Merrill Lynch: Apple "Has Its Groove Back"; Must Update iMac Form Soon

A new analyst report from brokerage firm Merrill Lynch has recommended buying Apple Computer stock saying the company "has its groove back for now," but expects competition in the portable music player market to get fierce and test Appleis 31 percent market share.

In a new analysis report for clients obtained by The Mac Observer, Merrill Lynch technology analyst Steven Milunovich wrote mostly positive comments about the Cupertino, Calif.-based company saying he expects the companyis stock to be around US$29.00 a share by this time next year. At present, the stock stands at right around US$24.00 a share.

"We think Apple has gotten its act together in focusing on core markets, building a mature management team, and most important innovating again," Mr. Milunovich wrote. "People will pay more for Porsches, but they have to perform."

Retail Stores Moving Forward

Mr. Milunovich said he believed Appleis 75 retail stores in the US will be profitable this quarter and that, "weire comfortable with the retail strategy." Apple executives told Mr. Milunovich that the company doesnit see its stores as a loss leader and that store expansion is going to slow this year. Just how much, Mr. Milunovich and/or Apple did not say.

"Appleis retail guru Ron Johnson told us 75% of retail sales likely are incremental," he wrote. "Now that the built-out (of stores) is done, Ron is focusing on comp store sales."

In Fiscal 2003, retail represented 10 percent of Appleis overall sales. Merrill Lynch estimates that for the Christmas quarter just ended, retail sales will account for more like 13 percent of sales "and should have been profitable." Mr. Milunovich also said he expects Apple to open "a few" additional stores internationally this year, but neither he nor Apple revealed where.

Music A Critical Piece To The Pie

Mr. Milunovich is positive on Appleis music future, saying Apple must continue to innovate and keep its "coolness" level up. He also said the deal for Hewlett-Packard (HP) to sell iPods, which was announced last week at the International Consumer Electronics Show in Las Vegas, Nevada should continue the iPod/iTunes momentum. Writing that Appleis real profit comes from iPod sales, Mr. Milunovich estimated Apple generated US$69 million in profits from the iPod on a 20 percent gross margin for fiscal 2003 and said that could double this fiscal year.

Somewhat confusing in his report is Mr. Milunovichis feeling that Apple will support other download services in the next few years, despite developments to the contrary.

"...we believe services such as those from Roxio, RealNetworks,, Amazon, and Wal-Mart would welcome the iPod," he wrote. At present, all these services have opted not to adopt Appleis services or Digital Rights Management (DRM) technology, known as FairPlay. Recent reports even indicate Wal-Mart turned down accolades from Apple to support the iPod and iTunes music technology. In addition, sources close to MusicMatch report Apple turned down attempts last year to partner with MusicMatch and license its FairPlay technology.

"We believe Apple will move slowly, adding tangential support to the iPod," Mr. Milunovich wrote. "Video, PDA functionality, wireless, and smartphone capabilities are possible."

As for competition, Mr. Milunovich admitted it will be fierce in the coming years, but said, "We believe Appleis iPod/iTunes will be able to stay ahead of the competition for at least the next two years."

iMac Needs Design Update

Mr. Milunovich said that after eight quarters in its current design, Apple needs to update the iMac iform factori. "As users continue to move to laptops in the home and educational markets and as the creative user is drawn to the PowerMac, the iMac is likely to continue to trail the market," he wrote.

As for the overall Apple computer line, Mr. Milunovich does not expect the price for basic performance to tilt in Appleis favor anytime in the future. "Apple will likely continue to be an innovator with a small (market) share," he wrote.

Other interesting tidbits in the report include:

- The iPod is pulling customers to buy Macs, but that will slow in the future.

- Apple could be considering making the iPod a "photo viewer where people could bring around pictures of their kids as well as their music."

- "PowerMac sales to creative users are the backbone of Appleis profits."

- Concern over Appleis focus on capturing more international sales. "We would like to see more plans for international sales growth," Mr. Milunovich wrote.

- "Appleis iLife i04 suite of software applications continues to differentiate Macs."

- "If Apple can make PCs easy to use (as it did with the iPod), then share gains in the years ahead are possible."

- Mr. Milunovich doesnit believe Apple will be switching to using Intel processors any time soon.

- Mr. Milunovich recommended Apple do some "beefing up" of the companyis board of directors. "Although Al Gore joined recently, weid like to see additions that are not "friends of (Apple CEO) Steve (Jobs)," he wrote.

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