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Apple's App Store could emerge as $1.2B business by 2009

Investment bank Piper Jaffray is urging investors who typically focus only on Apple's hardware announcements to also pay attention to the company's iPhone software strategy, particularly its upcoming App Store, which could balloon into a $1 billion market by next year.

In a research note to clients early Wednesday, analyst Gene Munster said his $1 billion market prediction represents the better of a three-case scenario that would add anywhere from 1 to 3% in operating income for the Cupertino-based electronics maker by the end of the 2009 calendar year.

To arrive at his estimates, the analyst initially conceived a neutral case scenario in which he assumed 91% of a market comprised of 85 million multi-touch handheld users (61.6 million iPhoner users and 23.4 iPod touch users) would at one time or another tap into the App Store during the course of a year.

Munster based this assumption off the adoption rates announced at WWDC for the iPhone's existing services. Specifically, Apple chief executive Steve Jobs said that 98% of iPhone owners browse the web, 94% use email, 90% send text messages, and 80% use 10 or more of the integrated features of the phone.

"Mobile service adoption rates show that iPhone owners are more sophisticated mobile users, likely a result of both the user profile and the device itself," the analyst told clients. "The bottom line is that we expect similar adoption of the App Store to other advanced services."

Overall, Munster's Neutral Case scenario assumes 77.7 million active App Store users will download two applications from the service each year at an average app revenue per sue of $10 — one free and one costing $10 — generating sales of about $777 million and a profit of $163 million. However, he notes that adoption rates could actually be much higher given the quality and ease of use of Apple's iPhone experience — or around 95 percent (or 80.8 million active users) — which would bump revenues to $1.21B and profits to $254 million.

For his most conservative case seen generating $416 million in sales and profits of $75 million, the Piper Jaffray analyst assumed that only 75% of iPhone and iPod Touch users will download content from the app store. He reached this assumption based on recent data on content consumption on the current iPhone without the App Store versus other smartphones.

"According to April m:metrics data, 45% of smartphone users play a game on their phone at least once in a month," he said. "For iPhones, data suggests the rate is closer to 32%; however, we believe the rate of application users/gamers for iPhones is depressed given that third party developers were not able to produce applications for the iPhone previously."

With the launch of the App Store in early July, Munster believes the iPhone and iPod touch are actually on their way to becoming "superior gaming/application" devices. He noted that the same m:metrics data suggests iPhone users are 70% more likely to consume video on their phones, given the YouTube application that exists on the handset.

"Applying this 70% higher likelihood to the rate of game usage for smartphones, we arrive at 75% of iPhone users engaging in downloading third party applications," wrote. "The reason we believe this could be conservative is that the iPhone heavily overindexes other smartphones in advanced services."

Each of Munster's case scenarios assume a 60% operating margin on the 30 percent cut of App Store sales Apple will received. He maintained his Buy rating and $250 price target on shares of the company.