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					MORGAN NORTH

STANLEY

RESEARCH

AMERICA

Morgan Stanley & Co. Incorporated

Kathryn Huberty, CFA
Kathryn.Huberty@morganstanley.com +1 (1)212 761 6249

Mathew Schneider
Mathew.Schneider@morganstanley.com +1 (1)212 761 3483

May 26, 2009

Stock Rating Overweight Industry View In-Line

Apple, Inc.
Long-Term iPhone Growth Underappreciated; Upgrade to Overweight
What's Changed
Rating Price Target Equal-weight to Overweight $105.00 to $180.00
Fiscal Year ending ModelWare EPS ($) Prior ModelWare EPS ($) Consensus EPS ($)§ P/E EV/rev Div yld (%) 09/08 09/09e 09/10e 09/11e

Key Ratios and Statistics
Reuters: AAPL.O Bloomberg: AAPL US
Systems and PC Hardware / United States of America Price target Shr price, close (May 22, 2009) Mkt cap, curr (mm) 52-Week Range

$180.00 $122.50 $110,732 $189.95-78.20

iPhone is feeding earnings growth that the market is missing: We believe Apple is emerging as the clear leader in the battle over the mobile Internet. We size this as an incremental 4 billion installed base opportunity for Apple, 4x the installed base of PCs and 10x the installed base of MP3 players. Our proprietary survey work points to iPhone-driven EPS upside over the next two years, muting any margin or growth concerns in Apple’s core iPod/Mac business. Consequently, we’re upgrading AAPL to Overweight, raising our EPS forecast (CY10 20% above consensus), and increasing our price target from $105 to $180. C3Q09 marks key inflection point: Two key factors drive iPhone unit and EPS upside based on our survey: 1) We expect a price cut to the current generation iPhone to drive 50-100% incremental unit demand (base case assumes 50% on $50 price cut; bull case assumes 100% on $100 cut). 2) Our survey data suggests 15%+ of the iPhone installed base typically upgrade to a new phone (15% base case, 20% bull case). We also factor in a inventory build post the launch of new products. Net-net, our CY09/CY10 iPhone unit estimates increase 42% and 61% to 24.8/36.2mn. CY10 GAAP EPS shift from $5.52 to $7.50; non-GAAP EPS, adj. only for actual sales of iPhone, increase to $9.00 from $5.67. Risks to our call: 1) Lack of a meaningful iPhone price cut could lower our CY10 EPS by $0.75-$1.00. 2) Mac and gross margins prove to be larger obstacles than we forecast, though a 1000 bps drop in gross margin or 50% cut to Mac sales is necessary for consensus EPS to be at risk. 3) Muted June quarter results, but we’re buyers on any related share price weakness.

5.35 5.36 5.36 21.3 2.5 -

5.48 5.23 5.47 22.3 2.1 -

7.03 5.38 6.19 17.4 1.5 -

8.83 5.85 6.65 13.9 1.0 -

Unless otherwise noted, all metrics are based on Morgan Stanley ModelWare framework (please see explanation later in this note). § = Consensus data is provided by FactSet Estimates. e = Morgan Stanley Research estimates

Quarterly ModelWare EPS
2009e
Quarter Q1 Q2 Q3 Q4 2008

2009e 1.78a 1.33a 1.14 1.22

2010e 1.48 1.28 1.31 1.32

2010e 1.80 1.62 1.76 1.85

Prior Current

Prior Current

1.76 1.16 1.18 1.26

1.78a 1.05 1.07

e = Morgan Stanley Research estimates, a = Actual company reported data

Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only a single factor in making their investment decision. Customers of Morgan Stanley in the US can receive independent, third-party research on companies covered in Morgan Stanley Research, at no cost to them, where such research is available. Customers can access this independent research at www.morganstanley.com/equityresearch or can call 1-800-624-2063 to request a copy of this research.

For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this report.

MORGAN May 26, 2009 Apple, Inc.

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Risk-Reward Snapshot: Apple (AAPL, $122.50, OW, PT $180)
Risk-Reward View: iPhone Drives Price Target Higher
$250 $220 (+80%) 200 $180.00 (+47%) 150 $ 122.50

Investment Thesis
iPhone demand should top expectations in 2H09 and CY10 driven by price cuts and upgrades from growing installed base driving estimate revisions and multiple expansion as growth reaccelerates. Gross margin pressure from components and currency are largely offset by mix shift to higher margin iPhone revenue (currently 15-20 pt. premium to rest of business) Mac/iPod near term weakness are offset by strength in the iPhone franchise – longer term Macs continue to take share while iPod faces secular headwinds from market saturation and mobile device convergence

100

$98 (-20%)

50

0 Apr-07

Oct-07

Apr-08

Oct-08

Apr-09

Oct-09

Apr-10

Price Target (Apr-10)

Historical Stock Performance

Current Stock Price

Bull Case $220

22x Bull Case C10e Adj. EPS of $10 20x Base Case C10e Adj. EPS of $9

Price Cut Boosts iPhone Units by 100%, 20% Installed base upgrade, New iPod products: 32.9/58.5mln iPhone units in CY09/10. New iPod product adds 8mln units in CY10. Non GAAP gross margins=35%, lower due to more aggressive price cuts. Price Cut Boosts iPhone Units by 50%, 15% Installed base upgrade: 24.8/36.2mln iPhone shipments in CY09/10. Non GAAP gross margins near 38% due to mix shift towards iPhone and component costs offset price cuts. Non GAAP EPS of $9 in CY10. Multiple expands to 20x, low-end of historical range. Price Cut Boosts iPhone Units by 25%, 10% Installed base upgrade, Gross margin pressure. 21.1/26.2mln iPhone shipments in CY09/10. Gross Margins = 33%. Non GAAP EPS of $7 in CY10. Lack of iPhone price cut over next 18-months would also get you to bear case. Market assigns market multiple as growth slows.

Price Target $180

Potential Catalysts
Reductions in iPhone total cost of ownership (hardware or service plan cost) Additional iPhone carrier distribution agreements globally Incremental revenue streams from iPhone installed base (e.g. application revenues) New iPod/Mac product introductions (expected by September) Signs of stabilization in core Mac business

Bear Case $98

15x Bear Case C10e Adj. EPS of $6.50

Base to Bull: iPhone Adds ~$60 to our Bull Case Value
iPhone Elasticity iPhone Upgrade iPhone Inventory Build New iPod Products Multiple 18 9 Bull 220.00 34 15 3 Gross Margins -39

Investment Risks
Lack of additional iPhone price cuts Gross margin pressure including higher component costs, currency and pricing PC market share deterioration due to lack of “value” offerings and ASP declines due to mix shift to lower priced systems

Target 180.00 -19 -15 -4 0 -23 Bear 98.00 -22
Current 122.50

All values are in U.S. Dollars

Source: Morgan Stanley, FactSet

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Investment Case
Summary & Conclusions We’re upgrading AAPL shares to Overweight from Equal-weight and raising our price target to $180 from $105. We believe the market is underestimating iPhone unit demand in 2H09 & CY10 which will drive an acceleration of earnings growth, estimate revisions and multiple expansion. Put simply, we view the mobile Internet, and related device proliferation, as one of the biggest opportunities in the history of the technology industry (Page 12-17). The opportunity to connect the 4+ billion mobile device users to the Internet is arguably 40x the opportunity to connect 100 million PCs to the Internet in the 1990s. Smartphones are taking increasing share from traditional handsets and Apple’s iPhone currently leads market share of the mobile Internet (38% mobile Internet operating system market share, up from 5% a year ago). While we believe that Apple will hold only 2% market share of mobile devices (15% of smartphones) at the end of ‘09, data usage on the iPhone is 6-10x, and application downloads are 100x other mobile devices – suggesting to us that Apple’s market share will continue to expand as mobile Internet adoption continues to rise. Even looking at Apple’s own history, the iPhone has already proven to be a more meaningful growth opportunity.
Exhibit 1

