What’s Driving Our $30 Billion Valuation For Apple Watch?

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The Apple (NASDAQ:AAPL) Watch is set to hit stores in early 2015, marking Apple’s first new product introduction in nearly five years. While the wearable technology market remains in its infancy, with smart watches yet to sell in large numbers, we believe that Apple’s entry could redefine the product category and take it to the mainstream consumer. In this note, we take a brief look at our forecasts and the rationale behind our valuation for Apple’s Watch division.

Our $120 price estimate for Apple is about 7% ahead of the current market price.

See Our Complete Analysis For Apple Here

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Apple Could Be The World’s Most Valuable Watchmaker

The Apple Watch has a lot going in its favor. It addresses some of the key issues that have riddled the smartwatch category by offering an attractive design, an intuitive user interface, strong fitness tracking capabilities and support for third-party applications. Even so, the company does face some challenges. Battery life remains a concern (estimated at one day) and the full set of use cases for the device remain unclear (although this should change as app developers come on board). Additionally, the incremental utility that the Watch offers over an iPhone beyond notifications and advanced fitness tracking appears to be somewhat debatable. That said, we believe that the watch will be an important product line for Apple, given its potentially attractive margins, growth prospects and the fact that it builds on Apple’s hugely popular iPhone/iOS platform. We are valuing the Apple Watch division at about $30 billion using our discounted cash flow model. This represents over 4% of Apple’s market cap. For perspective, that’s as much as the market cap of the Swatch Group, the world’s largest watch manufacturer and Fossil Group (NASDAQ:FOSL), one of the largest U.S. watch manufacturers, combined. Besides the direct financial impact, we think that the Apple Watch will also have significant intangible benefits for Apple by helping to further customer engagement, while also increasing the switching costs for the Apple ecosystem.

Apple Watch Shipments Estimates: The traditional watch market stands at over $45 billion a year, with a large chunk of volumes coming from cheaper quartz watches and a lot of the total value coming from luxury watches, largely manufactured in Switzerland. [1] However, we don’t think that Apple’s device will eat into this market. Instead, we believe that it will expand the overall watch and smartwatch market, given that it is effectively an upsell to existing iPhone users. iPhone users are surveyed to be wealthier and more engaged with their smartphones compared to other platforms such as Android – and this could provide a strong foundation on which Apple could build its wearable business. The device should be off to a strong start given the pent up demand for an Apple wearable and also due to favorable economic news and growing consumer confidence in the United States. Given that Apple Watch buyers will generally be iPhone users, it may be useful to view Apple Watch sales as a percentage of iPhone shipments. We estimate that Apple Watch shipments will stand at about 9% of our projected iPhone shipments for CY 2015, translating into shipments of around 17.5 million units for the first calendar year. We estimate that shipments will grow to about 36 million by CY 2o21 as prices fall and use cases for the device improve.

Apple Watch Pricing and Margins: Apple has announced a starting price point of $349 for its smartwatch lineup. While detailed pricing for the various styles is not available yet, it is likely that the price range will be wide, given that high-end models will use precious metals such as 18-karat gold. However, we believe that the base model will account for a bulk of the sales, translating to an average selling price of around $400 for 2015. We expect ASPs to decline going forward, falling below $300 by the end of our forecast period (CY 2021), as the company launches lower-end models or offers legacy models at cheaper prices. While bill of materials data is not available for the Apple Watch, we believe that the company’s custom designed hardware, chip architecture and the fact that the many electronic subsystems of the watch are integrated into a single module could help to keep component costs low. Additionally, the company’s strong bargaining power with suppliers and contract manufacturers should further help costs. However, key cost drivers are likely to be associated with the physical aspects of the watch (casings, sapphire crystal) and the potential complexities arising from the various design combinations that Apple intends to offer. We estimate that the Apple Watch will realize gross margins of around 42% in 2015, which is higher compared to Apple’s overall projected gross margins. We estimate that margins will fall to around 37% by 2021, as competition in the smartwatch space becomes more intense and average selling prices decline.

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Notes:
  1. Wrist Watch Industry Statistics, Statistic Brain, November 2014 []