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Wednesday, September 12, 2007, 09:00 am PT (12:00 pm ET)

UBS raises Apple target to $182, introduces fiscal 2009 estimates

Investment bank USB on Wednesday increased its estimates on gadget maker Apple Inc, explaining that the company's recent iPod touch and iPhone price cut announcements are likely drive additional revenues through higher iPod average selling prices and additional AT&T royalty payments, respectively.

"Over the last week we have had a chance to observe the impact of the Apple iPhone price cut and assess new iPods, surveying of dozens of Apple and AT&T stores," analyst Ben Reitzes wrote in a report to clients Wednesday. "Our retail checks continue to indicate robust demand for Apple’s Mac products and a significant pick up in demand for iPods and iPhones following the announcements on September 5th."

Given the compelling new features of the iPod touch, the analyst expects the player will help fuel a mix shift in demand towards the pricer iPods, hence generating additional revenues for the Cupertino-based company. Similarly, he explained, the $200 iPhone price cut will likely stimulated more demand for the handset, generating Apple additional royalty payments from AT&T that will in the long-run offset the per-unit revenue lost as a result of the cuts.

"As a result, Apple and AT&T will have more customers than previously expected sign up for cellular service, resulting in higher payments to Apple from AT&T (we estimate up to $10 per month)," Reitzes wrote. "It is important to note that Apple will immediately recognize payments from AT&T (a reflection of the iPhone installed base), while deferring revenue from the device itself."

Looking ahead, Reitzes is confident that the iPhone, new Macs and recently launched iPods, will help stimulate revenue acceleration through Apple's 2008 fiscal year. In addition, he thinks the company will see a lift from its new OSX Leopard, which is due out in October.

"Other opportunities that are still not fully reflected in our model include: ultraportable devices, additional movie partners for a pay-per-view service, gaming opportunities and additional phone models," he continued. "We expect Apple to make an announcement on its European iPhone carriers shortly and our contacts in the supply chain point toward a new iPhone model to be released before March of next year."

Raising Estimates

Given his outlook, the analyst raised his estimates for the company through fiscal 2008, saying he believes the aforementioned factors will combine for significant cash generation, culminating in over $8 per share in free cash flow by sometime in fiscal 2009.

Current Quarter Estimates

For the (current) fourth fiscal quarter of 2007 ending September 29th, Reitzes estimate Apple to report per-share earnings of $0.81, up from $0.79, primarily reflecting the benefit of new iPod nanos and solid software sales offset very slightly by the potential impact from iPhone rebates. His estimate is based on 25 percent year-over-year revenue growth (+12 percent quarterly) to $6.05 billion on gross margin of 31.0 percent and operating margin of 14.8 percent.

The estimate also factors in iPod unit growth of 32 percent year-over-year to 11.5 million with revenue growth of 21 percent year-over-year to $1.89 billion; Mac unit growth of 22 percent to 1.96 million with revenue growth of 25 percent to $2.76 billion, and iPhone unit shipments of 950,000 (was 800,000).

Fiscal 2007 Estimates

Accounting for his change in fourth quarter estimates, Reitzes rounded his 2007 fiscal year per-share earnings estimate up to $3.73 (was $3.72) based on 24 percent revenue growth to $23.8 billion and an operating margin of 17.8 percent.

When factoring in the positioning of the iPod touch product line, the analyst's ASP assumptions for iPods increased to $185 from $166 for all of fiscal 2008. He also raised his fiscal 2008 iPhone unit estimate to 10.7 million from 8.1 million, reflecting elasticity of demand from lower prices.

Fiscal 2008 Estimates

"As a result, we are now projecting higher payments from AT&T given more subscribers, which offsets the lower prices of the iPhone," he wrote. "To reflect the new iPod line and higher iPhone payments, we are raising our fiscal 2008 earnings-per-share estimate to $4.47 (was $4.35), now based on 33 percent revenue growth to $31.65 billion (was $30.51 billion) and an operating margin of 16.3 percent."

Reitzes said his fiscal 2008 estimates are based on Mac unit growth of 23 percent to 8.4 million vs. 6.85 million in fiscal 2007 and iPod unit growth of 22 percent to 64.83 million vs. 52.95 million in fiscal 2007. He estimates free cash flow per share for fiscal 2008 to remain around $6.80, but said that estimate could turn out to be conservative given the impact of payments from AT&T.

Initiating Fiscal 2009 Estimates

The UBS analyst also used his report to clients Wednesday to introduce a fiscal 2009 earnings-per-share estimate of $5.30 based on 21 percent revenue growth to $38.38 billion and an operating margin of 16.2 percent. He's basing this estimate on Mac unit growth of 17 percent to 9.85 million vs. 8.4 million in fiscal 2008, iPod unit growth of 10 percent to 71.3 million vs. 64.8 million in fiscal 2008 and iPhone growth of 58 percent to 17 million from 10.7 million in fiscal 2008.

"We are initiating a free cash flow per share estimate for fiscal 2009 of $8.20, which could turn out to be conservative if Apple continues to benefit from a negative cash conversion cycle," he explained. "Our new 12-month price target is $182 (was $175) based on our view that Apple’s valuation can reflect a 4.5 percent free cash flow yield in a year’s time now based on fiscal 2009 estimates."