Apple's iTunes Music Store could capture 20 per cent of the US paid-music download market, claims Needham's analyst Charles Wolf in a report this week.

Wolf believes Apple could generate annual revenues of $600 million through its store, and that this figure could increase. He describes the Store as "providing an arguably superior customer experience."

His figures represent Apple's potential yield from porting its service to Windows. The store's sales have settled to about 500,000 per week. "This demand appears to be significantly higher than Apple or the labels anticipated," he says.

Wolf advises: "At a profit of less than ten cents per song, the Music Store does not represent a major income opportunity for Apple. Pull-through sales of the iPod portable music player is likely to represent a far larger one, in our opinion."

His report – which claims that the market for unauthorized downloads now exceeds retail music sales – suggests that Apple's dollar-per-download model could capture around 16 per cent of the free file sharing market.

"This translates into $2.9 billion incremental revenues for the US music industry, equivalent to over a 20 per cent increase in annual revenues," he wote.

The analyst takes a look at the economics of the service, which he estimates earns Apple between five and ten cents per song, or $25 million in annual revenues and $2.5 million in annual operating income.

On a 99 cent single, Apple pays about $0.65, he claims, and adds: "Apple incurs three variable expenses in delivering songs. One is the cost of servers. A second expense is bandwidth," he says.

The third major expense for Apple is credit card charges. Credit card companies charge 25 cents for each transaction plus 2-3 per cent of the amount charged.

Because 46 per cent of music sold through the store are albums (at $9.99), and because singles buyers tend to buy multiple tracks in each purchase session, and because Apple combines individual transactions made each day before recording transactions with the credit card companies, credit card charges are kept low, Wolf says.

"Apple receives some price breaks from the credit card companies because of the sales volumes it generates," he adds.

iPod sales also benefit from Apple's music strategy. Releasing a Windows version of the service means: "Apple will offer music management software for portable music players that is arguably the best in the market." Sales of Windows version iPods now exceed those of the Mac version, Wolf reveals, "with the difference continuing to grow,"

The analyst estimates that Apple's annual revenue from the store once it releases a Windows version will be around $600 million with operating income of approximately $60 million.

"If we've erred on this assessment, it's probably on the low side with respect to possible revenues but on the high side with respect to the margin that Apple is likely to earn," he writes.

Apple closed at a 52-week high last night – $20.90 per share.