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Tuesday, April 10, 2007, 02:50 pm PT (05:50 pm ET)

Citigroup weighs in on Leopard, 3G iPhone, and new iPod nanos

Analysts at Citigroup are recommending that investors buy shares of Apple Inc. ahead of upcoming product launches, which they say will include Mac OS X Leopard, a touch-screen video iPod, higher capacity iPod nanos and a 3G version of the iPhone.

Leopard

As part of an in-depth company overview released to clients earlier this week, analyst Richard Gardner and his team said they expect Mac OS X "Leopard" to launch on June 11 at the company’s Worldwide Software Developers Conference in San Francisco. They estimate the release will generate between $50 and $75 million in incremental revenue per quarter for Apple during its first few quarters on the market, boosting the company's per-share earnings by about a nickel with its attractive 85 percent gross margin.

iPhone and iPhone 3G

Based on Gardner's checks, iPhone will follow the launch of Leopard in "late-June." The analyst told clients the device is likely to deliver more attractive economics than Wall Street is expecting, giving Apple's willingness to work exclusively with Cingular and its sticky, high-revenue subscriber based.

"We believe that Apple could receive as much as $200-300 per new subscriber from Cingular in up-front payments and residuals (depending on whether the phone is sold in Apple’s own stores or Cingular’s stores)," he wrote. "This is roughly 2-3X the payment that the Street currently expects and provides Apple with significant flexibility to drop prices or earn higher margins. We also expect Apple to release a 3G version of iPhone during [the first half of 2008]."

iPods and Mac notebooks

Gardner also told clients to keep a look out for new iPod models beginning in the fall, including a 12-16GB nano priced at $249 and a video iPod with the same touch screen as the iPhone priced at $250-400. "These products should launch in August or September and position Apple well for the peak Holiday 2007 selling season," he wrote. "Finally, we expect a newly redesigned MacBook Pro in the Fall, new iterations of all Apple laptops featuring Intel’s new Santa Rosa platform in the Summer or early Fall, and perhaps an ultra-portable laptop at some point this year."

Short-term share volatility

Given the robustness of Apple’s product pipeline between now and yearend, the Citigroup analyst said he remains comfortable with his well above-consensus EPS and revenue estimates of $24.6 billion and $3.48 for fiscal 2007. However, he told clients he would not be surprised to see shares of the Cupertino-based company retrace a portion of their recent gains later this month, "as shorter-term investors prepare for a 2-month news vacuum between [second quarter] earnings and the Worldwide Developers Conference keynote on June 11."

Second quarter preview

Citigroup is modeling for solid fiscal second quarter results from Apple when it reports on April 25th, with revenue and unit shipments generally aligning with the current sell-side consensus. Gross margins, however, should come in well above consensus at 32 percent or more, Gardner said. As a result, he increased his per-share earnings estimate to 73 cents, up from 71 cents and the Street consensus of 63 cents.

The analyst said his checks turned up no evidence of a slowdown in Mac purchases ahead of Leopard and he expects Apple to report sales of around 1.45 million Macs during the quarter, representing 30 percent year-over-year growth. Similarly, iPods sales are expected to grow 27 percent to 10.8 million units. "While this is slightly below our prior estimate of 11.5 million units, it is generally in line with consensus of 11.0 million," he explained. "The mix of U.S. iPod sales appears very consistent with that of the prior quarter (30-35 percent video, 40-45 percent nano and 20-25 percent nano)."

Looking ahead to Apple's fiscal third quarter, Gardner believes Apple will continue its historical trend of guiding conservatively, calling for revenues to be “flat to up modestly sequentially” from the second quarter. However, the analyst said he is sticking with his above-consensus revenue estimate of $5.6 billion as he expects the company to benefit from a full quarter of Apple TV sales, the shipment of Leopard, and iPhone channel fill for Cingular retail stores.

"Despite the recent rise in Apple shares from $83 to $94, we continue to like the shares ahead of new product introductions beginning in June," Gardner told clients. "We would buy any 'sell the news' dips following earnings."