iTunes, Apple's Golden Goose... Really?

| About: Apple Inc. (AAPL)

Music has defined generations. Apple (NASDAQ:AAPL) has defied generations. Apple iTunes has created a user base that spans decades and unites listeners across all age groups. Apple took the MP3 world by surprise when it expanded the iTunes Music Store in 2003 and made thousands of songs, albums, and movies available to nearly anyone with a PC. Like many Apple products since the early 2000s, iTunes was and continues to be a great success no matter how you look at it. But it seems that every Apple article or earnings report focuses on units of iPads or iPhones sold or Apple's "next big product" while iTunes is rarely discussed.

The beginning

Apple initially launched iTunes alongside the iPod in October 2001, making music available only through Apple's own software programs. By 2003, the company had introduced the iTunes music store and made downloadable music available to the masses. iTunes and other music related products sales in 2004 reached $278 million and made up to 3.36% of Apple's total sales. By 2009, iTunes and other music related products sales reached $4 billion and accounted for just over 11% of Apple's total sales. Today, iTunes sales are in excess of $8.5 billion annually. With explosive initial growth and continued 20%-30% annual growth in sales, this is an area to continue to watch for future revenue. While iTunes certainly isn't bringing in the massive amounts of revenue that iPhones and other hard products are, it's nearly $9 billion in revenue is nothing to scoff at, and it's a sustainable, recurring revenue source, unlike the iPhone and iPad that have already started to fade as competitors enter those markets.


Apple has continued to grow its market share in the downloadable music space through iTunes, yet it has started to lose market share in the smartphone and tablet markets with the iPhone and iPad. With competition from Samsung (OTC:SSNLF), HTC, BlackBerry (NASDAQ:BBRY) and other smartphone providers, Apple's share in the smartphone market has dropped to 18%. iTunes, on the other hand, now accounts for over 60% of all music downloads with Amazon's MP3 at a mere 22%. While the iPhone and iPad have been huge revenue producers accounting for $80 billion and $30 billion in sales, respectively, for 2012 versus iTunes revenue of only $8.8 billion, the iTunes revenue is cheaper to acquire and keep and is also cheaper to operate.

While the true cost of operating iTunes is difficult to determine, it's easy to see that Apple's total operating costs only increased by $123 million from 2002 through 2003, the years when the majority of the iTunes Music Store roll out and development costs would have been incurred. Even assuming all of that cost increase was due to iTunes, which is highly unlikely, that would mean the cost of operating that unit would be a mere $123 million versus the net sales for iTunes, which is nearly $9 billion. While margins on the music sales remain low, it is a low-cost, high volume product that continues to grow.

Bottom line

Apple has been under pressure lately as its stock price has been nearly cut in half from recent highs, but its robust product offering with a strong base in the growing digital music, movie, and other iTunes Store product availability seems to be dismissed by many investors. Many successful companies never reach the $1 billion sales mark, much less $10 billion which Apple is almost breaking in iTunes and other music related products alone. So if iTunes were a standalone company, producing $9 billion in annual revenue with only $123 million in operating costs and strong profit margins, what would it be worth today? How about if Apple used its $140 billion in cash for a massive share buyback, and then ran the company as iTunes? Answer that, and you may have found your golden goose.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.