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Tuesday, April 22, 2008, 10:00 am PT (01:00 pm ET)

Lehman initiates coverage of Apple, sees Mac share doubling by 2013

Global financial services firm Lehman Brothers initiated coverage on Apple this week with an Overweight rating and $195 price target given the company's ongoing share gains in the PC market, potential for open-ended growth with new iPhones, and prospects for groundbreaking new products later this year and next.

"Despite the economic environment, we do not believe that Apple’s momentum has waned in Macs," analyst Ben Reitzes, who recently made his way from UBS, wrote in his first research note at Lehman. "In fact, Macs may have reached a tipping point with share on its way toward doubling over the next 3-5 years."

In addition, Reitzes believes Apple is the best positioned out of all major technology players to capitalize on a new industry theme that is driving the desire for content and information to be multi-purposed and displayed on many types of devices.

The analyst said the first step of this content expansion was the proliferation of the Internet to computers, while the second phase was arguably sparked by the iPod. He believes the third phase will come from sales of "smart" devices, which will include everything from smart phones to ultra-portable PC’s to sleeker notebooks.

"We believe that Apple is the company best positioned in our coverage universe to take advantage of the content expansion theme—by far," Reitzes told clients. "We believe the content expansion trend drives obvious upgrade paths within the Apple eco-system with regard to iPhones, iPods, Macs and eventually Apple TV.

Another major advantage on Apple's part is the one-two punch of its scalable Mac OS X software architecture and international retail chain, both of which combine to allow the company to more rapidly introduce products into new open-ended growth markets faster than its competitors.

"Not only does the content expansion help create a platform for revenue growth, but for margin expansion as well. Apple’s vertically integrated model has 'trapped' in the wallets of consumers better than any business model we have seen in years," Reitzes wrote. "For example, we estimate that Apple’s Mac units will grow about 33 percent this year and about 20 percent next vs. only about 10-12 percent growth for the global PC market."

Apple is also better positioned than most of its peers to avoid over-exposure in slowing international markets, the analyst told clients. While Dell leads the category with only 39 percent international exposure, Apple is a close second at approximately 40 percent but "is gaining so much share in the US PC market and has so much potential with the iPhone" that "it is still possible perhaps 'to look the other way.'"

Reitzes added that potential exists for Apple to further boost its share gains in the PC market should the company manage to put forth a viable and affordable competitor in the ultra-mobile/ultra-portable PC market that is currently dominated by over-priced machines that cost several thousand dollars and run only Microsoft software.

"We believe there is a market for a very small PC in the sub-$1,000 range optimized for media playing, internet surfing and even navigation," he wrote. "We had expected that Apple could get a product like this out this year but it seems that it could be next year."

Specifically, the analyst said his checks indicate that Intel’s Silverthorne chip for mobile Internet devices may note have been quite ready for the kind of battery life that the Mac maker wanted. However, the chip's successor, Moorestown, is due out in late 2009, which could finally usher Apple into the ultra-mobile space.

"We believe that this kind of device with high speed wireless connectivity could eventually account for over 10s of millions of units, adding further support to the notebook market," Reitzes wrote. "We believe Apple would be the big winner if this market were to develop."

In the meantime, the analyst sees Apple benefiting from the best portfolio of portable products on the market, including the new ultra-portable MacBook Air, which he believes the company may expand to "a whole family of MacBook Air laptops with different sizes" at or around its annual Worldwide Developers Conference (WWDC) in June.

He also expects the highly anticipated 3G iPhone to be announced in June — though not necessarily at WWDC — possibly in multiple configurations and more attractive prices with new features such as contact search, better enterprise support and video chat.

"We believe new iPhones could ship in July and would not be surprised to see Apple ink several new international partners in that time frame, including in China ," he added. "Down the road in [the second half of] calendar 2009, we believe Apple is likely to introduce a new category of ultra-portable devices maximized for media-playback and internet surfing."

For Apple's second fiscal quarter of 2008, results of which will be announced Wednesday (tomorrow), Reitzes is modeling for earnings of $1.05 per share on revenues of $6.95 billion, which he said may prove conservative given the potential for higher than expected gross margin.

Looking ahead, the Lehman analyst explained the biggest risks to Apple not achieving his $195 price target are the economic environment and consumer spending trends. "Key areas to watch are iPod inventory levels and execution risk in Apple’s ability to launch new iPhones successfully in the US and international markets," he said.