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Wednesday, January 30, 2008

Apple's iPhone Elixir: Cut Prices

Apple (AAPL - Cramer's Take - Stockpickr) CEO Steve Jobs will need to work some magic to hit his sales target of 10 million iPhones this year.

Since the iPhone's launch in June, Apple has sold about 4 million devices, including 2.3 million during the important holiday season.

To reach the 10 million mark, it needs to average 2.5 million phones in sales a quarter over the next four quarters -- or 200,000 more than what it sold during the big holiday season.

"The number is a challenge, but unless the global economy slows down profoundly, Apple will make it happen," says Ezra Gottheil, an analyst with Technology Business Research
Some analysts say Apple will have to cut deals with more phone carriers outside the U.S., upgrade the iPhone and most importantly, drop the price in order to reach its ambitious sales target.

Apple's sales efforts have been stymied by a sour economy that could put these pricey $400 phones beyond the reach of some consumers. There's also the problem of some 1.7 million "missing" phones -- the difference between phones that were sold by Apple and those that were activated by AT&T (T - Cramer's Take - Stockpickr), the telecom carrier with exclusive rights to the iPhone.

Activiation of the phones is crucial to Apple's bottom line because it gets a 10 percent of the cut in monthly fees charged by AT&T.

Apple investors are understandably worried about the situation, though iPhone sales represent a fraction of the company's revenue. Total revenue recognized during the quarter from sales of iPhones, iPhone accessories and payments from carriers was $241 million compared to $1.75 billion in overall revenue.

Apple's stock has fallen nearly 35% since it closed at a 52-week high of $199.83 less than a month ago. Apple shares closed up $1.53, or 1.2%, to $131.54 Tuesday.

Jobs unveiled the iPhone at the Macworld conference last January to much fanfare. Apple stock soared nearly 132% last year, mostly on strong interest in the iPhone before pulling back to its current levels.

Many analysts then deemed as low the target of 10 million phones in 2008. They saw the phone as a "game-changer" with the potential to take away market share from rivals such as BlackBerry maker Research In Motion (RIMM - Cramer's Take - Stockpickr) and Nokia (NOK - Cramer's Take - Stockpickr).

But now, some company watchers fear a softening economy and limited carrier agreements for the iPhone could take its toll on consumer interest in the device.

That's where dropping the price of the iPhone could help. Gottheil believes Apple could shave $50 off the 8-GB iPhone's current price of $399 by the middle of the year. Apple saw a 20% to 25% improvement in sales when it cut the iPhone price by $200 in September.

"There is room in the iPhone margin to cut price now," he says.

A price cut is a possibility, agrees Mike Abramsky, an analyst with RBC Capital. But what's more likely to happen, he says, is that Apple will upgrade the software in the existing iPhone and offer new models, including the much-awaited 3G version of the phone.

"I think everything, including a price cut, is on the table but Apple is pleased with the performance of the product and maybe more inclined to add capabilities such as GPS or location-based services, and Bluetooth for the same value in the iPhone, as well as offer 3G," says Abramsky. RBC Capital makes a market in Apple shares.

Despite investor fears, Apple's iPhone sales have been solid, says Abramsky. iPhone sales in the quarter ended Dec. 30 were up 107% from the previous quarter, while the smart-phone industry is estimated to have grown at 13% to 15%.

"The 4 million phones sold in the first six months is also double the initial run rate of the Motorola (MOT - Cramer's Take - Stockpickr) Razr," says Abramsky. "From our perspective, the early performance of the iPhone is nothing short of remarkable relative to other historic phone launches."

Analysts and investors also have been concerned about the difference between the number of iPhones sold by Apple and the devices activations registered by AT&T.

In its fourth-quarter earnings, AT&T indicated that about 2 million iPhones had been registered for the service on the company's network while Apple sold about 3.7 million iPhones during that quarter.

