with software to download music from the Internet. This could rival iTunes, the online music store for iPod owners. Rio Audio is yet another contender (see BW Online, 12/2/04, "Music: Taking a Bite of Apple's Action").

FASHION WATCH. Along with growing competition, Graham-Hackett believes that Apple's stock price may already reflect much of the revenue gains from iPod sales. She notes the possibility that iPod shipments in the December quarter could surprise to the upside but adds that consumer-electronics sales generally decline after the holiday season. Graham-Hackett points out that Apple shares, after their spectacular 2004 run, trade higher than the outfit's industry peers on a price-to-sales basis.

Graham-Hackett also cites another reason for caution: The March quarter is a seasonally weak one for Apple. She notes that current consensus estimates point to a 40% decline in earnings per share for the March quarter, from the December period. This could dampen investor optimism regarding any potential upside in the short term.

Beyond those factors, a deeper concern exists: Can the iPod stay fashionable? Part of the device's appeal (and perhaps what motivated the first iPod nod) has been its ability to make its owner feel like part of the "in" crowd. But what happens as the iPod becomes more and more mainstream? As penetration of MP3 players grows, will it be considered cool to instead bop to a Photo Jukebox or a Network Walkman?

With the competition mounting -- and industry powerhouse Sony finally ready to compete more directly on iPod's turf -- Apple CEO Steve Jobs will have his work cut out for him. Burba is a reporter for Standard & Poor's MarketScope

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