Bank of America initiates coverage of Apple with Buy rating

"While we recognize we are late to the Apple party, we believe there is a significant amount of upside possible in Apple stock for a number of reasons," lead analyst Scott Craig wrote in note to clients.

First, he said, Apple is experiencing significant unit growth in its Mac business and new models in the second half of 2007 (as well as the Leopard) should help drive solid year-over-year growth in the near term.

Secondly, the analyst said, unit growth for iPods remains strong, despite concerns that the iPhone would cannibalize demand. And of course, he added, "what would an Apple conversation be without the iPhone?"

"In our opinion, investors are too focused on the near term unit sales for the iPhone over an extremely short period of time (30 hours in 2Q07)," Craig told clients. "Longer term, Apple’s agreement with AT&T is a game changer, in our view."

Ignoring subscription accounting, the analyst estimates that Apple's current operating margins on the iPhone are near 60 percent, including 2 years of monthly payments from AT&T at $6/month.

"In other words," he explained, "Apple is basically capitalizing on annuity payments, so to speak, similar to companies like Qualcomm (receives IP-related royalties from handset OEMs for every sale of a handset) and Research in Motion (receives monthly payment from carriers for every customer that activates data services using a Blackberry device)."

Based on his estimates of 3.2 million iPhone sales in 2007 and 9+ million in 2008, Craig said the handset could account for 25 percent or more of Apple’s revenues by the end of fiscal 2009 under a non-subscription-based accounting view.

"Valuing Apple has become increasingly challenging over the past few months, as the company announced it will be using subscription-based accounting for iPhone hardware, given it plans periodic software updates to the device," the analyst explained. "As a result, we believe that you have to value Apple using either (or both) adjusted 'cash' earnings-per-share (removing subscription accounting and accounting for iPhone revenue/gross profit as if realized in the quarter they sell the phone) or cash flow."

Craig's initial per-share earnings estimates for Apple's fiscal 2007, 2008, and 2009 are $3.75, $4.35, and $5.57, respectively, compared to consensus of $3.72, $4.37, and $5.39. However, when converting the subscription accounting revenues and profits to current period accounting, his adjusted cash per-share earnings estimates come out to $3.94, $5.10, and $6.70, respectively.

The Bank of America analyst issued a $160 price target on shares of Apple alongside his Buy rating Wednesday.