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. To put this in perspective, iPhone will drive approximately 50% of total company EPS in CY10 on our new forecast, up from 30% of EPS in CY08. As a result, gross margins would have to miss our model by 10 pts. or Mac units would have to fall by 50% or more for Street estimates not to move higher in C2010, if our iPhone forecast is accurate.
Exhibit 2

Profitable iPhone Will Represent Larger % of EPS
Non GAAP EPS by Product 3.50 3.00
Other

CY08: 30%

CY09: 45%

iPhone % of EPS CY10: 50%

2.50 2.00 1.50 1.00 0.50 1Q 08 2Q 08 3Q 08 4Q 08 1Q 09 2Q 09 3Q 09 4Q 09 1Q 10 2Q 10 3Q 10 4Q 10
iPhone Mac

iPod

Source: Morgan Stanley Research

iPhone Growth Opportunity Significant
Apple Product Cycles 250 200
Cumulative Unit Shipments

iPod Revolutionized digital music market Introduced: 2001 Installed base: 400 mn Annual Shipments: 200 mn Market Share: 40%
'08

150 100 50

iPhone Revolutionized the mobile internet/device market Introduced: 2007 Global Wireless Subs: 4.1 bn Annual Shipments: 1.2 bn Market Share: 1%, and growing

Mac II Revolutionized the personal computer market Introduced: 1977 Installed base: 1 bn Annual Shipments: 300 mn Market Share: 3%
'08 '87

0 1 2 3 4 5 6 iPod 7 8 Mac II 9 10
Years after launch

iPhone
Source: Morgan Stanley Research

Higher estimates driven by bottom-up analysis of iPhone demand: A bottom-up analysis of iPhone demand, based largely on our proprietary survey work, suggests there is material upside to iPhone market expectations over the next two years and provides sufficient upside to mitigate our previous concerns surrounding gross margins and Mac weakness. Specifically, incremental unit demand driven by price cuts and upgrades by the iPhone installed base combine with market share gains to drive our new iPhone unit estimates – 36.2 million units in CY10 (up from 22.5 previously). Our CY10 GAAP EPS estimate of $7.50 (up from $5.52) is 20% above consensus. While our base case assumptions assume the low-end of potential unit growth from price cuts and installed base upgrades to new phones, based on our historical surveys, our bull case forecast gives AAPL full credit for a $100 price cut and 20% upgrade by the iPhone installed customer base. Our bull case estimates point to an additional 11%/22% upside to AAPL EPS/share price.

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Exhibit 3

Exhibit 4

Price Cuts & Upgrades Drive #s Higher
Annual iPhone Shipment Breakdown, millions 40 35 30
25 36 4 2 2
Inventory Build

iPhone Drives FCF & Non GAAP EPS Above GAAP
GAAP, Non GAAP & FCF Per Share 14 12

11.62 10.58

12.28

Upgrade

10 8

25 20
14

3 3 2
Price Cut

6.30 5.06

7.87 5.37

8.25 5.50

9.00 7.50

15 10 5 2008
Source: Morgan Stanley Research

29
Core Sales

6

-

2

17

4 4.48 2
2007

11

2008
GAAP EPS Non GAAP EPS

2009
FCF

2010

2009

2010

Source: Morgan Stanley Research

Where we could be wrong: In the near term, shares could be volatile due to supply chain noise ahead of the iPhone launch, limited iPhone revenue recognition in the June quarter along with weak Mac demand, but we would view any share price weakness as a buying opportunity. Longer-term, the key risk to our thesis is that Apple does not continue to lower the cost of the iPhone, raising the total cost of ownership versus other devices. While we see a high likelihood of additional price cuts, as early as this summer, the lack of any cost reduction would lower our C2010 iPhone unit estimates by 8-14mln and GAAP EPS by $0.75-$1.00 (in-line with our bear case scenario). As we mention above, while gross margin and revenue growth in Apple’s core business are risks, significant drop-offs in these metrics are necessary to see downside to consensus CY10 estimates. Key catalysts: We view the EPS reacceleration, driven by refreshed iPhone products and a lower price point (likely announced around WWDC on 6/8/09) as the key catalyst for AAPL shares. We expect to see a meaningful uptick in earnings as early as the September 2009 quarter.

Valuation. We think Apple shares are fundamentally undervalued relative to our revised earnings and free cash flow expectations in CY09/CY10. Apple shares currently trade at 15x our CY09 Non GAAP EPS estimate of $8.25 and 14x our CY10 Non GAAP EPS estimate of $9.00, relative to its historical P/E range of 20-30x. We view non-GAAP EPS (GAAP, adjusted for iPhone shipments in the period) as the right metric for in-period earnings generation. Valuation is even more attractive on our $12.28 CY10 FCF estimate – at just 10x today. With an attractive valuation, $29B of cash, no debt and product cycle EPS growth over the next three years, we would be buyers of AAPL today and incrementally on any near term weakness. Our $180 price target is based on 20x our CY10 Non-GAAP EPS estimate of $9, the low end of its historic range. Multiple expansion possible as iPhone unit growth reaccelerates. We would argue that Apple’s P/E multiple could expand over time in light of two main factors. First, the iPhone market opportunity is multiples of Apple’s prior addressable markets (PC, MP3), suggesting revenue growth from this product category could surpass historical ranges and last for a longer period of time. Second, as Exhibit 5 shows, AAPL’s P/E multiple typically expands as revenue/unit growth of new products accelerate. While Apple’s P/E did expand around the launch and ship dates for the original iPod, the meaningful multiple expansion came months later, when unit growth accelerated.

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Exhibit 5

Exhibit 7

P/E Multiple Expansion Coincides with Unit Growth
FY2 Price/Earnings 90 80 70 60 50 40 30 20 10 0 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 iPod launch & ship iPod growth inflection point Average

Summary of Estimate Changes
Old C2009 Mac Revenue YoY Chg Units YoY Chg ASP YoY Chg iPhone Revenue, GAAP YoY Chg Non GAAP YoY Chg Units YoY Chg ASP YoY Chg iPod Revenue YoY Chg Units YoY Chg ASP YoY Chg GAAP Revenue YoY % Non GAAP Gross Margin Non GAAP GAAP EPS YoY % Non-GAAP EPS YoY % $ $ $12,143 -15% 9,715 -2% 1,250 -13% $7,389 162% 9,980 12% 17,543 28% 569 -13% New C2009 $12,143 -15% 9,715 -2% 1,250 -13% $8,226 192% 14,345 60% 24,830 82% 578 -12% % Diff 0% 0% 0% Old C2010 $12,724 5% 10,783 11% 1,180 -6% $9,825 33% 10,771 8% 22,500 28% 479 -16% New C2010 $12,229 1% 10,299 6% 1,187 -5% $14,313 74% 18,722 31% 36,212 46% 517 -11% % Diff -4% -4% 1%

iPhone launch & ship

11% 44% 42% 2%

46% 74% 61% 8%

Source: Morgan Stanley Research, Factset

Exhibit 6

On GAAP basis, we’re meaningfully above street starting in 1Q10; On Non GAAP basis, we’re likely well above starting in 3Q09
Morgan Stanley vs. Consensus GAAP EPS 2.50 2.30 2.10 1.90 1.70 1.50 1.30 1.10 0.90 0.70 0.50 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10
MS Consensus

$6,922 $7,334 -19% -14% 48,263 52,213 -13% -6% 143 140 -7% -9% $ 34,994 $ 36,270 6% 10% $ 37,584 $ 42,389 33.6% 34.4% 4.93 $ -8% 5.82 $ -26% 34.6% 38.1% 5.50 2% 8.25 5%

6% 8% -2% 4%

$5,128 $6,352 -26% -13% 37,000 47,400 -23% -9% 139 134 -3% -5% $ 37,914 $ 43,049 8% 19% $ 38,860 $ 47,459 34.2% 33.9% $ $ 5.52 $ 12% 5.67 $ -3% 37.2% 37.9% 7.50 36% 9.00 9%

24% 28% -3% 14%

104

294

12% 0% 42% 0%

36% 0% 59% 0%

Source: Morgan Stanley Research

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Debate 1: How Will an iPhone Price Cut & New Products Impact Demand?
Market View: Conservative. We believe the market
forecasts iPhone demand of approximately 18-20mln units in CY09 focusing mainly on macro drivers including handset/smartphone market growth/share rather than product cycles, price cuts and upgrades (bottom-up analysis).
Exhibit 8

Survey Suggests Elastic iPhone Demand
iPhone Price Elasticity 180% 160% 140% 124% 150% 161%

Our View: We see more than that. A bottom-up approach
to iPhone demand suggests material upside to expectations. We utilize our proprietary survey work along with an analysis of the iPhone 3G launch to forecast iPhone demand based on price cuts, upgrades and inventory builds. Our base case assumes the total cost of ownership (TCO) for the iPhone is reduced from current levels. At a minimum, we expect a price cut on the current generation iPhone to $99-$149 from $199 currently. The bottom line: we expect 24.8mn unit shipments in CY09 including a 2.0mn boost from price cuts, 3.1mn units from upgrades and 2.8mn units from an inventory build.

