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04/23/15 05:00:11 PM
TECH KNOWLEDGE

SECTORS: APPLE WATCH CONSENSUS VIEWS APPEAR TOO AGGRESSIVE

Apple plans to start taking pre-orders on the much anticipated Apple Watch, the company's newest product category since the release of the iPad in 2010, tomorrow with deliveries to begin April 24th. The price of the Apple Watch starts at $350 (Sport Edition) and range as high as $17,000 for the gold model. In this piece, we highlight our expectations for the Apple Watch.

Thus far, the initial reviews on the Apple Watch appear mixed but were largely in-line with many of our expectations. Overall, we believe most reviewers see the Apple Watch as a good-looking device that has the "cool-factor" with significant capabilities (fitness functionality appears to be a notable positive). However, some of the drawbacks are similar to those that we have already expressed, specifically the short battery life and a new user interface that will require consumers to be patient (with a steep learning curve).

With the launch of the Apple Watch, the company is embarking on a new sales strategy, with an emphasis on making individual appointments at retail stores and ordering the product on-line. We believe the reason for this is largely due to the high customization associated with the product, designed to meet the individual preferences of each buyer. This is a stark change to Apple's previous product releases, which were highly standardized and often resulted in long lines at Apple stores on the day of a release. Given that no physical devices will be delivered on April 10th, we expect long lines typically seen with new product ramps to be elusive. This may or not take some of the "buzz" away that we have seen with prior product launches.

Following initial reviews of the Apple Watch, we maintain our below-consensus view that the Apple Watch will only sell 10 million units this year, lower than the consensus of Street analysts, which we believe to be in a range of 15 million to 20 million units for 2015. Our belief is that it will take time for consumers to fully understand the capabilities and become familiar with the emerging wearables category. As a result, we expect future releases to see greater success but nonetheless see near term demand initially driven by early adopters purchasing the device.

Our initial forecast points to Apple Watch shipments rising from 10 million in 2015 to 30 million in 2016 and 45 million in 2017. We assume average selling prices in the current year will be $430 as most consumers will purchase the lower end Sport watch given the belief that future releases will prove to be a better purchase. Given our shipment and selling price assumptions, we expect the Apple Watch to comprise just under 2% of Apple's sales in the current year, rising to 5.4% and 7.7% of total revenues in 2016 and 2017, respectively. While we believe the impact to earnings will be minimal in the coming quarters, we believe the Apple Watch has the potential to contribute $0.45-$0.50 in EPS for 2016 and more than $0.70 per share in 2017.

While the Apple Watch is unlikely to be a major driver on the company's fundamentals in the immediate future, we see it as a critical launch as it will begin to define the legacy of Apple's management team post the Steve Jobs era. Although future potential expansion opportunities into areas like TVs and cars have the ability to be game changers for the company, an unsuccessful Watch launch may negatively impact Apple's image to both consumers and investors.

From an investment perspective, we believe Apple's ecosystem, significant cash balance, robust free cash flow generation, and reasonable valuation positions the company well in the coming years. However, we have near term concerns surrounding the next generation iPhone release as the iPhone 6 and 6 Plus likely pulled in future demand and will make comparables much more challenging as we exit the calendar year. In addition, Apple Watch expectations may have to be tempered.

 

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