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Apple Wins in Italy

Zacks Equity Research

Apple Inc. (AAPL) recently scored another legal victory over its arch rival Samsung Electronics Co., after a Milan court rejected the Korean company’s bid to ban the iPhone 4S sales in Italy. Apple seemed to be having a favourable run as this is Apple’s second victory in consecutive months. Just last month, Samsung had failed to block iPhone 4S sales in France.

Apple and Samsung have been at loggerheads since April last year, suing each other over more than 30 patents across four continents. Apple’s lawsuits are mainly targeted at design-related issues, while Samsung’s lawsuits primarily focus on technology patents. Specifically, in both the cases (Italy and France) Samsung's complaint focused on two patent infringements related to wireless telecommunications technology, or Wideband Code Division Multiple Access (:WCDMA) standards for 3G mobile handsets.

We believe that these victories are important for Apple due to the fact that iPhone is its best selling device to date. Moreover, it has also been a major revenue contributor for the company over the last few years. Apple surely will be cheering its recent victories, as a temporary ban on the latest iPhone sales would not only have resulted in significant revenue loss, but would have also hurt Apple’s reputation.

Over the last 12 months, Apple has been highly vocal about saving its intellectual property from misuse and violations. The company has been aggressive in filing lawsuits against other handset makers such as Samsung and HTC, in order to protect its patents. Apple has accused these manufacturers of not only blatantly copying its iPhone and iPad designs, but also its technology. In such a scenario, an injunction against Apple on the ground of violation of technology patents would not only have hurt customer sentiments, but would also have made it difficult for Apple to justify its own patent infringement claims in other lawsuits.

Nonetheless, Apple still has some things to worry about, because despite the fact that the temporary bans were rejected, the French court allowed Samsung’s infringement lawsuits to continue. However, Apple is expected to report robust growth in the fourth quarter, driven by the strong holiday season sales of iPhone 4S and iPad. Apple is also increasing its penetration in the emerging markets of Brazil, Mexico, Russia and China, which will further boost its top-line growth going forward.

We believe that the strong sales of iPhone 4S and upcoming release of iPad 3 (expected March 2012) will boost Apple’s competitive edge over Google Inc.’s (GOOG) Android operating system. According to Gartner, in the third quarter of 2011, market share of Android operating system had almost doubled from the year-ago quarter to 52.5%. Meanwhile, Apple’s iOS had a 15.0% share, which declined from the previous year (16.6% in 3Q10).

We believe that Apple will remain entangled with further lawsuits, as competition heats up in the mobile and tablet space. We also believe that increasing legal expenses will hurt Apple’s operating profit going forward. Additionally, the impending lawsuits in different countries will remain an overhang on the stock going forward. However, we believe that Apple’s ability to innovate and grow in developing nations, where the market is more cost-sensitive, will determine the company’s fortunes in future.

We maintain our Neutral rating over the long term (6-12 months). Currently, Apple has a Zacks #3 Rank, which implies a ‘Hold’ rating in the near term.

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