120% 100% 80% 60% 40% 20% 0% 250 200 150 100 50 0
Note: % increase in demand at various device costs Source: Morgan Stanley Research, AlphaWise

58% 19% 2%

We start with core demand. iPhone unit shipments have
been extremely volatile since the launch in June ’07, driven by inventory builds, new product introductions, price cuts, seasonality and expansion into new markets. The volatility in shipments has made it difficult to forecast quarterly demand and more importantly, to get a sense of what demand could potentially look like over the next 2-3 years given AAPL’s global handset market share of 1% in ‘08. Looking past all of this noise – removing inventory builds and focusing on trended shipment patterns – we believe core demand for iPhone units is currently running at a run rate of approximately 3.5mln units per quarter. We now consider the impact of a price cut, upgrades from the installed base and inventory builds. How Elastic is iPhone Demand? We approached this question from two angles, the first being our annual proprietary Apple survey of 2,500 consumers. In our Nov. ’08 survey, we asked respondents who were not “extremely interested” in purchasing an iPhone and cited cost as a gating factor: At what price would consumers be interested in purchasing an iPhone? According to our survey, there would be a 58% increase in demand for the phone at $150 and a 124% increase in demand at $100. Our second approach is the analysis of the iPhone 3G launch in July ’08, which we expect to be similar to the upcoming launch in terms price cuts and new products/functionality.

If we estimate core demand leading up to 3G launch and back out the inventory build in the quarter, we can get a sense of the boost in demand from the new product launch, price cut and upgrades. We believe that core demand leading up to the 3G launch was running at approximately 1.5mln units per quarter and we know that there was a 2mln inventory build. Therefore, we believe that demand initially increased by 200%+ relative to core demand heading into last year’s product launch (Exhibit 9). While the international expansion of the iPhone in 2H08 likely boosted demand during this period, we would note that the dynamics in the U.S. market followed a similar pattern as demand initially increased over 200% relative to our estimate of core demand. Both approaches yield a similar conclusion: iPhone demand is undeniably elastic and a doubling of demand again this year is possible. While hardware price cuts have been the sole source of cost reductions to date, we note that reductions to the service plan cost could potentially provide a significant stimulus given that the hardware only represents approximately 10% of the total cost of ownership. According to our proprietary survey, 35% of respondents said they would be more likely to purchase an iPhone at a lower service plan cost. Our Base case assumes that a price cut boosts core demand by 50% or 2mn units in CY09, vs. a 100% boost or 4mn units in our Bull case (similar to what we believe happened last year).

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Exhibit 9

Exhibit 10

July ’08 3G Launch Boosted Demand 200%+ Initially
iPhone 3G Case Study, millions 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 2Q08 3Q08 4Q08 1Q09
1,500 1,500 3,200 4,100 3,700 200%+ increase in demand
Price Cut/New Products/ Upgrade Core Demand Inventory Build

Growing Installed Base Drives Upgrades
iPhone Installed Base, millions 25 21 20 15 10 10 5 5 1 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09
Source: Morgan Stanley Research

18 14

6

3

Source: Morgan Stanley Research

Growing, loyal, installed base should make a larger dent this time around. At least part of the increase in demand following the 3G launch was due to 2G users upgrading to the 3G phone, and we expect upgrades to have a more meaningful impact on new product launches as the installed base of loyal iPhone users grows. To quantify the impact of upgrades from the installed base, we again turn to our Nov. ’08 survey, which suggests that approximately 15% of iPhone 2G subscribers upgraded to the 3G version in the first two quarters following the product launch, with about half coming in the first three months of the launch. We estimate that the installed base was roughly 6mln before the 3G launch and we expect the installed base to be approximately 21mln units at the end of 2Q09, a 250% increase. Upgrades from the existing installed base likely boosted shipments in 2H08 by approximately 900k. Applying a similar methodology to this product cycle leads to our base case expectation of 3.1mln upgrade units in 2H09 (15% of iPhone installed base upgrades to new version). Our Bull case assumes 20% upgrade, or an incremental 4.1mln units.

Inventory build also boosts growth early in product cycle. The 3G iPhone launch in 3Q08 came with a large 2mln inventory build as distribution of the phone expanded to over 50 countries and existing countries built inventory of the new phones. We expect an even larger inventory build this time around as the iPhone is currently in over 80 countries and unit sales per week are running at a higher rate. Our Base case assumes an inventory build of 2.8mln units (equivalent to 5.0 weeks of inventory, on par with the inventory build last year) and our Bull case assumes a build of 4mln units. All in, our base case expectations of unit shipments are materially higher than consensus. Putting all the pieces together, our base case assumes 9.9mln unit shipments in 3Q09 and 24.8mln for the full year ’09 vs. consensus of approximately 18-20mln units. For CY10, our base case assumes 36.2mln units which we believe is materially higher than market expectations. In terms of market share, on our revised numbers we estimate Apple will have 3% of the global handset market and 17% of the smartphone market in 2010, up from 1% and 10% respectively in 2008.

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Exhibit 11

Apple Handset Market Share Increases 3.6x by 2011
Apple Handset & Smartphone Marketshare 25% 20%
17% 19% 15%
Handsets Smartphone

15% 10% 5%
1% 2% 10%

3%

4%

0% 2008 2009 2010 2011
Source: Morgan Stanley Research, Gartner

Our bull case, assuming higher larger price cuts, upgrade rates and inventory builds, looks for 33mln units in CY09 and 58mln units in CY10. Other potential catalysts that are not explicitly in our bull base are: 1) The expansion into China and 2) the possibility of additional carriers in the US market in 2010/2011. In terms of potential unit demand in China, we believe that Apple will have to introduce a new product with a lower bill of materials to be competitive in the market where the average ARPU is approximately $10/month, the average handset selling price is quite low and most carriers don’t subsidize devices. Although the subscriber base in China is over 2x the U.S. market, we don’t expect a very meaningful unit opportunity near term (~1-2mln units in CY10 potentially). In terms of the opportunity to expand distribution to new carriers in the U.S. market, we think this is likely a late 2010/2011 event and could present a case for upside to our estimates.

