UPDATE 2-Morgan Stanley raises Apple to overweight

Tue May 26, 2009 10:34am EDT

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(Adds comments from Global Equities Research, updates share movement)

By Mansi Dutta

May 26 (Reuters) - Morgan Stanley upgraded Apple Inc (AAPL.O) to "overweight," saying the iPhone maker is emerging as the clear leader in the battle over mobile Internet and will see iPhone-driven earnings growth over the next two years.

Apple shares rose more than 5 percent to $129.13 in morning trade on Nasdaq.

"The core of our stock call is that the iPhone's success and higher margins will begin to mute the fundamental margin and growth risks in Apple's core Mac/iPod businesses," analyst Kathryn Huberty wrote in a note to clients.

The analyst, who raised the price target on the stock to $180 from $105, said the market is underestimating iPhone unit demand in the second half of 2009 and 2010 which will accelerate earnings growth, estimate revisions and multiple expansion.

Huberty said iPhone will drive about 50 percent of Apple's earnings per share in 2010, up from 30 percent in 2008.

"We expect a price cut to the current generation iPhone to drive 50 percent to 100 percent (2 million to 4 million units) incremental unit demand," Huberty said.

"Our survey data suggests 15 percent plus of the iPhone installed base typically upgrade to a new phone."

Smartphones are taking increasing share from traditional handsets and Apple's iPhone currently leads market share of the mobile Internet.

Apple has 38 percent of mobile Internet operating system market share, up from 5 percent a year ago, the analyst said.

COMPETITION AHEAD?

However, Global Equities Research analyst Trip Chowdhry said iPhone will face tough competition from Palm Inc's PALM.O smartphone Palm Pre when the latter is launched on June 6.

Chowdhry has an "equal weight" rating on Apple stock with a price target of $95.

"Investors should not think the upcoming version of iPhone 3 is going to be as successful as iPhone 2.0 because it will have solid competition from Palm Pre, developed by ex-Apple designer Jon Rubinstein," Chowdhry said by phone.

"Palm Pre has a superior operating system than iPhone. It runs on a better network -- Sprint CDMA -- versus iPhone which runs on GSM," Chowdhry added.

He said investors should also be very careful about the fact that about 60 percent of iPhone developers have signed up for the Palm Pre developer program.

Apple is expected to announce the launch of iPhone 3 on June 8.

Apple shares were up $6.17 at $128.67 in morning trade. The stock has gained more than 65 percent since hitting a 52-week low in January. (Editing by Ratul Ray Chaudhuri and Gopakumar Warrier)

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