Apple and Microsoft get contrasting Wall Street ratings

Apple is sailing towards its fourth iPhone launch on the crest of a wave of market approval. Its iPad tablet has sold two million units in two months and is now going international, and it has overtaken Microsoft to become the largest US technology firm by market capitalization. Wall Street analysts are doing little to question the sad contrast. In near-simultaneous client notes, Bank of America Merrill Lynch raised its target for Apple, saying the iPhone was nowhere near saturation, while Barclays Capital cut its target for Microsoft, citing fears over the mobile software strategy.

Focal Points:

• What is clear is that Microsoft's decline is far more to do with its own mistakes than the good decisions of competitors. Even with a strong looking Windows Phone 7, the firm has little prospect of a real mobile play outside its niche markets. In his research note, Barclays Capital's Israel Hernandez cut his price target on Microsoft to $32 from $35. His main concerns are underperforming shares, depressed by decelerating PC growth and the failure to balance this with mobile growth - a failure just accentuated by the recent reorganization of the entertainment and devices division. The reorganization was lame and just seemed to put more control in the hands of Ballmer, who has never shown any instincts for this market. And many believe the whole unit should be dismantled, removing the conflicts of interest with OEMs, diverting dollars from hardware to software, and leaving Microsoft to focus on web and cloud services, and on its 'post-Windows' OS Midori.
• Hernandez is concerned that, however good WP7 may be, it needs to dominate the tablet and smartphone market in order to be a success, which means tens of millions of sales. There are so many alternatives now, that this seems unlikely - some of them coming from companies which were previously loyal Windows licensees, like HP after its acquisition of Palm.
• Hernandez wrote: "We view the mobile/tablet/smartphone market as a strategic imperative for Microsoft, not so much for the immediate revenue opportunity but more so because of the potential competitive impact on the core Windows franchise over the long term…In our view, the inroads that Apple and now Google have made with smartphones and tablets have created a scenario whereby a new generation of consumers is increasingly looking beyond Windows for their basic computing needs, especially with more and more content and applications available in the cloud and accessed through a browser, obviating any need for a Window-based machine."
• By contrast, Apple appears to have plenty of growth in mobile, even though it, like Microsoft, pursues a closed and tightly controlled model under a veneer of web services. The Bank of America research note, from Scott Craig, says there is plenty of upside left for the iPhone, which is nowhere near saturation. Craig lifted his price target on Apple to $325 from $300, writing that the iPhone has "multiple tailwinds" that will continue to drive sales, and arguing that Wall Street's consensus estimates "meaningfully underestimate Apple's gross margin potential".
• Craig sees upside for the iPhone in foreign markets, and also on the US, especially if and when it reaches other operators. "We believe the iPhone can grow 20-30% in the US over the next several years, excluding the addition of Verizon, on overall smartphone growth and customer preference for the iPhone within AT&T existing subscriber base, despite the perceived existing network quality issues and perceived saturation," Craig wrote. The addition of Verizon would be "potential upside to our model". Craig maintained his iPhone sales forecast of 34.5m units for the 2010 fiscal year but raised his 2011 target from 37.5m units to 43.5m. He raised his iPad forecast for this year to 3.75m units from 2.5m.
  

Editor’s Note: It is interesting to note that while the iPad was not developed as competition to the netbook, it has from a market perspective, overtaken netbook sales. While there are definitive differences between the functionality of the iPad and netbooks, it appears that the proliferation of applications, wireless communication and cloud computing is positioned to eliminate or reduce the significance of those differences.

Apple itself does not market the iPad as a replacement for the laptop. However, when you look at the way in which the iPad is being used, namely email, texting and internet queries, it appears that the iPad is catering to an underlying market that does not need all of the functionality in a netbook or assumes that the new apps will deliver the bulk of the missing functionality.

Another observation is that consumer preferences are changing. While most members of the new generation have mobile phones, ironically the use of the voice option has been replaced by texting. This is supported by recent articles in the trade press announcing AT&T’s intention to eliminate unlimited texting.