Wednesday, December 13, 2006

Comments on Apple

Several firms are commenting on Apple Computer (NASDAQ:AAPL) this AM. The two topics include the upcoming iPhone and also iTunes sales data. The latter is said to have caused yesterday's fall-out in AAPL stock as Forrester Research noted iTunes has experienced a collapse in sales revs this year:

- UBS notes they continue to believe that Apple will launch its cell phone initiative in the March/April timeframe with initial phone shipments possible as early as the end of next quarter.

Firm's research points toward Apple becoming its own carrier-or MVNO, likely using Cingular's GSM network. While there a number of challenges associated with an MVNO (many failed attempts by others), Apple may be the best positioned of any player yet to make it work given its distribution, brand, installed base of iPods & software/iTunes integration. An MVNO model would allow Apple to have total control over the user experience, which is something the firm cannot imagine Steve Jobs relinquishing by allowing just about anyone to sell his phone.

They would not be surprised if the company offered 2 or more phones for customers by year-end 2007, with the first version shipping as early as March. UBS believes one phone will likely be a GSM/GPRS phone, with a second phone potentially being a 3G/WCDMA product.

Based on checks in the supply chain, the firm believes the initial iPhone will initially be equipped with 4-8 gigabytes of NAND flash and could have a 2 megapixel digital camera. They expect the phone to work seamlessly with iTunes (Mac or PC versions) and photos will be easy to load on
and off the devices as well. Another key function could be chat, which Apple could make easier through what some have called an "iChat Mobile" application.

Assuming Apple is able sell about 5 million units in calendar 2007 (about 1.4% share of the estimated 2007 music player handset market), the firm estimates potential incremental annual revenue contribution of about $1.5 billion (assuming a $300 ASP to Apple) and annual EPS contribution of about $0.09. UBS' assumptions include operating margins of about 8% (well below Apple's current 12.6% margin) due to the incremental costs associated with entering the cell phone market (note that Motorola, one of the most established cell phone providers, currently has operating margins of 11.9%). They believe estimates may prove conservative if Apple is able to navigate through the challenges of entering such a competitive market.

Maintains Buy and $108 tgt.

- Morgan Stanley notes they believe Apple shares will trade higher once again by year-end 2007. Near-term, the introduction of new products and less exposure to any disruption from Microsoft's Vista OS launch could help reduce seasonal risk for AAPL shares. In the intermediate term, an expanding product portfolio, growing distribution engine and market share opportunities all keep the firm Overweight AAPL with an increased priced target of $110 (from $90).

Proprietary supply-chain checks give the firm high conviction in a 1H07 iPhone launch. They expect Steve Jobs to announce the iPhone at MacWorld or early next year. To-date, they've found two models that began initial production this month - a 4-gig and 8-gig version with capacity plans to build up to 12 million total units in C2007 (MS' new model only includes a conservative 6M units).

Raising their C2007 revenue and EPS from $22.7B and $2.58 to $28B and $3.13, respectively. Firm's new forecast assumes revenue growth accelerates to 41% YoY in C2007 - to $28 billion, well above consensus forecast of $24.3 billion. As new product leverage kicks-in, firm's F2008 EPS surpasses the current consensus forecast by $0.34 ($3.58 vs. consensus $3.24).

- Piper Jaffray notes that contrary to recent reports suggesting sales on iTunes are declining rapidly, their analysis of Apple company data regarding iTunes sales shows strong growth y/y.

In light of recent media reports of slowing iTunes sales, they analyzed music sales data and saw strong y/y growth in 2005 and 2006. Specifically, the firm compared total sales between Jan. and Sept. of '05 and '06 and saw 78% growth during that period. From Jan. to Sept. in 2005 Apple sold 10.4m songs/week and in 2006 that number was up 78% to 18.5m songs/week.

While Apple does not release the financial details of the iTunes Store, the company has indicated that they run the store "above break-even." The iTunes Store, therefore, is a supplement to
the iPod as Apple's vehicle to monetize the free iTunes software. The integration of iPod with the iTunes software along with some profitability from the iTunes Store represent the three ingredients of Apple's digital music ecosystem.

Firm also comments on Mac mkt share saying it should continue to grow in CY07 due to: 1) completion of Intel transition, 2) improved availability of Macs, 3) expanding footprint of Apple customers (iPod halo effect), and 4) ability to run Windows on a Mac.

Mac market share in Q3 was 2.8% and will likely be ~3.0% in Q4, which is up from 2.1% in Q1. Street estimates currently call for Mac market share in CY07 of 2.7%. If Mac market share grows at the same rate seen in CY06 (approx. 1.0%), we could see 4.0% by the end of CY07, with an average of 3.5% for the year. If Apple achieves an average of 3.5% Mac market share for CY07, they estimate Street EPS estimates are $0.34, or 11.6% too low.

Maintains Outperform and $99 tgt.

Notablecalls: I wonder what triggered yesterday's sell-off in AAPl stock. It sure wasn't the iTunes data from Forrester. I suspect some mkt participants took a closer look at iPhone margins and discovered to their surprise these to be lower than current ones. And so they sold. That of course is a faulty conclusion on their part. Just take a look at the new ests from Morgan Stanley. I suspect that for traders, yesterday's sell-off provides an opportunity not seen since Piper upped their tgt to $100 (pre-split). Sitting at my old trading desk I would be all over the stock this morning.

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