The difference of 1.7 million phones could indicate some excess inventory in the channel, which could come back to bite Apple's target of 10 million for the year and stoke fears of lower-than-anticipated demand for the phones.

Apple has not commented about the unlocked phones yet, and the company did not respond to a request for comment for this story.

Apple could have sold about 400,000 phones in Europe during the quarter, and about 20% have been sold unlocked, estimates Keith Bachman, an analyst with BMO Capital. In the U.S., about 25% of the phones sold could be unlocked.

The rest are likely to still be in inventory, while some will be returned and a small percentage are being used for nonphone features, such as iPod touches, until the owners can switch their wireless contracts to AT&T, says Gottheil.

The high percentage of unlocked iPhones should not deter investors, says Abramsky. "It's a leading indicator of the demand," he says.

As Apple signs up contracts with carriers in countries such as Canada, Italy, Spain, and Australia, Apple could bring more users into the fold, he says.

Meanwhile, U.K. mobile company O2 is doing its part to make the iPhone more attractive to its customers, in what some see as an attempt to revive flagging sales. The company said that while the cost of the iPhone remains unchanged, it will give three times as many free calls and text messages on its £35 ($69)-a-month service plan for iPhone customers.

Where Are Those Million iPhones? Everywhere.

Our readers think they have found the million unaccounted-for iPhones discussed in an earlier post — phones that were bought but then never activated on the networks of the wireless carriers that are Apple’s partners. They are all around the world, in many countries where Apple has not yet worked out deals with local carriers, indicating that these phones have been “unlocked.” A sample of some of the comments (with a little editing for punctuation):
Australia: “I personally know of one person who brought eight of these phones back from the U.S. to be activated here in Australia for family members.”
India: “I was in India a few weeks ago and I saw the iPhone being sold in almost every store.”
Brazil: “I live in Brazil and just about all my friends here, the who’s who of Brazil, have iPhones, all unlocked and adapted to our local carriers. ”
Bolivia: “Truth in my small third world country city in Bolivia, South America you can find iPhones available signs all over the cellular dealers.”
Colombia: “The iPhone is for sale in Colombia quite cheaply. That is in spite of it not being officially sold there by Apple.”
Elsewhere in South America (and Spain): “I live in South America, have couple friends in Mexico and some friends in Spain, most of them got iPhones for christmas. They are everywhere, gray market is huge over here, so no surprise.”
Uganda: “I am yet to get mine but I know two friends who already own iPhones here in Uganda, East Africa.”
Russia: “I live in St. Petersburg, Russia, and you can get an unlocked phone for $1,000. A simple phone call to any one of about 20 different dealers and there you go.”
China: “I live and work in China. iPhones modified to work on the Chinese cell networks are very easy to find at all the electronics markets.”
Kuwait: “Back home in Kuwait cellphones are all the rage. Having the newest model is a status symbol.”
Canada: “Here in Canada, iPhones are everywhere. A carrier plan has not been reached with Apple yet so all of them are unlocked.”
Thailand: “I am currently in Bangkok on vacation and in one mall alone I must have seen hundreds of unlocked iPhones for sale. On a quick calculation the local vendors are making about $50-100 per unit.”
New Zealand: “I work at a university in New Zealand and have noticed several Asian students using unlocked iPhones (no, they’re not iPod Touches), perhaps the gray market is the explanation.”
The Philippines: “Here in the Philippines, unlocked iPhones are easily available in most cellphone shops in the malls. No big deal. And it must be this way in a lot of other countries as well.”
It sure looks like it.

Judge extends Microsoft monitoring for antitrust oversight

Microsoft Corp., facing new antitrust investigations in Europe, will remain subject to oversight by a federal judge in the U.S. to ensure it is competing fairly.

U.S. District Judge Colleen Kollar-Kotelly in Washington yesterday extended an antitrust decree governing the conduct of the world's largest software maker until November 2009. The judge agreed with a group of states that said Microsoft withheld important information on communications links from its competitors.

