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January 10, 2007

Apple's iPhone: Initial Impressons

There is no doubt that the new iPhone from Apple, Inc. (AAPL) – they officially changed their name yesterday by dropping "computer" – has a serious WOW! factor. The product is substantially beyond any expectations and easily supports the 8% gain in APPL shares yesterday.

Make sure to head over to Apple's website and check out the various demos on the music, video, telephone, internet, email, and text messaging capabilities of the iPhone. It really is amazing. Something as simple as rotating the iPhone from portrait to landscape and watching a photo automatically reorient itself will make you go WOW!

Or better yet, watch this 4 minute live demo of the phone courtesy of CBSNews.com and YouTube.

Beyond the iPhone as a product, I tried to take a stab at what it could mean financially….

I started with Bernstein's 2008 revenue breakdown. Bernstein's new research on AAPL was cautious but incredibly through and well reasoned so I figure their numbers might be a good place from which to benchmark.

Bernstein is using an estimate of $26.8 billion, a little below the current consensus revenue estimate for 2008 which stands at $27.8 billion. Of that $26.8 billion, Bernstein currently assumes that the iPhone will bring in $1.2 billion with Macs and iPods each generating $9-10 billion.

In his keynote, Steve Jobs said that APPL is targeting a 1% share of the phone market in 2008, equating to 10 million units. Pricing for the two versions of the iPhone was announced at $499 and $599. Presently, a nano plus a Blackberry will cost you about $500. Assuming that APPL sells 10 million units at $550 per unit, the revenue will be $5.5 billion. So even if Bernstein's concerns about iPhone cannibalization of iPods prove correct, there appears to be plenty of upside for APPL in 2008 if the iPhone meets initial expectations.

Assuming the iPhone produces an incremental $3 billion in revenue at an iPod-like 20% margin, AAPL is potentially looking at an incremental $600 million in operating income. Subtract taxes and you are looking at more than 45 cents in incremental EPS. Current consensus EPS for 2008 is $3.29.

I'd call that significant. Even more important, the iPhone along with AppleTV (formerly iTV) look like they are opening up massive new markets for APPL. This should improve investor confidence in the company’s long-term growth rate which in turn helps to support the premium valuation on APPL shares.

I am staying long AAPL with my focus now on next week's earnings report. I expect good numbers from both Macs and iPods. My only real concern at this point is how much the growth rate will slow on iPods in 2007 and beyond. With the iPhone likely to be very popular and highly priced, I am not too worried but it is worth keeping an eye on.

Posted by Steve Birenberg at January 10, 2007 09:38 AM in AAPL