After dominating the mobile market with smartphones and tablets, Samsung Electronics (PINK:SSNLF) is looking to lead the mobile foray into wearable devices with its smartwatch launch on Wednesday. Christened Galaxy Gear, Samsung’s latest mobile addition is designed to work as a smart companion to its market-leading Galaxy smartphones, allowing users to perform many of the basic functions such as sending messages, receiving calls or clicking photos from their wrist without having to access their smartphones. While there are many smartwatches such as the Pebble currently available in the market, Samsung’s entry could popularize this segment a lot more and open up new opportunities to boost growth.
However, priced at an expensive $299, the Galaxy Gear is not built for the mass-market and seems to be just an experiment by Samsung to see if it can increase the appeal of its Galaxy brand in a high-end market that is nearing saturation. For starters, the Gear will be launched with limited compatibility, working only with the Galaxy Note 3 phablet that was launched alongside the smartwatch the same day. Older smartphones such as the Galaxy S4 which do not support Android 4.3 currently, will be able to synch with the Gear only after they receive the 4.3 update. It is also not clear if Samsung will make the Gear compatible with rival Android smartphones or just look to build its own hardware ecosystem around the wildly popular Galaxy smartphones. The strategy will likely depend on the kind of initial response the smartwatch gets from buyers in the coming months.
A $6 Billion Market Opportunity
Assuming that Samsung restricts the Gear’s compatibility to its own smartphones, it would be apt to size the market opportunity in terms of its smartphone sales mix. We estimate that Samsung will sell as many as 450 million mobile phones in 2013 at an ASP of over $250. If we divide the phones that Samsung sells into two categories, the high-end ones with an average ASP of $600 and the low-end ones an with average ASP of $150, we see that the sales mix of the former has to be close to 25% for our overall ASP assumption to hold. This means that Samsung will likely sell a total of about 110 million high-end smartphones and the rest at the low- and mid-end this year. The Galaxy S3 launched last year sold as a many as 50 million units in a year, and Samsung has set a lofty target of selling more than 100 million units of the more recently launched S4. Even if we assume that Samsung doesn’t meet this target, sales of other high-end smartphones such as the Galaxy Note should help it easily reach our estimate.
In order to gauge Samsung’s smartwatch potential, we make the assumption that about 20% of Samsung’s high-end customers and almost none of the low-end ones buy the Galaxy Gear considering the high starting price. This brings the Gear’s market opportunity to only about 20 million unit sales, assuming that Samsung quickly makes the smartwatch compatible with the rest of its high-end smartphone portfolio. At $299 apiece, the Galaxy Gear could net Samsung additional revenues of almost $6 billion annually. Considering that the global watch industry is expected to generate around $60 billion in revenues this year, Samsung would capture about 10% of this market if the above scenario materializes. Any upside or downside to our estimates would depend on whether or not Samsung decides to make the smartwatch compatible with rival Android smartphones to incentivize app development for smaller screens.
Little impact on valuation
Going forward, if Samsung is able to lure 30% of its high-end customers into purchasing its smartwatch, there could be upside of about $2 billion to our long-term EBITDA forecast. This translates into a value addition of only about $7 billion, or $50 per share (3.4% of our current price estimate). If the respective percentages were to increase to about 50% for the high-end, Samsung would see additional EBITDA of $3 billion in the long run which translates into a $10 billion opportunity, or value addition of about $70 per share (5% of our current price estimate). We do not change our EBITDA margin estimates since our long-term forecasts are already in the 15-20% range, which is very similar to the kind of margins that watchmakers such as Movado and Fossil have. Considering the amount of technology that has gone into the Gear, it is unlikely to have gross margins higher than the 50-60% that watchmakers generally command.
While the value-addition due to the smartwatch alone doesn’t seem to be much for a $200 billion company, Samsung will intangibly benefit from having a broader hardware ecosystem with multiple mobile product categories doing well in the market. This halo effect could further drive the adoption of Samsung’s other more valuable mobile devices such as smartphones, and prove to be even more value-accretive to shareholders.