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Debate 2: Is Gross Margin Guidance of “About 30%” Reasonable/Likely in 2H09?
Market View: The market is mixed on this debate and will
likely remain so until we move past the September quarter, which is the period management has highlighted as the “at risk” quarter for gross margins.
Exhibit 12

Need 17-22% Gross Margin for “Rest” of the Business in Order to Hit 30%
Gross Margin by Product 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%
3Q08
iPhone Mix

Our View: Unlikely. While we still view rising component
prices, currency and anticipated price cuts as headwinds to gross margins, we believe that the mix shift to higher margin iPhone revenue (currently ~15-20 pt gross margin premium) will more than offset these headwinds. iPhone Mix Shift Is Underappreciated. On a Non-GAAP basis, we expect the iPhone to reach close to 50% of gross profits over the next year, up from approximately 30% currently. An analysis of deferred revenue and costs associated with the iPhone suggests that the iPhone gross margin has been tracking in the 50-55% range over the last few quarters. This implies that the “remainder” of the business (Macs, iPod, etc) is currently at a gross margin of approximately 35%, 15-20 pts. below the iPhone. So, all else equal, what would need to happen to the “remainder” of the business for the total gross margin to equal 30% over the rest of year? Assuming the iPhone gross margin remains near 52.5% for the rest of the year, the gross margin for the “remainder” of the business would need to average 17.5% to get to a 30% consolidated gross margin. Taking a more conservative approach, if we assume that the iPhone gross margin drops 10 pts. to 45%, closer to the margin when the iPhone 3G was introduced, the “remainder” of the business would need to post a gross margin of 22% to get to a 30% consolidated margin. Despite the abovementioned gross margin headwinds, we think both of these scenarios are unlikely given that the gross margin of the “remainder” business has averaged 35% recently and the company’s CY01-CY06 gross margin average, before the iPhone was introduced, was 28% and never dropped below 26%.

45%

33%

37%

43%

80% 59%

4Q08

1Q09
Total

2Q09E
iPhone

3Q09E

4Q09E
Other

E = Morgan Stanley Research estimates

Source: Morgan Stanley Research

NAND Pricing = the Wild Card. While we believe that gross margins are unlikely to trend towards 30% in the near term due to this mix shift, we acknowledge the high correlation between NAND and Apple’s gross margin and the risk of further increases in NAND prices. NAND prices are up sharply since troughing in Dec ’08 and are now at levels, on a contract basis, that are commensurate with the months leading up to the 3G launch in the spring of ’08 (when iPhone gross margins were ~45%). We would note that NAND as a % of the bill of materials is far less for the iPhone vs. the iPod portfolio which would suggest the gross margin volatility as NAND prices move higher may not be as great as the margin upside when iPods were the core source of unit growth. We estimate that for 8GB version of the iPhone and iPod, NAND represents approximately 30% of the BoM for iPod vs. only 10% for the iPhone.
Exhibit 13

NAND Up Sharply Since Dec ’08 but Flattening
NAND Spot Price, 8GB 1Gbx8 12.0 10.0 8.0 6.0 4.0 2.0 0.0
Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Source: DRAM eXchange, Morgan Stanley Research

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Track Record of Conservatism on Gross Margins. Although the company understandably needs to point out both headwinds and tailwinds on gross margins, we point out that management has a history of conservatism on gross margins evidenced by the average gross margin beat of approximately 300bps since ’05.
Exhibit 14

History of Conservative Gross Margin Guidance
Gross Margin Guidance 600 500 400 300 200 100 0 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09
Actual vs. Guidance (bps) Average

Source: Company filings, Morgan Stanley Research

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Debate 3: Will Mac & iPod Fundamentals Derail the iPhone Story?
Market View: The market is broadly concerned about Apple’s lack of Macs priced below $1,000 and a maturing MP3 market. Our View: No. Mac/iPod weakness is factored into our estimates and we think the strength in the iPhone franchise will provide earnings growth in CY09/CY10, despite the lack of a “netbook”-priced Apple product. MacShare loss concerns overdone. While we factor Mac weakness into our estimates for CY09 and CY10, we think concerns surrounding the potential EPS impact of market share losses are largely overdone. The Mac business is global in nature, with approximately 50% of unit shipments and revenue coming from outside the U.S. Recent revenue and unit share losses have been U.S. centric, while Apple has actually gained revenue and unit share through 1Q09 outside of the U.S. While Apple lost 30 bps of revenue share YoY in the U.S., they gained 70bps of revenue share outside the U.S. in 1Q09, which actually boosted revenue share globally.
Exhibit 15 Exhibit 16

Int’l Shipments Provide Support to iPod Biz
iPod Unit Shipments by Geography 20% 15% 10% 5% 0% -5% -10% -15% -20%
1Q08
Total

2Q08

3Q08
Int'l

4Q08
U.S.

1Q09

Source: NPD, Morgan Stanley

Mac Share Losses Confined to U.S.
Mac Revenue Share by Geography 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0%
Mar-00 Jul-00 Nov-00 Mar-01 Jul-01 Nov-01 Mar-02 Jul-02 Nov-02 Mar-03 Jul-03 Nov-03 Mar-04 Jul-04 Nov-04 Mar-05 Jul-05 Nov-05 Mar-06 Jul-06 Nov-06 Mar-07 Jul-07 Nov-07 Mar-08 Jul-08 Nov-08 Mar-09

Even with Mac and iPod weakness, still see iPhone helping Apple beat the Street’s earnings estimates. We expect Mac revenue to fall 15% in CY09 and then rise only 1% in CY10, which could prove conservative. The brand still has the highest satisfaction ratings amongst PC vendors and a growing installed base of loyal users that will drive upgrades (with a potential catalyst coming later this year as the company launches its next OS, code named Snow Leopard). Near term, we acknowledge the headwinds, especially in the U.S. market, due to cyclical weakness and the growing pricing premium as well penetration rates at the high-end of the US consumer PC market. Longer term, we continue to believe that Apple will at least maintain share in consumer and potentially gain share in the enterprise PC market. On the iPod front, we expect revenue to fall 14% in CY09 followed by a 13% decline in CY10 as secular challenges hit the business.

Global

U.S.

Int'l

Source: IDC, Morgan Stanley Research

iPod Resilience. iPod shipments have been surprisingly resilient recently due to strong international growth and iPod Touch demand. While NPD data suggests that iPod unit shipments are down 10-15% in the U.S. over the last few months, this implies that international shipments have been rising 10-15%, likely due to market share gains. Longer term, we see headwinds for the iPod business as markets approach saturation and mobile devices converge.

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Mobile Internet is largest market opportunity we’ve seen in the history of Technology sector
• • • Global mobile subscribers exceed Internet users by > 2x As mobile Internet usage penetration increases, we expect mobile subscriber and Internet user figures to converge Smartphone users may rise 3x over 5 years – to ~1B, up from 288MM in 2008E
Internet Users – 1.6B 2008
ROW 6% North America 17%

Mobile Subscribers – 4.1B 2008
North America 7% Europe 22%

Latin America 10%

ROW 13% Latin America 11%

Europe 22% Asia Pacific 45%

Asia Pacific 46%

Note: ROW = Rest of World; Source: ITU, Morgan Stanley Research

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Apple emerging as the clear leader of the mobile Internet
Worldwide Mobile Internet Usage Share by Opearting Systems, 4/08 - 3/09
100%
5% 20% 6% 13% 11% 4% 1% 5% 10% 13% 3% 3% 6% 11%

80%

60%

25%

20%

38%

5%

40%
64%

20%

43%

49% 37%

0% 4/08 5/08 Symbian 6/08 7/08 8/08 RIM 9/08 10/08 11/08 Palm 12/08 1/09 2/09 Android 3/09

iPhone

Windows

Hiptop

Note: Usage share represents % of total ad requests coming from the operating system, data may not be representative. Source: AdMob, 3/09.

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Apple changing behavior of mobile device users
Daily Usage Breakdown, % of Time Spent on Each Activities Average U.S. Cell Phone User 40 Minutes Per Day Internet - 3% Other - 3% Games - 3% Music - 2% E-Mail - 4% iPhone User 60 Minutes Per Day Other - 3% Internet 9% Games 8% SMS - 15% Voice Call 70% Music 10% E-Mail 12% SMS 14% Voice Call 45%

Note: CTIA estimates average voice call time per day is 27 minutes, assuming 70% of total time spent is on voice call, per iSuppli, total average time spent on cell phone is approx. 40 minutes per day. iPhone time spent per day is our estimates. Source: iSuppli ConsumerTrak survey, 10/08, Morgan Stanley Research.

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Apple changing behavior of mobile device users
iPhone Ecosystem – Subscribers, Apps Available & Downloads, 6/07 – 3/09
25 21 Global iPhone Subscribers (MM) 20 17 15 13 10,000 1,000,000 Applications Available & Cumulative Downloads Log Scale (000)

100,000

1,000

10 6

100

5 5 1 0 0 6/07 9/07 4

10

1

0 12/07 3/08 6/08 9/08 Global iPhone Subscribers (MM) iPhone Applications Available (000) Cumulative Application Downloads (000) 12/08 3/09

Source: Apple, Morgan Stanley Research.

