iPods, music to remain key at Apple: Merrill Lynch

After meeting with Apple management in California, Merrill Lynch concludes that music remains extremely important to Apple, despite slowing iPod growth and increasing Mac sales. Store surveys still show over 40 percent of Macs sold are to new Apple users. Still, "Apple doesn't want to get distracted from music," the investment firm said. "Only 5% of paid music is online today; the company says many youths will never buy a CD." Although moderately profitable, Apple "doesn't seem optimistic" that the iTunes Music Store will be a major profit contributor.

Merrill Lynch thinks the record labels get about $0.65 per song with credit card fees taking close to $0.20 (PayPal is available but not a big hit). Apple is not opposed to a subscription service but thinks most users want to own their music. "We think Apple could introduce a subscription service in the next year, which could be less profitable than selling songs initially though possibly more profitable long term if sub rates rise."

Apple downplays iTunes/iPod video

Apple "continues to downplay video," pointing out that movies take too long to download for now, are not watched over and over, and that unlike music there are many ways to acquire movies. "Still, we think video capability (especially for music videos) could be added to the iPod," the firm said. "Audio books and podcasting should contribute to iPod's popularity; management was not optimistic that satellite radio would take off."

Outlook: Apple still a "Buy"

Merrill Lynch maintains a Buy rating and price objective of $51 per share. "The stock was hit on Friday. First, we believe the battery failure lawsuit has been reserved for and should not have a long-lasting effect. Second, reports of higher inventory are likely true with Apple supply caught up on almost all products and retailers preparing for back to school. The issue is sell-through, which is hard to track but appears solid."

Filed under: iPod