U.S. District Judge Colleen Kollar-Kotelly extended portions of the landmark antitrust consent decree between Microsoft Corp. and state and federal antitrust regulators for another two years, until Nov. 12, 2009.

Eleven states, lead by New York and California, had asked that the monitoring of Microsoft's business practices continue for five years, until late 2012. Microsoft, on the other hand, had repeatedly argued that no further oversight was necessary.

Kollar-Kotelly explained the reasoning behind the extension in a six-page summary of her 78-page opinion, which she issued late Tuesday from her District of Columbia court. "The provisions of the final
judgments have not yet had the chance to operate together as the comprehensive remedy the court and the parties envisioned when the final judgments were entered," she said.

She put much of the blame on the failure of the 2002 settlement to live up to its billing on Microsoft's shoulders, saying its foot-dragging was largely responsible. "Although the technical documentation project is complex and novel, it is clear, at least to the court, that Microsoft is culpable for this inexcusable delay. To be sure, the delay has developed in stages, and at each step Microsoft commendably has been willing to work with the plaintiffs and the TC to address issues and identify a means of resolving them.

"Nevertheless, practically speaking, Microsoft has never complied with § III.E," Kollar-Kotelly continued. "While Microsoft eventually proposed a plan that now appears to be producing the type of quality technical documentation required by § III.E, it did so in the face of mounting pressure from all plaintiffs and the court. In addition, there is no reason why the type of documentation finally being created could not have been created from the outset if the necessary resources had been devoted to the project.

The technical documentation that Kollar-Kotelly referred to was one of the major requirements of the consent decree, and forced Microsoft to document numerous Windows protocols so that rivals could create software that would work smoothly with Microsoft-powered servers. Those provisions -- in the section dubbed § III.E -- had already been extended for an additional two years, with Microsoft's consent, but the states claimed that the settlement was interconnected, and urged the judge to extend all the decree's rules if some had been.

"The court concludes that the § III.E delay, with its ramifications for the final judgments' overall implementation, is entirely incongruous with the original expectations of the parties and the court, and thus constitutes a 'significant change in circumstances' that warrants modification," reasoned Kollar-Kotelly.

Microsoft countered with a statement after the judge issued her ruling. "We will continue to comply fully with the consent decree," said Brad Smith, Microsoft's general counsel, in an e-mailed statement. "We are gratified that the court recognized our extensive efforts to work cooperatively with the large number of government agencies involved. We built Windows Vista in compliance with these rules, and we will continue to adhere to the decree's requirements."

The tussle over extending oversight had been relatively brief, but involved. In late August, the so-called California group of California, Connecticut, Iowa, Kansas, Minnesota, Massachusetts and the District of Columbia, said Microsoft should be watched until 2012 because "Microsoft's market power remains undiminished and that key provisions of the final judgment have had little or no competitively significant impact."

In a series of briefs filed during November, the U.S. Department of Justice urged Kollar-Kotelly to reject the states' arguments, but other states -- the "New York group" -- joined in calling for more monitoring after earlier seeming to agree with the DoJ.

At one point, the states said that oversight should be continued because without it, Microsoft might use the dominance of its Internet Explorer browser to stymie competition from Web-based applications and services. A similar line of reasoning was recently used by Opera Software ASA, the Norwegian browser developer, in its formal complaint to the European Union. The EU's antitrust agency announced earlier this month that it had launched a formal investigation of Opera's charges.

But while Kollar-Kotelly noted that the extension should not be "viewed as a sanction against Microsoft," she also said that Tuesday's ruling may not be the final word. "Ultimately, the court's decision not to extend the final judgments beyond Nov.12, 2009, now does not foreclose the possibility of doing so in the future," she wrote in the executive summary.

"The door likewise remains open for the court to reassess the need for continued oversight as the expiration of the final judgments in November 2009 approaches."

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