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Apple will move down the cost curve to drive demand
Hypothetical iPhone Pricing Points & Number of Survey Respondents Showing "Extreme Interests" in the iPhone 3G, 11/08
iPhone Price Elasticity

180% 161% 160% 140% 124% 120% 100% 80% 60% 40% 20% 0% 150 100 50 0 58% 150%

Note: From Morgan Stanley’s 11/08 survey of 802 U.S. consumers. Source: Morgan Stanley Research.

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Component cost reductions help maintain margin profile
Component 8GB NAND Storage LCD Display Baseband Chip (1) Application Processor 2 MP Camera Module SDRAM Wi-Fi Chipset Lithium-Ion Battery RF Transceiver Accelerometer Charger Bluetooth Chip Other Total Bill-of-Material Costs iPhone 2.5G (6/07) $70 34 11 19 11 11 15 12 5 2 2 4 61 $256 iPhone 3G (6/08) $23 20 15 14 7 5 4 4 4 2 2 2 72 $173 % Change -67% -40 33 -27 -36 -54 -74 -67 -10 -11 -18 -47 17 -33%

Note: (1) Baseband chip cost increased 33% due to iPhone 3G’s use of HSDPA (3G)-capable chip vs. original iPhone’s EDGE (2.5G) baseband chip. Source: iSuppli.

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Exhibit 17

Apple Income Statement
($ in millions) Revenues Consumer Revenue Professional Revenue iPod, iPhone, and Related Revenue Other Hardware and iTunes iPod iPhone Software, Service & Other Revenue Non-GAAP Revenue Cost of Sales Non-GAAP Cost of Sales Gross Profit Gross Margin Non-GAAP Gross Profit Non-GAAP Gross Margin Operating Expenses Research and Development Selling, General and Administrative Operating Income PTOP Margin Non-GAAP Operating Income Non-GAAP PTOP Margin Total Interest & Other Income Pretax Income GAAP Income Tax Provision Operating Tax Provision (excl one time tax eff Effective Tax Rate Operating Net Income Operating Net Income Margin Total Non-recurring Charges Non-GAAP Pretax Income Non-GAAP Income Tax Provision Non-GAAP Operating Net Income Non-GAAP Operating Net Income Margin GAAP Net Income Fully-diluted EPS EPS - ModelWare EPS - Reported EPS - ModelWare excl. Stock Option Expe EPS - Non-GAAP Period Ending Outstanding Shares Avg Shares (Basic) Avg Shares (Fully Diluted) Dec-07 9,608 2,557 994 5,428 1,190 3,997 241 628 10,568 6,276 6,781 3,332 34.7% 3,787 35.8% 1,206 246 960 2,126 22.1% 2,581 24.4% 200 2,326 745 745 32.0% 1,581 16.5% 2,781 891 1,890 17.9% 1,581 2008A Mar-08 Jun-08 7,512 2,087 1,406 3,489 1,293 1,818 378 529 8,114 5,038 5,341 2,474 32.9% 2,773 34.2% 1,159 273 886 1,315 17.5% 1,614 19.9% 162 1,477 432 432 29.2% 1,045 13.9% 1,776 520 1,257 15.5% 1,045 7,435 2,076 1,534 3,324 1,256 1,678 390 501 7,542 4,846 4,887 2,589 34.8% 2,654 35.2% 1,208 292 916 1,381 18.6% 1,446 19.2% 118 1,499 438 438 29.2% 1,061 14.3% 1,564 457 1,107 14.7% 1,061 Sep-08 7,895 2,115 1,505 3,726 1,260 1,660 806 549 11,682 5,156 7,131 2,739 34.7% 4,551 39.0% 1,297 298 999 1,442 18.3% 3,254 27.9% 140 1,582 446 446 28.2% 1,136 14.4% 3,394 957 2,437 20.9% 1,136 Dec-08 10,167 2,612 942 6,007 1,389 3,371 1,247 606 11,799 6,635 7,272 3,532 34.7% 4,527 38.4% 1,406 315 1,091 2,126 20.9% 3,121 26.5% 158 2,284 679 679 29.7% 1,605 15.8% 3,279 975 2,304 19.5% 1,605 2009E Mar-09 Jun-09 8,164 1,792 1,153 4,593 1,407 1,665 1,521 625 9,057 5,193 5,433 2,971 36.4% 3,624 40.0% 1,304 319 985 1,667 20.4% 2,320 25.6% 63 1,730 525 525 30.3% 1,205 14.8% 2,383 723 1,660 18.3% 1,205 8,180 1,781 1,163 4,642 1,458 1,441 1,742 595 8,533 5,408 5,505 2,772 33.9% 3,028 35.5% 1,333 327 1,006 1,439 17.6% 1,694 19.9% 58 1,497 464 464 31.0% 1,033 12.6% 1,752 543 1,209 14.2% 1,033 Sep-09 8,944 1,906 1,151 5,244 1,488 1,524 2,231 644 12,356 5,938 7,499 3,006 33.6% 4,857 39.3% 1,476 358 1,118 1,531 17.1% 3,381 27.4% 74 1,604 497 497 31.0% 1,107 12.4% 3,455 1,071 2,384 19.3% 1,107 Dec-09 10,982 2,401 796 7,057 1,623 2,704 2,731 727 12,444 7,173 7,803 3,809 34.7% 4,641 37.3% 1,537 340 1,197 2,272 20.7% 3,103 24.9% 91 2,362 732 732 31.0% 1,630 14.8% 3,194 990 2,204 17.7% 1,630 2010E Mar-10 Jun-10 9,737 1,761 1,048 6,157 1,687 1,379 3,091 770 10,363 6,162 6,424 3,575 36.7% 3,938 38.0% 1,538 370 1,168 2,037 20.9% 2,400 23.2% 97 2,134 662 662 31.0% 1,473 15.1% 2,498 774 1,723 16.6% 1,473 10,178 1,786 1,150 6,520 1,744 1,312 3,464 722 10,154 6,367 6,428 3,812 37.4% 3,726 36.7% 1,629 397 1,232 2,183 21.4% 2,097 20.7% 138 2,321 720 720 31.0% 1,602 15.7% 2,235 693 1,542 15.2% 1,602 Sep-10 10,698 1,898 1,183 6,830 1,779 1,331 3,720 787 13,844 6,665 8,338 4,033 37.7% 5,506 39.8% 1,733 417 1,316 2,300 21.5% 3,773 27.3% 148 2,448 759 759 31.0% 1,689 15.8% 3,921 1,216 2,706 19.5% 1,689 2007A 24,006 6,206 4,108 12,184 3,756 8,305 123 1,508 24,694 15,852 16,232 8,155 34.0% 8,463 34.3% 3,745 782 2,963 4,410 18.4% 4,718 19.1% 599 5,009 1,512 1,580 31.5% 3,429 14.3% 67 5,317 1,678 3,638 14.7% 3,496 Fiscal Year 2008A 2009E 32,450 8,835 5,440 15,968 4,999 9,153 1,815 2,207 37,906 21,316 24,140 11,134 34.3% 13,766 36.3% 4,870 1,109 3,761 6,264 19.3% 8,896 23.5% 620 6,884 2,061 2,061 29.9% 4,823 14.9% 9,516 2,824 6,692 17.7% 4,823 35,455 8,091 4,409 20,486 5,742 8,002 6,741 2,470 41,745 23,174 25,709 12,282 34.6% 16,035 38.4% 5,519 1,319 4,200 6,762 19.1% 10,516 25.2% 352 7,115 2,165 2,165 30.4% 4,950 14.0% 10,869 3,312 7,557 18.1% 4,950 2010E 41,595 7,846 4,177 26,565 6,833 6,726 13,006 3,006 46,805 26,366 28,994 15,229 36.6% 17,811 38.1% 6,437 1,525 4,913 8,791 21.1% 11,374 24.3% 475 9,266 2,872 2,872 31.0% 6,393 15.4% 11,848 3,673 8,175 17.5% 6,393 2011E 49,006 8,954 4,643 31,592 7,758 6,179 17,655 3,817 52,916 30,438 33,093 18,568 37.9% 19,823 37.5% 7,569 1,763 5,806 10,999 22.4% 12,254 23.2% 779 11,778 3,651 3,651 31.0% 8,127 16.6% 13,033 4,040 8,993 17.0% 8,127 2012E 56,318 10,758 5,213 35,410 9,360 4,185 21,864 4,938 59,926 34,917 37,252 21,401 38.0% 22,674 37.8% 8,360 1,857 6,503 13,041 23.2% 14,314 23.9% 987 14,027 4,349 4,349 31.0% 9,679 17.2% 15,301 4,743 10,558 17.6% 9,679 2013E 64,261 12,082 5,492 40,727 10,062 4,409 26,256 5,960 67,208 39,240 41,859 25,021 38.9% 25,349 37.7% 8,611 1,928 6,683 16,410 25.5% 16,738 24.9% 2,970 19,380 6,008 6,008 31.0% 13,372 20.8% 19,708 6,109 13,598 20.2% 13,372

