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Despite inferiority, Zune likely to see modest success - analyst

Although Microsoft Corp's forthcoming Zune digital media player is somewhat bulky and lacking appeal, its likely to see "some modest success" due to Microsoft's vast resources and the company's willingness to take a loss with each unit it sells, one Wall Street analyst says.

"Yesterday, Microsoft announced pricing for its Zune portable media player with 30 GB HDD storage at $250 and a ship date of November 14, 2006," American Technology Research analyst Shaw Wu wrote in a research note on Friday. "As we mentioned recently, we believe Microsoft was caught off guard by Apple's aggressive $249 video Pod pricing and was forced to match Apple's pricing to stay competitive." 

Wu believes Microsoft inability to price Zune even lower demonstrates Apple's under-appreciated supply chain strength. With its current pricing, the analyst estimates Microsoft will suffer an approximate $50 loss with each sale of the player. This compares to Apple's industry-leading iPod profitability, which, according to his estimates, falls along the lines of 18 to 22 percent gross margin and 8 to 11 percent operating margin.

"To us, the key question is whether Zune priced in-line with a video Pod will take share with its bulkier form factor, same Windows software currently available from 15-20 vendors, and inferior battery life," Wu wrote. "Regardless, we believe Zune will likely see some modest success due to Microsoft's vast resources, but at the expense of its Windows "partners" (particularly ones that sell HDD-based players including Sony, Creative, iRiver, Samsung, Archos, and Toshiba)."

He said Apple retains key competitive advantages that include its strong brand, vertically integrated iPod+iTunes model, its proprietary clickwheel technology, and "unique and pleasant customer experience with its Apple stores."

Wu maintains a "Buy" rating and $91 price target on Apple shares and continues to recommend that investors buy on weakness.