Merrill Lynch to Apple investors: Sell

A leading financial firm late Monday urged investors to sell their shares in Apple Computer, just as the company's premier trade show and rally of the faithful was getting under way.

Merrill Lynch analyst Michael Hillmeyer said he was "reinstating coverage with a sell opinion." He also rated Apple's stock volatility risk as high.

In trading Tuesday, however, Apple hardly missed a beat, closing off just a nickel at $14.85.

The stock recommendation came on the eve of the Macworld Expo in San Francisco, where Apple CEO Steve Jobs is expected to announce a new portable digital device. But rumors of a new product, which could bolster Apple's bid to position the Mac as hub for connecting digital devices, may not be enough to turn the tide on sagging sales.

"Although Apple makes great products, in our view the new product pipeline looks skimpy and we expect continued market share losses," Hillmeyer wrote. "A product differentiation strategy is difficult in a business increasingly commoditizing."

The financial analyst also warned of other product line problems, which he said wouldn't be easily resolved by the new product Jobs is expected to announce. "Given the weak state of IT demand and our belief that the bulk of Apple's current products like the Power Mac are becoming stale or remain too expensive, we are carrying conservative financial forecasts," he wrote.

Hillmeyer also offered grim projections for Apple's fiscal 2003 first quarter, which closed at the end of December. "We believe that Apple's December quarter sales should be $1.45 billion, $50 million below the Street consensus, with (earnings per share) of (2 cents) below consensus," he wrote. For fiscal 2003, "our estimate of 12 cents is roughly 50 cents below consensus."

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Apple has been struggling to stave off the effects of a weak economy and a product line that cannot match the higher clock speeds and lower prices of Windows PCs. For the fourth quarter of its fiscal 2002, Apple posted an unexpected net loss of $45 million, or 13 cents per share, on revenue of $1.44 billion.

Sources familiar with Apple's product strategy said the company had planned to release new models of existing Mac lines on Tuesday, but instead delayed the announcement at least several weeks. Apple wants to clear out more inventory first, sources said.

Hillmeyer projected a run of numbers in the red. "We expect Apple to post operating losses through most of this year," he wrote.

The Merrill Lynch analyst projected a modest 2 percent gain in notebook sales from the fourth quarter of Apple's fiscal 2002 to the first quarter of fiscal 2003. But he warned that sales of Apple's iMac would fall 3 percent, with Power Mac sales down 15 percent.

"In a typical year, Apple could expect to see good December quarter spending by design professionals, but the combination of the weak economy and Apple's professional products--Power Macs--becoming long in the tooth likely precludes a great showing here."

Hillmeyer concluded that Apple would have to get costs in line if it hopes to recover momentum. But he warned of trouble spots, such as the cost of maintaining 50 retail stores and Apple's plans to open even more.

"While Apple's marketing prowess remains top-notch, the retail stores only compound its problem in reducing costs," Hillmeyer wrote.

In a December filing with the Securities and Exchange Commission, Apple reported that several high-profile store locations, such as New York's Soho district, are expensive to maintain and require commitments of five- to 12-year leases.

Hillmeyer noted that Apple opened eight stores in fiscal 2001, 32 in fiscal 2002 and 11 so far in fiscal 2003. "The company has said that an additional $77 million will be spent on stores in (fiscal 2003), indicating to us that a significant uptick in store locations is on tap," he wrote.

Apple isn't the only consumer computer company having troubles. Gateway appointed new division heads on Monday, as part of a larger restructuring program. Like Apple, Gateway saw slower-than-expected holiday sales.