Much has been written about Apple Pay and Apple Watch already.
I will just collect some of my comments below and once again point out the issues related to Apple's large numbers (i.e. even a few additional billion in net income won't move the needle that much for a huge company like Apple with close to 200 billion in revenue/year and with very high gross margins compared to other hardware makers)
1) Apple Pay
Apple will not be in this "tap to pay" market alone forever if mass-market acceptance for NFC-based technology (finally) takes off.
But Apple for sure has assembled a nice payment service and hardware portfolio with TouchID/secure chip container, iBeacon and most recently the various Apple Pay partnerships and security mechanisms that could help customers accept the system. See here for a nice overview on Apple Pay features and details enabling easier mass-market adoption than previous NFC-based efforts.
Apple's biggest competitors in this segment? Probably the same companies as in the smartphone business:
Higher-end Android vendors like Samsung and Google have a fair share of wealthy users in Europe and Asia as well, it's not just Apple. North America, Japan and a few other countries are the ones where AAPL retains a high stronghold market-share wise, other markets less so.
(Compare iOS vs Android marketshare in some key countries here: http://bit.ly/1y3yW6l )
Also, it's not all about people with high purchasing power in the payments space. "Poorer" users are very interesting customers for credit card companies as well. Why? Late fees with very high interest rates. They make more on late fees than transaction volume with high-spenders who pay their CC bill on time in many cases.
If Apple Pay can process around 1 trillion USD/year in few years globally, that's already a huge success in my opinion. (I will use even larger numbers below for my best case scenario as an example.)
First, it will take years for the system to spread and gain acceptance; for example, some big US chains like Best Buy and Wal-Mart so far decided not to participate.
I'm also quite sure that the Android Camp will have a similar solution (using the same NFC terminals) within 1-2 years - which as usual may not be elegant at first as Apple's integrated hardware and package, but it will also work. The pressure is simply too high, Android vendors and Google can't and won't cede that nascent NFC checkout market to Apple. The existing Google Wallet foundation could be updated and adapted, for example, it's not like Apple's competition in Androidland has to start from scratch.
Longer-term, an international 'Apple iBank' with a high consumer market share (should Apple decide to enter the payments game with their own bank license and debit/credit card in the far future, I discussed this before) is not all rosy for Apple anyway:
Apple could face all sort of lawsuits and new regulations by customers watchdogs on fees etc. because it would likely be too dominant, at least in some areas. Apple could get into a re-run of Microsoft's situation in the late 1990s. In that respect, Android and other competition is probably welcome to a certain extent longer-term!
It's therefore more realistic for now to think of Apple as a channel partner rather than a disruptor displacing existing credit car companies.
Let's run the numbers in a really optimistic scenario for Apple Pay:
I assume only two payment networks will probably matter in a few years on wearables and smartphones because of current marketshare and purchasing power:
- Android & various Android Wear vendors (Samsung...)
- Apple's system on iOS including Apple Wearables
Assumptions for a really optimistic Apple Pay scenario:
- 4 trillion USD in transaction volume over Apple Pay (short notation trillions of course, that's much higher than the number I used above) out of a total volume of around 20 trillion, so assuming one in five transactions measured in value.
Given available 2010 numbers for global credit and debit card volumes (see here for details) that's really optimistic, but let's assume Apple gets a very high percentage of its user base with traditionally higher purchasing power to adopt Apple Pay.
Let's also assume more buyers will ultimately use Apple's system in the future. No more manual pin entries or card swiping will result in faster check-out, more users might switch from using cash or "traditional" credit cards to an NFC like checkout.
- 0.2% cut for Apple (because international credit card fees are higher than in North America, Apple might get a little more on average, this is another optimistic assumption over the original 0.15% cut the FT reported on.)
- Assuming all of that cut going directly to operating income (not accounting for any other expenses) and with taxes at just 25%
- Assuming no discount to present value, this roll-out would all happen overnight in 2014 already (and on a global level).
Summary of this very simple calculation example: These giant transaction volumes of 4 trillion USD would "only" add around 6 billion USD to Apple's net income/year!
Compare that to the current net income of around 40 billion USD (numbers for 2012 and 2013) for AAPL. Apple Pay would have a meaningful impact, but certainly would not multiply net income - as it would for all (smaller) other companies on the planet not named Apple.
2) Apple Watch
Since I have written a long article on the Apple Watch already (see my five key questions that might impact the success and market acceptance of an Apple Watch device) I will keep this short and just present another best-case calculation example below.
Assumptions for a really optimistic Apple Watch scenario:
An Apple Watch impact using 20 billion USD in revenue. This would of course be equal to about 10% of Apple's total revenue in the future:
20 billion @ 500 USD ASP results in 40 million Watches/year, that's one out of five iPhone buyers that year - or a 10% attach rate assuming around 400 million active iPhone users with a compatible iPhone5 or above looking into potentially buying an Apple Watch by the end of 2015 (that number will not grow forever since many iPhone are bought as replacements and not net new buyers entering the iOS pool).
