As smartphone maker Apple Inc. (AAPL) shifts its focus from its hardware segment to software and services businesses in efforts to hedge against longer iPhone replacement cycles and weakening demand for its products, one team of analysts on the Street says the Street is underestimating upside from this transition. (See also: Apple, AMZN, Tech Q1 Strong on Pricing: TheStreet.)

AAPL bulls at Morgan Stanley expect the tech giant’s services segment to represent 67% of sale growth in the next five years. Analyst Katy Huberty lifted her 12-month price target on the FAANG stock to $214 from $200, reflecting a 14.6% upside from Thursday morning. Trading down about 0.9% at $186.79, AAPL reflects a 10.7% gain year-to-date (YTD), and a 21.9% increase over 12 months, outperforming the broader S&P 500's 1.4% return and 12.9% growth over the same respective periods. 

"We've increasingly heard from investors that the fastest growing but lowest margin businesses within Apple Services, such as Apple Music, iCloud, and Apple Pay, will drive negative mix shift away from higher margin, more established businesses like the the App Store, such that Services margins are close to peak levels," Huberty wrote. "We disagree." 

AAPL 'Structurally Different' From 5 Years Ago

The analyst, who rates AAPL at outperform, is particularly optimistic about the App Store, arguing that its growth is "sustainable" and that "take rates are defensible." Take rate refers to the fees and commissions that Apple collects on sales by third-party sellers. As the App Store grows off a $12 billion revenue base, it should contribute "the largest portion of incremental revenue growth going forward," wrote Huberty. In the most recent quarter, Apple's services revenue grew 31% over the year-ago quarter, compared to a 18% year-over-year (YOY) growth rate in the last five quarters. Meanwhile, iPhone unit sales rose just 1% in the first quarter of 2018. 

Morgan Stanley indicated that Apple is a "structurally different company today than it was just five years ago," and as a result, investors that use hardware-based P/E or EV/EBITDA multiple valuation to derive their price targets are undervaluing the company.

Apple stock has soared to new highs earlier this month on better-than-expected earnings results and a vote of confidence from billionaire philanthropist and Berkshire Hathaway Inc. (BRK.A) Chief Executive Officer Warren Buffet, who indicated that the Omaha, Nebraska-based conglomerate bought 75 million more shares of the tech titan in Q1. (See also: Spotify Stock Seen Soaring 19% as It Beats Apple.)

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