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Kevin Chang, a JP Morgan analyst based in Taiwan, cited people in the supply channel he did not name and an application with the US Patent and Trademark office for his report.

Apple filed a patent application document dated July 5 that refers to a multifunctional handheld device with a circular touch pad control, similar to the Nano's scroll wheel.

Apple spokeswoman Natalie Kerris declined comment.

Long lines of people turned out on June 29 when US sales began for the iPhone, a mobile phone with a music player and web browser. Analysts have estimated that sales in the first weekend were as high as 700,000 units.

Chang says a way to follow up the iPhone with a cheaper version would be to convert the Nano into a phone and price it at $300 or lower. The iPhone sells for $500 and $600, depending on storage space.

"We believe that iPod Nano will be converted into a phone because it's probably the only way for Apple to launch a

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lower end phone without severely cannibalizing iPod Nano," he claims, noting that the new phone could have "rather limited functionality."

Another analyst Gene Munster of Piper Jaffray says he expects Apple to bring out iPods that resemble iPhone, with features such as a touch-sensitive screen, later this year. Such products would help stop iPhone eating into iPod sales.

"We believe the iPhone reveals much of what the iPod will soon be," Munster claims in a note to clients. "iPods with some of the touchscreen features of the iPhone should lessen the impact of cannibalisation."

Apple also declined comment on Munster's note.

Because of the anticipated lower price for the Nano-based phone, 2008 sales of 30 million to 40 million units "is achievable," according to JP Morgan's Chang.

This would be a much larger volume than is expected of the first iPhone. Apple has targeted sales of 10 million units in 2008, which would give it a 1% share of the global market.

But analysts forecast that a cheaper phone from Apple, which leads the digital music player market, could pose a much bigger threat to long-established phone makers such as Nokia, Motorola, Samsung and Sony Ericsson.

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