Assuming better iPhone 6 family (and beyond), one can also use 500 million active iPhones going forward to add a more optimistic scenario - but instead lower the attach rate to a more modest 5% (that scenario would obviously result in 25 million watches per year).
Concerning the ASP: I estimate the ASP to be higher (because of the Edition watches, I even consider the discussed $1200 in the link as too low) than most sell-side analysts, therefore I used 500 USD as a channel ASP.
The widely discussed $349 number is just the retail starting price for the cheapest watch version, there are many others editions and upgrades (up to the gold edition, see link above for details).
My $500 ASP also includes a small slice of app and services revenue (except for Apple Pay, of course) on top of hardware to keep my calculations quick and simple.
Finally, smartphone sales are subsidized by carriers, smartwatches are not - maybe they will be once health/fitness functions improve, but that means at least waiting for version 2 or 3 of the Apple Watch which is rumored to feature more sensors.
I see the Watch upgrade and replacement cycle much slower than for smartphones which will impact sales volumes over time.
I therefore don't see very high unit sales in year two and following, but I'm still sticking to these over-optimistic numbers:
My assumptions would equal to one in five to one in ten iPhone customers opting for a new Apple Watch each year (!) assuming that around 200 million iPhones are sold each year and only a few second-hand iPhone buyers will buy a new Watch.
My reasoning is that the watch might gain more functionality over time (GPS, waterproof, longer battery life...) and work better in stand-alone mode without a paired iPhone - then 40 or 50 million units sold per year could be realistic.
But if Apple ever achieves such a high marketshare, it will have to expand the watch collection further (which could negatively gross margins):
The design collection Apple has presented so far is very small compared to the variety of traditional watch designs from dozens of manufacturers.
Not everyone will want to wear a similar watch and Apple would probably need to think about extending the collection with rising marketshare (even with third-party fashion houses and accessory makers offering different bands and bracelets, design differences may not be meaningful enough).
In addition to these unique design challenges, the Apple Watch specifically has three large "chains" that need to be removed over time...
- the very short battery life (around 1-2 days only!)
- the physical need for an iPhone in its vicinity (limited stand-alone functionality so far)
- lack of killer apps that make it a "must have device" (this links to the short battery life mentioned above, as long as the Watch is just "nice to have" it may impact the buyer's willingness to charge it nightly)
Running the above numbers on Watch segment net income (the optimistic 20 billion USD for Watch revenue and current AAPL gross operating margins around 40% and net profit margin around 20%) could add another 4 billion USD for Apple over time.
Again, these numbers would not be that big for Apple but have huge implications for traditional watch makers, especially for their mid-end brands selling up to $1k USD or so:
Even at 10 billion USD in Apple Watch revenue - 50% off the 20 billion estimate I used above - Apple would instantly become the world's largest watchmaker by revenue in 2015!
For a comparison: Switzerland's Swatch Group, the current global leader in the watch space by revenue, does around 8.5 to 9 billion CHF in revenue assuming some revenue growth for Swatch Group in 2015 and beyond (and a simplified USD/CHF exchange rate of 1/1).
3) Summary
The Watch and Pay categories could become important longer-term for AAPL (for this the Watch battery life needs to be improved and for Pay enough NFC-compliant terminals need to be rolled out globally).
The Watch and Apple Pay could perform well together once these issues are solved, paying for goods or getting access to a venue by "waving your wrist" is very convenient.
In terms of numbers, the Apple Watch and Apple Pay categories could add around 10 billion in net income in 5-10 years combined in these very optimistic scenarios outlined - that's quite meaningful but remember these were just quick back-of-the-napkin calculations.
To reiterate again, what I presented above were very optimistic (or even over-optimistic) best case scenarios to calculate the upper end for AAPL if everything goes alright for the company in the next 5-10 years.
Many other factors would have to be considered as well. For example, Apple today still depends on iPhone sales for well over 50% of revenue and net income. One would have to consider the iPhone's line future as well, especially potential cuts in carrier subsidies and general market saturation coupled with slower upgrade cycles!
Assuming Apple can organically grow to around $45 billion of net income with current product lines (from the current $40 billion*) over time, Apple Watch/Wearables** and Apple Pay would increase that number to a total of around $55 billion within 5-10 years (always assuming a very optimistic scenario with around $10 billion combined for Watch/Wearables and Apple Pay).
PS: Note I didn't use any EPS numbers on purpose because Apple might continue or even step up its share buyback program in the future.
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* I assume increased revenue thanks to the iPhone6 and beyond and other pending product like the Apple TV or an expanded Beats product line in 2015 and beyond.
** I assume the Watch family will evolve into more wearable devices over time. Wearables may move beyond the wrist and we might wear more than one device.