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Thursday, April 20, 2006, 08:00 am PT (11:00 am ET)

UBS lowers Apple estimates, price target on iPod outlook

Despite optimism about the company's product pipeline, UBS Investment Research on Thursday cut its price target on shares of Apple Computer to $90 from $95 and also adjusted its estimates downward for the next two fiscal years.

"We are adjusting our estimates through 2007 to reflect prospects for modestly slower growth for iPods and accessories, partially offset by higher Mac sales along with better sales for software and peripherals," analyst Ben Reitzes told clients in a research note released today.

For Apple's current (June) quarter, the analyst lowered his revenue estimate to $4.4 billion, down from $4.6 billion based on 24 percent year-over-year growth. "This estimate now factors in lower iPod unit growth of 36 percent year-over-year to 8.4 million and accessories sales of $495 million," he said. Reitzes' previous estimates on these data points were 9.6 million and $546 million, respectively.

He said his June quarter estimates factor in Mac unit growth of 5 percent to 1.24 million versus his previous estimate of of 1.16 million, which should offset some of the lower revenues expected from iPods and iPod accessories. The analyst is now modeling earnings-per-share (EPS) for the quarter to fall around 42 cents, adjusted from 47 cents. However, he said this estimate could prove to be conservative if Apple continues to see favorable reductions in NAND flash pricing.

For the 2006 fiscal year, Reitzes sees Apple falling shy of a $20 billion company, lowering his revenue estimates to $19.3 billion from $19.9 billion, which reflects growth of 39 percent year-over-year and EPS of about $2.03 — the Street is modeling about $2.10. The analyst said these estimates also factor in a higher gross margin of 28.3 percent (up from 27.6 percent) and iPod unit growth of 82 percent to 40.9 million units (down from 44.5 million). Additionally, he is now forecasting Mac unit sales of 4.96 million for the year, which is an increase from his previous estimates of 4.7 million.

Looking ahead to Apple's 2007 fiscal year, Reitzes told clients that he is cutting EPS from $2.70 down to $2.60 based on 25 percent revenue growth to $24.1 billion, which he lowered from 25 billion. "We note that these estimates now factor in iPod unit sales of 55.3 million (was 61.9 million) and Mac unit sales of 6.3 million (up from 6 million previously)," the analyst wrote. "We believe that prospects for share gains with Macs are getting even stronger with a new operating system (OS X Leopard), a 3 month delay of Microsoft’s Vista and strong acceptance of new Intel Macs."

As a result of his adjustments, Reitzes lowered his price target on Apple shares to $90 from $95, which is still based on an enterprise value to sales multiple of about 3x his fiscal year 2007 sales estimate. He notes this figure is still higher than Apple’s "pre- bubble" multiple and above its peers in the PC industry due to its much faster growth and much higher margins.

"We believe that Apple’s shares warrant a 3x sales multiple to reflect share gain potential with the transition to the Intel platform and continued solid sales of iPods," the analyst told clients. "While we acknowledge risks including some continued near-term disruptions from the transition to Intel and potential impact from pending lawsuits and French legislation, we continue to believe Apple is one of the best positioned stories in digital media (getting content onto all devices) with EPS upside potential and better relative growth vs. alternative investments."

While Reitzes would consider Apple's March quarter "a mixed bag" with positives and negatives, he believes bad news has made its way into investor expectations and is looking for prospects to improve later this year with new products.

The analyst believes Apple's recently released Beta of Boot Camp may further stimulate share gains, as additional users may contemplate a switch to Macs from Windows PCs, now that concerns over interoperability seem to have been addressed. "We estimate that each point of PC market share equates to about $2 billion in incremental Macintosh revenue (vs. approximately $14 billion in revenue for Apple as a whole in fiscal 2005) and estimate that the bottom line impact from each point of share would top $0.20 per share using incremental margin analysis," he wrote.

Reitzes also said he continues to believe Apple will announce a new hard disk drive-based video device that looks like a video iPod with a larger color screen in the holiday season. "We think this announcement could come in conjunction with additional digital content as Apple seeks to further cement its leadership position in the digital home," he wrote. "In addition, we believe it is likely that the video iPod will move from 30GB/60GB to 40GB/80GB by the fall and that the nano could see 6GB and 8GB introductions (currently 1GB, 2GB, and 4GB versions available) by the end of 2006 as lower NAND flash prices provide an opportunity to get more for less."

Additionally, the analyst expects Apple to announce new iBooks and a larger MacBook Pro based on Intel processors within a matter of 6 weeks as the company continues to rapidly proceed with its transition. "In addition, we believe the company may choose to enter new consumer markets including an Apple branded cell-phone over the next year where the company would be able to leverage its market leading innovations and creative designs that have made the iPod such a tremendous hit with customers," he said. On top of this, the potential for slower PC sales during the holiday season — due to the delay of Microsoft Vista — may help stimulate sales of new and existing Apple products like the iPod.

Of all Apple's opportunities, UBS is particularly excited about cell phones — which is an 800+ million unit market each year — given its view that consumers clearly want content but lack true "plug and play" capabilities with computers. However, the firm said such an Apple product may not materialize until 2007 despite recent hype given complex intellectual property issues in this industry.

"Building on success with iTunes," Reitzes said, "we believe Apple could create a phone that allows for the easy loading of content by docking to a PC or Mac." In addition, the company could take advantage of its retail distribution to sell the product and create powerful revenue stream of post-sale accessories, the analyst said.

UBS Investment Research maintains a Buy rating on Apple shares.