JP Morgan analysts Bill Shope and Elizabeth Borbolla on Wednesday issued a research report in response to Yahoo!’s announcement of the Beta release of its subscription-based online music store. In the report, a copy of which was obtained by The Mac Observer, the analysts wrote: “In our view, the service does little to break the tight grip that Apple has on the nascent digital music market with its iPod-iTunes link.” They reiterated their “overweight” rating on the stock, which means they expect it to outperform the other stocks among those the analysts cover during the next six to 12 months.
Shope and Borbolla acknowledge in the report that “The launch of Yahoo’s service will likely put some incremental pressure on Apple’s stock,” but they cited four reasons why this race is Apple’s to lose: added functionality in the iTunes Music Store, including the new video downloads feature; the expectation of 5.55 million iPods shipped during the June quarter and more than 22 million in fiscal year 2005; the fact that the company is trading below its five-year average of 39 times EPS (earnings per share); and “with an installed base approaching 20 million users, Apple is still the lead steer in the digital music industry.”
The analysts also examine Yahoo!’s new service in their report, noting that while it is compatible with Microsoft’s DRM-encoded WMA format, also known as Janus, it doesn’t work with the iPod. They also cite several drawbacks to the subscription-focused service, such as the fact that it’s only compatible with “a limited number of MP3 players” and that “some of the most popular tracks on albums will not support Janus licensing,” which means consumers must purchase them anyway. They also note that “consumers have shown a preference toward owning music.”
On the flip side, Shope and Borbolla acknowledge that “iTunes customers cannot listen to their purchased content on any device other than the iPod. As a result of this fact, iTunes users that own iPods face significant switching costs.” Nowhere do they mention, however, that it’s not difficult for users to defeat Apple’s relatively weak DRM and port their iTunes Music Store songs into MP3 format for use on another digital music player. Of course, given the iPod’s dominance in the market, it doesn’t seem like those consumers are inclined to switch. JP Morgan’s analysts write: “It is also critical to recognize that none of Apple’s competitors, in music services or devices, has developed a bundled store-device system similar to Apple’s iTunes-iPod model. The synergies resulting from this type of model are critical for customer satisfaction, and from the vendor’s perspective, for developing customer stickiness.”
Shope and Borbolla also see Apple setting the stage for expansion into other digital content areas, such as video downloads, given iTunes 4.8’s integration with QuickTime for music video playback. In addition, they think Apple can easily add a subscription-based service to the iTunes Music Store if CEO Steve Jobs thinks the company should make that move. In fact, they cite Jobs’ previous reluctance to enter the flash MP3 player market, along with the company’s hiring of Julia Miller, who worked on the Xbox Live subscription service at Microsoft, as evidence that Apple could easily change its mind. They see such a move creating a hybrid service where a la carte purchases remain the focus.