$1.76 $1.76 $1.84 $2.10 878.9 875.9 900.1

$1.16 $1.16 $1.27 $1.40 881.6 879.5 899.3

$1.18 $1.18 $1.28 $1.23 885.7 883.7 903.2

$1.26 $1.26 $1.37 $2.69 888.3 887.1 904.8

$1.78 $1.78 $1.91 $2.56 890.6 889.1 901.5

$1.33 $1.33 $1.43 $1.84 892.1 891.2 903.0

$1.14 $1.14 $1.24 $1.34 893.5 892.0 903.0

$1.22 $1.22 $1.33 $2.64 896.7 895.1 904.6

$1.80 $1.80 $1.92 $2.44 899.2 898.0 905.1

$1.62 $1.62 $1.73 $1.90 902.2 900.7 907.8

$1.76 $1.76 $1.87 $1.69 905.2 903.7 910.6

$1.85 $1.85 $1.97 $2.96 908.0 906.6 913.2

$3.86 $3.93 $4.05 $4.09 872.3 864.6 889.3

$5.35 $5.35 $5.75 $7.42 888.3 881.6 902.1

$5.48 $5.48 $5.92 $8.37 896.7 891.9 903.0

$7.03 $7.03 $7.49 $8.99 908.0 902.2 909.2

$8.83 $8.83 $9.31 $9.77 919.3 913.6 920.7

$10.39 $10.39 $10.93 $11.33 929.9 924.6 931.6

$14.29 $14.29 $14.64 $14.53 935.5 933.8 935.6

Source: Morgan Stanley Research

A = Actual, E = Morgan Stanley Research estimates

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Exhibit 18

Apple Margin Analysis
($ in millions) Margin Analysis Gross Margin Consumer Revenue Professional Revenue iPod, iPhone, and Related Revenue Software, Service & Other Revenue R&D SG&A Operating Expenses EBITDA Margin PTOP Margin Pretax Margin Net Income Year-Over-Year Growth (%) Revenue Consumer Revenue Professional Revenue iPod, iPhone, and Related Revenue Other Hardware & iTunes iPod iPhone Software, Service & Other Revenue Gross Margin Consumer Revenue Professional Revenue iPod, iPhone, and Related Revenue Software, Service & Other Revenue R&D SG&A Operating Expenses PTOP Margin Pretax Margin Net Income ModelWare EPS Sequential Growth (%) Revenue Consumer Revenue Professional Revenue iPod, iPhone, and Related Revenue Software, Service & Other Revenue Gross Margin Consumer Revenue Professional Revenue iPod, iPhone, and Related Revenue Software, Service & Other Revenue R&D SG&A Operating Expenses PTOP Margin Pretax Margin Net Income ModelWare EPS Revenue Mix Consumer Revenue Professional Revenue iPod, iPhone, and Related Revenue Software, Service & Other Revenue Dec-07 34.7% 37.9% 37.6% 30.6% 52.0% 2.6% 10.0% 12.6% 23.2% 22.1% 24.2% 16.5% 35% 52% 37% 25% 28% 17% NM 81% 50% 66% 50% 38% 81% 34% 34% 34% 61% 61% 57% 54% 55% 41% -23% 102% 46% 59% 61% -21% 110% 46% 19% 17% 17% 100% 89% 89% 88% 27% 10% 56% 7% 2008A Mar-08 Jun-08 32.9% 33.2% 34.0% 29.8% 50.0% 3.6% 11.8% 15.4% 19.0% 17.5% 19.7% 13.9% 43% 56% 52% 32% 34% 8% NM 53% 34% 44% 36% 24% 47% 49% 30% 34% 33% 30% 36% 34% -22% -18% 41% -36% -16% -26% -28% 28% -38% -19% 11% -8% -4% -38% -36% -34% -34% 28% 19% 46% 7% 34.8% 37.1% 37.9% 29.6% 51.0% 3.9% 12.3% 16.2% 20.2% 18.6% 20.2% 14.3% 37% 51% 32% 33% 37% 7% 7700% 30% 30% 49% 26% 21% 25% 40% 23% 27% 33% 25% 30% 28% -1% -1% 9% -5% -5% 5% 11% 22% -5% -3% 7% 3% 4% 5% 2% 2% 1% 28% 21% 45% 7% Sep-08 34.7% 35.9% 37.0% 30.7% 51.0% 3.8% 12.7% 16.4% 20.0% 18.3% 20.0% 14.4% 27% 17% 16% 39% 33% 3% 583% 28% 31% 26% 17% 45% 25% 44% 21% 26% 36% 29% 36% 34% 6% 2% -2% 12% 10% 6% -1% -4% 16% 10% 2% 9% 7% 4% 6% 7% 7% 27% 19% 47% 7% Dec-08 34.7% 32.7% 33.9% 34.0% 52.0% 3.1% 10.7% 13.8% 22.5% 20.9% 22.5% 15.8% 6% 2% -5% 11% 17% -16% 417% -4% 6% -12% -15% 23% -4% 28% 14% 17% 0% -2% 2% 1% 29% 24% -37% 61% 10% 29% 12% -43% 79% 13% 6% 9% 8% 47% 44% 41% 42% 26% 9% 59% 6% 2009E Mar-09 Jun-09 36.4% 32.0% 34.1% 36.5% 52.0% 3.9% 12.1% 16.0% 22.5% 20.4% 21.2% 14.8% 9% -14% -18% 32% 9% -8% 303% 18% 20% -17% -18% 62% 23% 17% 11% 13% 27% 17% 15% 15% -20% -31% 22% -24% 3% -16% -33% 23% -18% 3% 1% -10% -7% -22% -24% -25% -25% 22% 14% 56% 8% 33.9% 29.0% 30.0% 35.0% 47.5% 4.0% 12.3% 16.3% 19.9% 17.6% 18.3% 12.6% 10% -14% 40% 16% -14% 347% 19% 7% -33% -40% 65% 11% 12% 10% 10% 4% 0% -3% -3% 0% -1% 1% 1% -5% -7% -10% -11% -3% -13% 3% 2% 2% -14% -13% -14% -14% 22% 14% 57% 7% Sep-09 33.6% 27.6% 27.0% 35.7% 46.0% 4.0% 12.5% 16.5% 19.4% 17.1% 17.9% 12.4% 13% -10% -24% 41% 18% -8% 177% 17% 10% -31% -44% 64% 6% 20% 12% 14% 6% 1% -3% -3% 9% 7% -1% 13% 8% 8% 2% -11% 15% 5% 9% 11% 11% 6% 7% 7% 7% 21% 13% 59% 7% Dec-09 34.7% 30.0% 29.4% 35.3% 50.0% 3.1% 10.9% 14.0% 22.6% 20.7% 21.5% 14.8% 8% -8% -15% 17% 17% -20% 119% 20% 8% -16% -27% 22% 15% 8% 10% 9% 7% 3% 2% 1% 23% 26% -31% 35% 13% 27% 37% -25% 33% 23% -5% 7% 4% 48% 47% 47% 47% 22% 7% 64% 7% 2010E Mar-10 Jun-10 36.7% 28.0% 28.8% 39.1% 48.0% 3.8% 12.0% 15.8% 23.3% 20.9% 21.9% 15.1% 19% -2% -9% 34% 20% -17% 103% 23% 20% -14% -23% 44% 14% 16% 19% 18% 22% 23% 22% 22% -11% -27% 32% -13% 6% -6% -32% 29% -3% 2% 9% -2% 0% -10% -10% -10% -10% 18% 11% 63% 8% 37.4% 28.7% 29.0% 40.2% 48.0% 3.9% 12.1% 16.0% 23.8% 21.4% 22.8% 15.7% 24% 0% -1% 40% 20% -9% 99% 21% 37% -1% -4% 61% 23% 21% 22% 22% 52% 55% 55% 54% 5% 1% 10% 6% -6% 7% 4% 10% 9% -6% 7% 5% 6% 7% 9% 9% 8% 18% 11% 64% 7% Sep-10 37.7% 29.0% 29.0% 40.4% 48.0% 3.9% 12.3% 16.2% 23.9% 21.5% 22.9% 15.8% 20% 0% 3% 30% 20% -13% 67% 22% 34% 5% 10% 47% 27% 17% 18% 17% 50% 53% 53% 51% 5% 6% 3% 5% 9% 6% 7% 3% 5% 9% 5% 7% 6% 5% 5% 5% 5% 18% 11% 64% 7% 26% 17% 51% 6% 27% 17% 49% 7% 23% 12% 58% 7% 19% 10% 64% 7% 18% 9% 64% 8% 19% 9% 63% 9% 19% 9% 63% 9% 2007A 34.0% 35.2% 37.4% 30.0% 52.3% 3.3% 12.3% 15.6% 19.7% 18.4% 20.9% 14.3% 24% 45% 33% 14% 26% 8% NM 18% 46% 64% 60% 37% 22% 10% 22% 19% 80% 78% 80% 77% Fiscal Year 2008A 2009E 34.3% 36.1% 36.6% 30.2% 51.0% 3.4% 11.6% 15.0% 20.8% 19.3% 21.2% 14.9% 35% 42% 32% 31% 33% 10% 1376% 46% 37% 46% 30% 32% 43% 42% 27% 30% 42% 37% 41% 39% 34.6% 30.5% 31.1% 35.2% 49.4% 3.7% 11.8% 15.6% 21.1% 19.1% 20.1% 14.0% 9% -8% -19% 28% 15% -13% 271% 12% 10% -23% -31% 50% 8% 19% 12% 13% 8% 3% 3% 3% 2010E 36.6% 29.0% 29.0% 38.7% 48.5% 3.7% 11.8% 15.5% 23.4% 21.1% 22.3% 15.4% 17% -3% -5% 30% 19% -16% 93% 22% 24% -8% -12% 42% 20% 16% 17% 17% 30% 30% 29% 28% 2011E 37.9% 29.0% 29.0% 40.5% 48.0% 3.6% 11.8% 15.4% 24.0% 22.4% 24.0% 16.6% 18% 14% 11% 19% 14% -8% 36% 27% 22% 14% 11% 24% 26% 16% 18% 18% 25% 27% 27% 26% 2012E 38.0% 29.0% 29.0% 40.7% 48.0% 3.3% 11.5% 14.8% 24.8% 23.2% 24.9% 17.2% 15% 20% 12% 12% 21% -32% 24% 29% 15% 20% 12% 13% 29% 5% 12% 10% 19% 19% 19% 18% 2013E 38.9% 37.1% 37.0% 37.8% 52.0% 3.0% 10.4% 13.4% 27.1% 25.5% 30.2% 20.8% 14% 12% 5% 15% 8% 5% 20% 21% 17% 44% 34% 7% 31% 4% 3% 3% 26% 38% 38% 38%

