Apple: Pay And Watch Offerings Unlikely To Move The Needle

| About: Apple Inc. (AAPL)


Apple released exciting new products - Apple Watch and Apple Pay.

Apple Watch introduced a high price point and inventory requirements that reduce the impact to earnings for FY15.

Simple analysis suggests Apple Pay doesn't materially impact revenues for now.

While the market was fascinated with the release of what is considered the first true new product categories after the passing of legendary CEO Steve Jobs, the products are unlikely to move the needle for Apple (NASDAQ:AAPL). The payments and wearable initiatives are a good start and provide some encouraging long-term opportunities, but big questions exist whether the products will move the needle. Remember that Apple is worth nearly $600 billion with annual revenue heading toward $200 billion for the fiscal year ending in September 2015.

The stock quickly jumped to $103 on excitement over these new products, but it eventually declined to $98 as the reality set in on the near-term impacts of these products. Lets look at some quick calculations to see if either initiative or the combined new products will help the company claim higher stock prices.

Apple Watch

At the conference on the Sept. 9, Apple released a new watch that will become generally available sometime in early 2015. The Apple Watch features a Digital Crown and introduces health and fitness apps along with other standard apps familiar on the iPhone.

The interesting part is the inclusion of three distinct collections including a sport and special edition. The watches come in two different sizes and multiple colors including 18-karat gold versions. Other options include numerous watch straps and 11 watch faces. The watches start at $349 and require the newer versions of the iPhone including the previous iPhone 5 to operate.

At this point, let's leave the technical details to the experts and focus on the financials. Remember that in order to account for 10% of revenue, the Apple Watch must produce roughly $22 billion in annual revenue. One can safely assume that anything lower isn't overly material to the technology leader. If my calculations are accurate, Apple must sell roughly 55 million watches at the average low-end price of $349.

Luckily for us, a whole slew of Citigroup (NYSE:C) analysts worked on a project to forecast the smartwatch market. The bad news for Apple is that the forecast concluded that this category alone could reach $10 billion for all participants, at some point in the future. The report suggests that up to 1.5 million smartwatches were shipped in 1H14.

The Citigroup analysts forecasted 14 million units of the Apple Watch sold in FY15 with an ASP of $300. Clearly the ASP is likely off by $100 when the higher prices for the Sport and Edition watches are factored into the analysis, but the analysts come up with revenue of only $4.2 billion followed by $6 billion in FY16 when 20 million units are sold. The assumption is that gross margins of 21-22% yield an EPS impact of up to $0.10.

The higher ASP could lead to higher margins, but the higher price likely reduces the units sold. If you double the numbers and assume an EPS impact of $0.20, it doesn't move the numbers on a company forecast to earn over $7 per share in FY15. Another key point for investors hyped over this sleek looking watch is that the company has introduced inventory issues never before encountered by Apple. The relatively low volumes and customizable sizes, versions and straps are all likely to pressure margins including leaving the company susceptible to inventory gluts in certain versions not demanded by the market.

Apple Pay

The promise of mobile payments has been the talk for years now. Is it possible that the Apple Pay offering solves the problem of creating a mobile feature that eliminates the need for carrying credit cards? Is it even ideal for a user to have both their mobile phone and wallet linked to one device? If the battery dies will a user be stranded with no phone service or money?

Regardless to the concerns, Apple introduced a mobile pay service based on the NFC system and a dedicated chip. The company has impressive support of banks to cover 83% of credit card purchase volume in the US. The press release is full of some top notch retailers already signed up to accept this version of payments.

Questions on whether adoption will take off exist. But assuming one does the numbers suggest investors are overly optimistic on the importance, at least financially in the near-term. First, the Apple Pay feature is only available on the new iPhone 6s announced today and released to the market in a few weeks. The Apple Watch provides access to the pay feature when it hits the shelves next year. Second, the product is only available in select retail locations and the attach rate is likely small for now. Third, the company is partnering with the major payment networks of Visa (NYSE:V) and MasterCard (NYSE:MA) that will take a major cut of the profits.

BCG analyst Colin Gillis provided the following basic analysis on Fast Money to prove the immaterial point. He estimated that 100 million phones would soon have access to the Apple Pay product. If each phone owner spent $15 on lunch each day or $75 per week, the total spend would come out to $7.5 billion in payments per week, or $390 billion for the year. Using an estimate of 30 basis points of revenue for Apple and the pay product generates $1.2 billion in annual revenue, or equivalent to less than 1% of current revenue. Even at operating margins of 40% similar to that produced by Visa, Apple is only talking profits in the $500 million range for FY15, or the equivalent of another $0.10.

Investors can quickly do different what-if scenarios based on different assumptions of more users and higher average spend - the key is that it takes a ton of transactions for 30 basis points to produce enough revenue to reach a material threshold for Apple. Even Visa only expects revenue of roughly $12.6 billion for FY14 suggesting a long runway before payments is a major contributor to profits for Apple.


The key to the analysis of these new products for Apple is that the near-term impacts aren't very material to the bottom line of Apple. The rough estimate is that even a best case scenario produces earnings of $0.20. The real concern is that the Apple Watch and the new phablet phone actually cannibalize existing products. Will users really buy a watch, phone and tablet? Either way, the new products including the phablet were needed, but the near-term impact is very immaterial to the company. Anybody buying the stock based on the new products of Apple Watch and Apple Pay will be sorely disappointed in the near term.

Disclosure: The author is long AAPL.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.

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