Apple's iWatch Profit Potential

| About: Apple Inc. (AAPL)


Morgan Stanley's Katy Huberty has predicted that Apple could sell 60 million iWatches in the first year of production.

This may be optimistic, but it's in line with growth estimates for the wearable market for 2015.

This sales volume for iWatch could add as much as $9 billion in gross profit for 2015.

Since the beginning of the year, I've been very bullish about the sales potential of Apple's (NASDAQ:AAPL) iWatch, but in my recent review of iWatch rumors, even I offered only a very conservative prediction of Holiday quarter sales: 3-5 million units, based on supply constraints. Many Apple bears have been understandably skeptical about the market potential for the iWatch, so I was gratified to hear Morgan Stanley's Katy Huberty offer a bullish take on iWatch in her most recent guidance for Apple. In fact, her prediction that Apple could sell as many as 60 million iWatches in its first year took my breath away.

All Over the Map

Market forecasts for wearable tech have been all over the map. In the table below, I summarize some of the more recent forecasts that I've been able to find.


Estimate Date

2014 Unit Volume millions

2014 $ Volume billions

2015 Unit Volume millions

2015 $ Volume billions


IHS Performance Monitor

Sept. 2013





also assumes ASP $42


Sept. 2013





ASP $42 applied

NPD DisplaySearch






ASP $42 applied

Business Insider






assumes ASP $42






Click to enlarge

Often, the predictions state unit volumes or dollar values, but not both, so I've applied an ASP of $42 where it wasn't stated, with the original source data highlighted in bold. The IHS (Performance Monitors) data is a prediction for the relatively mature market for sports/fitness performance monitor devices such as heart-rate monitoring watches. The median of the predictions just happens to be equal to Business Insider's predictions: 123.8 million units for a sales volume of $5.2 billion for 2014.

Keep in mind that these predictions are for everything wearable, from low cost fitness bands from Fitbit to high end GPS watches and true smartwatches such as the Pebble. If we take the median to be our best guess for the 2014-2015 wearable market, then Huberty is saying that Apple will sell roughly 36% of that market in the first year of production (basically 2015) and account for all of its growth.

iPhone Effect

Huberty's predictions may seem overly optimistic, but I've always felt that the iWatch would have an effect on the wearable market akin to the effect of the iPhone on the mobile handset market. At the time the iPhone was introduced, the mobile handset market was dominated by feature phones, which were relatively smart for their time, and offered a limited set of capabilities such as messaging and email. Such phones were ad hoc agglomerations of app programs with no real operating system or ability to install additional apps.

Even the true smart phones from companies such as Nokia and BlackBerry (then Research in Motion) offered relatively primitive operating systems and little app selection. Most importantly, the user interfaces were crude, based mostly on mechanical push buttons and D-pad directional controls. Display screens were tiny and with low resolution, good enough for reading text messages but not much else.

A similar situation exists within the electronic watch market today. Most electronic watches have become "feature watches" akin to feature phones. They have some smarts, and can do some things well such as heart rate monitoring or GPS tracking. They can also feature electronic compasses and barometric altimeters. Displays are typically tiny, since these need to be always-on, low power devices, and the user interfaces mostly rely on physical buttons. The parallel between feature watches and feature phones is very pronounced.

Feature watch makers such as Garmin (NASDAQ:GRMN), Timex and Polar have begun to introduce smart-watch like devices. Garmin offers the Forerunner 620, which features a color touch screen, GPS and heart rate monitor. Timex has the Ironman One GPS+, which also features a color touch screen, GPS, and text messaging via AT&T. Polar's V800 fitness watch, while not touch screen equipped, offers GPS and Bluetooth connectivity to sensors and for data transfer.

Even the true smart watches (watches that feature an OS and user installable apps) are relatively crude in terms of user interface and display capability. The Pebble doesn't have a touch screen or even a color display, and relies on mechanical buttons for user input. Android based smart watches from Samsung (OTC:SSNLF) and Sony (NYSE:SNE) offer a touch screen, but the operating systems and user interfaces are still relatively crude, and the screens are still tiny. The devices are also very bulky and heavy, requiring a large battery to power the processors and screens.

All Apple has to do to clobber the smart/feature watch market is what they did with the iPhone: provide a true iOS based operating system, an app-rich ecosystem, a large, attractive screen, and abandon mechanical buttons in favor of a touchscreen user interface. Easier said than done, of course. There are significant technical challenges to provide a larger screen wearable device in terms of battery life.

Here, I expect Apple's holistic engineering approach to come to the rescue. Almost all the smart watch concepts or designs, including the latest Google Android Wear devices, make use of a dumb wrist band. All the electronics are in the box, and the band is just wasted bulk and weight. Only the Samsung Galaxy Gear makes some intelligent use of the wrist band: it holds the camera. By placing some electronics and the batteries in the wrist band (as the Nike Fuel Band does), Apple can produce a slimmer device that doesn't feel like wearing an old style pager strapped to your wrist. This is where I believe Apple will go for the iWatch.

Profit Prospects

Does the iPhone effect account for 60 million unit sales in 2015? Huberty's estimate still feels a little high, but I consider it a reasonable upper bound to a range where the low end is about 40 million devices. I expect an ASP for the iWatch of about $300 for total revenue of $12-18 billion. And the gross margin will be very juicy. According to Garmin's latest calendar Q2 earnings release, Garmin earned a 65% gross margin on its fitness watches. Apple will invest more in their engineering of the device, but I still expect a gross margin of at least 50%, for $6-9 billion in additional gross profit per year.

Whether the iWatch will actually be called iWatch is still open to question. Last I checked on the U.S. Patent and Trade Mark Office site, iWatch still had a number of non-Apple claimants. It almost doesn't matter. Apple's current line of wearables, iPod, will evolve into the next generation of wearable devices, including a wrist device and head phone device (combined with Beats). Apple may simply retain the iPod branding for these new devices.

Whether Apple will be able to get its new line of wearables onto store shelves by the end of the year remains iffy. GT Advanced Technologies' (GTAT) recent acknowledgement that they would only be starting production at the Mesa, AZ plant this month makes getting the iWatch ready for a Fall roll-out difficult. The August production start is about what I thought it would take, and actually, they've done a magnificent job just to get into production roughly 8 months after start. But there needs to be time to get the sapphire to screen makers and then assemble these into iWatches, build up product inventory and transport the inventory to retailers. It all takes time. It's like getting a very long freight train into motion.

Apple may end up unveiling the iWatch in December with sales commencing in January 2015. Will this delay hurt the stock? I doubt it. Sentiment has turned so bullish on Apple that nothing seems to faze the retail investors who entered the stock after the split. And why should it? Apple's Next Big Thing is on its way.

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