Seeking Alpha
, Think Finance (1,113 clicks)
Long/short equity, arbitrage, event-driven, research analyst
Profile| Send Message|
( followers)  

Summary

  • There's tremendous expectation regarding the iWatch.
  • However, I show that the iWatch cannot move the needle for Apple.
  • This is so even if we use rather optimistic assumptions, including making Apple the worldwide leader in the watch space, which is rather unlikely to happen.

Currently, there's massive faith that Apple (NASDAQ:AAPL) is about to launch new product categories which will enable it to rekindle growth. Apple is in dire need of excitement, because while it's massively profitable and has a boatload of cash sitting in the bank, the truth is that presently the company is hardly growing.

Present consensus estimates for 2014 have improved somewhat, but still revenues are expected to grow just 6.3% and earnings to increase 11%. Lately, the faith that new products would push this up has been obvious, not only in the constant speculation regarding the iWatch launch, but also in the way the market speculated with Apple's modest smart home initiative.

So the question here is, can an iWatch move the needle for Apple? My own answer, which I will explain in this article, is that it can't. At least not to a great extent if using rational but optimistic assumptions.

Comparison to Swatch

The first basis for me saying that a smartwatch cannot move Apple's needle much, is simply the amount of money that people spend on watches. The Swatch Group (OTCPK:SWGAF) is the largest player in watchmaking. It possesses multiple brands, from the lowest rungs of the market (Swatch) to the highest (Breguet, Omega, etc), as well as many other activities including producing components for the watchmaking industry.

At most, one would expect Apple's entry into the watch space to match the size of its present leader. And even that would require a change in the consumption patterns for watches, as watches are presently seen more as jewelry or fashion accessories than as useful gadgets.

Still, if Apple was able to dislodge the Swatch Group at the top of the watchmaking heap, what would the impact be on Apple's P&L?

Back in 2013, the Swatch Group had the following P&L: (Source: Annual Report)

  • Revenues of 8.82 billion CHF, which translates to $9.86 billion;
  • Net profits of 1.92 billion CHF, which translates to $2.15 billion.

Now, The Swatch Group has been tremendously successful. But Apple is simply a massively profitable giant. Over the last 12 months, Apple had (Source: Yahoo Finance):

  • Revenues of $176 billion;
  • Net profits of $37.7 billion.

What this means is that even if Apple somehow "destroyed" the Swatch Group by taking market share equal to what the Swatch Group now holds, this would make for an increase in Apple's financial performance of just:

  • 5.6% in revenues ($9.86/$176);
  • 5.7% in net profit ($2.15/$37.7).

Apple is a victim of its own success. Entire markets don't move the needle much, because the iPhone is so incredibly profitable while selling in large numbers. The iWatch cannot hope to change this simply because people don't spend enough on watches. And they don't spend nearly as often as on smartphones, either.

Subsidization

Then, there's another problem. Not only do people not change their watches often, but when someone buys a watch he has to pay full price upfront. Such is not the case with smartphones. The fact that there's carrier subsidization of smartphones gives people a feeling that they're not actually buying a $650 device.

Were smartphones not subsidized at all, and price sensitivity would be much higher. It would be much harder to sell pricier smartphones such as the iPhone. While this isn't changing for smartphones just yet, no such subsidization exists for smartwatches. This will expose consumers to the full cost of the devices upfront and is thus likely to make the market much smaller than it would otherwise be and certainly will torpedo the speculations of 50 million units which already float about.

Indeed, if the rumor is right and Apple starts manufacturing 50 million units, it will most likely lead to a significant charge down the road.

Also it is expected that Apple will get the design right. There are rumors of a rectangular shape and that would probably be a big no-no. Motorola seems on the right track with the upcoming Moto 360, which is much more jewel-like, but even such a watch would fall prey to the mechanics regarding the watch market: no subsidization, limited size of market and the fact that people don't buy watches all that often.

Conclusion

Even assuming massive success for Apple's watch, namely by assuming that Apple would quickly take on the size of the Swatch Group, shows that the iWatch can't possibly move Apple's needle much.

Apple is about the iPhone. The iPhone can move the needle, everything else is, for now, a sideshow.

Editor's Note: This article discusses one or more securities that do not trade on a major exchange. Please be aware of the risks associated with these stocks.

Source: An iWatch Cannot Move The Needle Much