Source: Morgan Stanley

A = Actual, E = Morgan Stanley Research estimates

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Morgan Stanley ModelWare is a proprietary analytic framework that helps clients uncover value, adjusting for distortions and ambiguities created by local accounting regulations. For example, ModelWare EPS adjusts for one-time events, capitalizes operating leases (where their use is significant), and converts inventory from LIFO costing to a FIFO basis. ModelWare also emphasizes the separation of operating performance of a company from its financing for a more complete view of how a company generates earnings.

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The information and opinions in Morgan Stanley Research were prepared by Morgan Stanley & Co. Incorporated, and/or Morgan Stanley C.T.V.M. S.A. and their affiliates (collectively, "Morgan Stanley"). For important disclosures, stock price charts and rating histories regarding companies that are the subject of this report, please see the Morgan Stanley Research Disclosure Website at www.morganstanley.com/researchdisclosures, or contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Equity Research Management), New York, NY, 10036 USA. The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Kathryn Huberty. Unless otherwise stated, the individuals listed on the cover page of this report are research analysts.

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Morgan Stanley Research has been published in accordance with our conflict management policy, which is available at www.morganstanley.com/institutional/research/conflictpolicies. The following analyst, strategist, or research associate (or a household member) owns securities (or related derivatives) in a company that he or she covers or recommends in Morgan Stanley Research: Mathew Schneider - Hewlett-Packard (common stock). Morgan Stanley policy prohibits research analysts, strategists and research associates from investing in securities in their sub industry as defined by the Global Industry Classification Standard ("GICS," which was developed by and is the exclusive property of MSCI and S&P). Analysts may nevertheless own such securities to the extent acquired under a prior policy or in a merger, fund distribution or other involuntary acquisition. As of April 30, 2009, Morgan Stanley beneficially owned 1% or more of a class of common equity securities of the following companies covered in Morgan Stanley Research: Apple, Inc., DELL, Lexmark International, NetApp Inc, QLogic Corporation, Sun Microsystems, Teradata. As of April 30, 2009, Morgan Stanley held a net long or short position of US$1 million or more of the debt securities of the following issuers covered in Morgan Stanley Research (including where guarantor of the securities): Brocade Communications Systems, DELL, EMC Corp., Hewlett-Packard, IBM, Lexmark International, NetApp Inc, Seagate Technology, Sun Microsystems. Within the last 12 months, Morgan Stanley managed or co-managed a public offering of securities of DELL, Hewlett-Packard, IBM, NetApp Inc, Seagate Technology. Within the last 12 months, Morgan Stanley has received compensation for investment banking services from Brocade Communications Systems, Compellent Technologies, Inc., Data Domain Inc., DELL, EMC Corp., Hewlett-Packard, IBM, NetApp Inc, Seagate Technology. In the next 3 months, Morgan Stanley expects to receive or intends to seek compensation for investment banking services from Apple, Inc., Brocade Communications Systems, Compellent Technologies, Inc., Data Domain Inc., DELL, EMC Corp., Hewlett-Packard, IBM, Isilon Systems, Inc., Lexmark International, NCR Corp., NetApp Inc, Netezza Corporation, QLogic Corporation, Seagate Technology, Sun Microsystems. Within the last 12 months, Morgan Stanley & Co. Incorporated has received compensation for products and services other than investment banking services from Apple, Inc., Brocade Communications Systems, Hewlett-Packard, IBM, Seagate Technology. Within the last 12 months, Morgan Stanley has provided or is providing investment banking services to, or has an investment banking client relationship with, the following company: Apple, Inc., Brocade Communications Systems, Compellent Technologies, Inc., Data Domain Inc., DELL, EMC Corp., Hewlett-Packard, IBM, Isilon Systems, Inc., Lexmark International, NCR Corp., NetApp Inc, Netezza Corporation, QLogic Corporation, Seagate Technology, Sun Microsystems. Within the last 12 months, Morgan Stanley has either provided or is providing non-investment banking, securities-related services to and/or in the past has entered into an agreement to provide services or has a client relationship with the following company: Apple, Inc., Brocade Communications Systems, DELL, EMC Corp., Hewlett-Packard, IBM, NCR Corp., NetApp Inc, QLogic Corporation, Seagate Technology, Sun Microsystems. Within the last 12 months, Morgan Stanley has either provided or is providing non-securities related services to and/or in the past has entered into an agreement to provide services or has a client relationship with the following company: Brocade Communications Systems. The research analysts, strategists, or research associates principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues. Morgan Stanley & Co. Incorporated makes a market in the securities of Apple, Inc., Brocade Communications Systems, Data Domain Inc., DELL, EMC Corp., Hewlett-Packard, IBM, Isilon Systems, Inc., Lexmark International, NCR Corp., NetApp Inc, QLogic Corporation, Seagate Technology, Sun Microsystems, Teradata, Western Digital. Certain disclosures listed above are also for compliance with applicable regulations in non-US jurisdictions.

