Merrill Lynch: Apple building consumer electronics franchise

"We believe the Mac mini will sell well to both PC switchers and Mac lovers wanting to put iTunes, iPhoto, and iVideo into entertainment room," the analyst said. "The lower price point could entice PC owners to consider the Mac, particularly those with iPods." Milunovich believes the Mac mini's S-video output could be an overlooked feature that many a Mac lover will use to drive their TVs.

Merrill Lynch also believes Apple is poised to take the top position in the flash-based MP3 market in the next few quarters if the company ramps production, citing attractive pricing on the new flash-based iPod shuffle. "If Apple hits 5% share this quarter, that could be 300,000 units. If it takes off, the number could be much higher, possibly passing the 1 million mark."

Going forward, the firm believes the iMac and iPod need to be positioned to feed off each other. "The new Mac mini should act as a bridge to the iPod in the living room and the basis for an entertainment server." The firm said dropping price points could be the catalyst needed to get consumers to switch from Windows or at least try out the Apple offerings.

The firm also expressed a favorable reaction to this year's Macworld Expo in San Francisco, which it says was packed with both exhibitors and attendees. "We had trouble navigating the showroom floor as the Mac faithful mingled with the press and investors. The show had a festive atmosphere with attendees jumping at products from QLogic SAN switches to Mercedes iPod attachments to video professional editing systems." Merrill Lynch contrasts this to the last LinuxWorld it attended, which was 'much calmer' despite Linux's growth.

Merrill Lynch maintains its 'Buy' rating for AAPL with a price objective of $78 per share based on a 2.2X EV/Sales ratio, which is an 18% premium to Dell and Lexmark. The firm is modeling earnings of $0.47 for the December quarter on $3.35 billion in sales, stating that strong iPod sales could have pulled up retail and notebook sales, which should help the company's margins.