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Thursday, August 24, 2006, 05:00 am PT (08:00 am ET)

Apple's settlement seen as the right move

Apple Computer's decision to settle its legal disputes with Creative Technology by way of a $100 million cash payment will likely save the iPod maker from potential headaches that could have arisen down the line, one Wall Street analyst says.

In a research note released to clients on Thursday, PiperJaffray analyst Gene Munster dubbed the one-time payment a "drop in the bucket," explaining that it represents just 1.1 percent of Apple's total cash holdings.

"If Creative had been able to win any favorable rulings in the five outstanding lawsuits, Apple could have faced headaches including: further appeals, product injunctions, future and historical royalty payments, etc.," the analyst wrote. "Considering $100 million represents 1.1 percent of Apple's $9.2 billion in cash, we believe the settlement will prove to be the right course of action."

Separately, Munster said he sees Creative's decision to join Apple's "Made for iPod" accessory program as a turning point in its digital music strategy.

"Over the last several years, Creative has been focused on head-to-head competition with the iPod and it appears that the company is now embracing the iPod eco-system as a way to grow revenue," he said. "We see this as a subtle admission by Creative that iPod does in fact dominate the MP3 player market and more may be gained from 'coopetition' than direct competition."

In a second research note, also released on Thursday, Munster said he continues to find Apple's share price attractive despite the Street's consensus that shares currently trade at premium valuation.

"We believe many investors generally feel that Apple shares have a high relative valuation and, therefore, the Street remains split between those that believe shares deserve to continue to trade at a premium and those that believe shares should trade lower due to declining momentum," the analyst wrote. "Our take is that Apple shares do not trade at a premium valuation."

Munster said he believes the best valuation metric to provide a parallel comparison between Apple shares and its hardware and software competitors is to examine the company's price-to-earnings ratio divided by its year-over-year earnings growth rate (P/E/G) — a metric where lower figures represent higher value.

"Apple is a unique company in that its business stretches into both hardware and software," the analyst explained. "As such, we believe a comparative valuation group should consist of Apple's competitors in both hardware and software."

Munster chose to use his valuation metric to compare Apple to Dell, IBM, HP, Adobe, Autodesk and Microsoft. "With all of the relevant pieces in place, we see that the P/E/G excluding cash on Apple shares is 1.0, while the comp group average is 1.5," he told clients. "Clearly the right valuation metrics to use on any given company are up for interpretation, but we believe this method provides the most consistent strategy for comparison."

Going forward, Munster believes that Apple will continue to outpace the growth of its competitors and that it is destine for further market share growth in the PC sector over the next 2 years. The analyst maintains an "Outperform" rating on shares of Apple with a price target of $99.