Important US Regulatory Disclosures on Subject Companies

STOCK RATINGS
Morgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight, Not-Rated or Underweight (see definitions below). Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold and sell. Investors should carefully read the definitions of all ratings used in Morgan Stanley Research. In addition, since Morgan Stanley Research contains more complete information concerning the analyst's views, investors should carefully read Morgan Stanley Research, in its entirety, and not infer the contents from the rating alone. In any case, ratings (or research) should not be used or relied upon as investment advice. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations.

Global Stock Ratings Distribution
(as of April 30, 2009)

For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sell alongside our ratings of Overweight, Equal-weight, Not-Rated and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold, and sell but represent recommended relative weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy recommendation; we correspond Equal-weight and Not-Rated to hold and Underweight to sell recommendations, respectively.

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Stock Rating Category

Coverage Universe Investment Banking Clients (IBC) % of % of % of Rating Total Count Count Total IBC Category

Overweight/Buy Equal-weight/Hold Not-Rated/Hold Underweight/Sell Total

668 1005 33 517 2,223

30% 45% 1% 23%

205 272 8 108 593

35% 46% 1% 18%

31% 27% 24% 21%

Data include common stock and ADRs currently assigned ratings. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations. Investment Banking Clients are companies from whom Morgan Stanley or an affiliate received investment banking compensation in the last 12 months.

Analyst Stock Ratings
Overweight (O). The stock's total return is expected to exceed the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Equal-weight (E). The stock's total return is expected to be in line with the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Not-Rated (NR). Currently the analyst does not have adequate conviction about the stock's total return relative to the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Underweight (U). The stock's total return is expected to be below the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months.

Analyst Industry Views
Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be attractive vs. the relevant broad market benchmark, as indicated below. In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevant broad market benchmark, as indicated below. Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevant broad market benchmark, as indicated below. Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index; Europe - MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index.
.

Other Important Disclosures
Morgan Stanley produces a research product called a "Tactical Idea." Views contained in a "Tactical Idea" on a particular stock may be contrary to the recommendations or views expressed in this or other research on the same stock. This may be the result of differing time horizons, methodologies, market events, or other factors. For all research available on a particular stock, please contact your sales representative or go to Client Link at www.morganstanley.com. For a discussion, if applicable, of the valuation methods used to determine the price targets included in this summary and the risks related to achieving these targets, please refer to the latest relevant published research on these stocks. Morgan Stanley Research does not provide individually tailored investment advice. Morgan Stanley Research has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The securities/instruments discussed in Morgan Stanley Research may not be suitable for all investors. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. The securities, instruments, or strategies discussed in Morgan Stanley Research may not be suitable for all investors, and certain investors may not be eligible to purchase or participate in some or all of them. Morgan Stanley Research is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. The "Important US Regulatory Disclosures on Subject Companies" section in Morgan Stanley Research lists all companies mentioned where Morgan Stanley owns 1% or more of a class of common securities of the companies. For all other companies mentioned in Morgan Stanley Research, Morgan Stanley may have an investment of less than 1% in securities or derivatives of securities of companies and may trade them in ways different from those discussed in Morgan Stanley Research. Employees of Morgan Stanley not involved in the preparation of Morgan Stanley Research may have investments in securities or derivatives of securities of companies mentioned and may trade them in ways different from those discussed in Morgan Stanley Research. Derivatives may be issued by Morgan Stanley or associated persons Morgan Stanley and its affiliate companies do business that relates to companies/instruments covered in Morgan Stanley Research, including market making and specialized trading, risk arbitrage and other proprietary trading, fund management, commercial banking, extension of credit, investment services and investment banking. Morgan Stanley sells to and buys from customers the securities/instruments of companies covered in Morgan Stanley Research on a principal basis. With the exception of information regarding Morgan Stanley, research prepared by Morgan Stanley Research personnel are based on public information. Morgan Stanley makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete. We have no obligation to tell you when opinions or information in Morgan Stanley Research change apart from when we intend to discontinue research coverage of a subject company. Facts and views presented in Morgan Stanley Research have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business areas, including investment banking personnel. Morgan Stanley Research personnel conduct site visits from time to time but are prohibited from accepting payment or reimbursement by the company of travel expenses for such visits. The value of and income from your investments may vary because of changes in interest rates or foreign exchange rates, securities prices or market indexes, operational or financial conditions of companies or other factors. There may be time limitations on the exercise of options or other rights in your securities transactions. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized. Unless otherwise stated, the cover page provides the closing price on the primary exchange for the subject company's securities/instruments. To our readers in Taiwan: Information on securities/instruments that trade in Taiwan is distributed by Morgan Stanley Taiwan Limited ("MSTL"). Such information is for your reference only. Information on any securities/instruments issued by a company owned by the government of or incorporated in the PRC and listed in on the Stock Exchange of Hong Kong ("SEHK"), namely the H-shares, including the component company stocks of the Stock Exchange of Hong Kong ("SEHK")'s Hang Seng China Enterprise Index; or any securities/instruments issued by a company that is 30% or more directly- or indirectly-owned by the government of or a company incorporated in the PRC and traded on an exchange in Hong Kong or Macau, namely SEHK's Red Chip shares, including the component company of the SEHK's China-affiliated Corp Index is distributed only to Taiwan Securities Investment Trust Enterprises ("SITE"). The reader should independently evaluate the investment risks and is solely responsible for their investment decisions. Morgan Stanley Research may not be distributed to the public media or quoted or used by the public media without the express written consent of Morgan Stanley. 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Additional information on recommended securities/instruments is available on request.

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Industry Coverage:Systems and PC Hardware
Company (Ticker) Kathryn Huberty, CFA Apple, Inc. (AAPL.O) Brocade Communications Systems (BRCD.O) Compellent Technologies, Inc. (CML.N) DELL (DELL.O) Data Domain Inc. (DDUP.O) EMC Corp. (EMC.N) Hewlett-Packard (HPQ.N) IBM (IBM.N) Isilon Systems, Inc. (ISLN.O) Lexmark International (LXK.N) NCR Corp. (NCR.N) NetApp Inc (NTAP.O) Netezza Corporation (NZ.N) QLogic Corporation (QLGC.O) Seagate Technology (STX.O) Sun Microsystems (JAVA.O) Teradata (TDC.N) Western Digital (WDC.N) Rating (as of) Price (05/22/2009)

O (05/26/2009) E (05/04/2009) E (11/19/2007) O (05/23/2008) E (02/01/2008) O (03/29/2005) O (11/16/2007) O (07/13/2004) E (11/16/2007) U (10/07/2005) E (03/12/2004) U (07/17/2006) O (10/22/2007) U (05/04/2009) E (10/07/2008) U (05/23/2008) O (05/04/2009) U (10/07/2008)

$122.5 $7.15 $10.62 $10.85 $24.31 $11.61 $34.14 $101.89 $2.81 $15.8 $10.5 $18.46 $7.37 $13.65 $8.44 $9 $21.07 $24.48

Stock Ratings are subject to change. Please see latest research for each company.

© 2009 Morgan Stanley


				
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