Apple Inc.; Market Cap. (as of 13/03/2015): $719.88bn

A Record Company

Apple is a company of excesses. With fiscal reports exceeding even bullish estimates more often than not, the Cupertino-based company has become synonymous with exuberance. In its most recent quarterly earnings, Apple reported $18bn of net profit, setting a historical record. Sales of the iPhone, which barely consisted of 1.4m units in the year of its launch, also hit a record, totaling 74.5m in the last three months of 2014. Apple broke yet another ceiling last November with its market valuation reaching $700bn. Not surprisingly, that staggering figure has since been eclipsed as the company’s valuation headed for new horizons.

There has certainly been no shortage of controversy surrounding the world’s largest market valuation, whose bewildering heights have brought many to conclude that it has been driven by what Keynes famously described as “animal spirits”. Others, including famed investor Carl Icahn, have come to a different conclusion, claiming Apple is actually undervalued with cautious markets fearing those very same spirits. In a letter to his Twitter followers in February, Icahn argued that Apple was selling at a “totally irrational” discount to the market with its share price trading below the S&P 500’s 17x expected earnings. Because of strong growth and what he called “a peerless innovation track record”, Icahn claimed Apple should be earning a premium to the market. He has since been joined by a cohort of analysts forecasting not only a rising share price but an impending valuation of $1 trillion. Whether arriving to the $1 trillion benchmark is a possibility, and if so with what speed and timing is difficult to say. With the launch of the Apple Watch, however, the company seems to be taking strides in the right direction.

The Apple Watch

Much like the Mac, the iPod and the now prevalent iPhone, have marked Apple’s past ascent, the company’s new flagship product, the Apple Watch, will certainly mark the company’s future. Seen as a break with Apple’s tradition of introducing technology, which simplifies and unites functionalities, the Apple Watch is an addition without much simplification. As such it has been highly contested, attracting a great deal of predictions of its impending doom. But precisely because of the backlash, the watch has obtained the quintessential Apple feel, that of bold innovation which we are prone to develop a strong fondness for, regardless of whether we really need it or not.

The launch of the Apple Watch represents the company’s push into wearable technology, hailed by many as a revolutionary direction the industry is headed towards. The watch is thus a pioneer move for Apple but unlike its previous star products, it is unique because of its apparent lack of utility. Aside from introducing a handful of touch-technology gimmicks and solving the issue of taking out our phones from our pockets to receive notifications, the Apple Watch does not do much. It is rather an extension of the iPhone and it is intended to be used as its complement and in no way as its replacement.

What is striking is the unorthodox strategy the company is implementing for its launch. The watch will be sold in three collections: the Apple Watch Sport, the Apple Watch and the Apple Watch Edition, all of which will offer 38mm and 42mm sizes as well as a range of options for customization.  The watch is after all, according to Apple the “most personal product” they have ever made. With a price range from $349 to a staggering $17,000, it also targets the most wide-ranging customer base. The Apple Watch Sport and the Apple Watch boast premium prices from $349 to $1099 and cater to Apple’s traditional consumer base. On the other hand, the Apple Watch Edition targets a very different buyer and shows the Cupertino giant is venturing into luxury.  Starting at $10,000, the Edition is made of compressed 18-karat gold and may go for as much as $17,000.

Potential Revenues

With regards to the success of the watch, we present our estimation of the Apple Watch sales for 2015 after its planned launch in April, taking owners of iPhones which are compatible with the watch as the target consumers. We estimate the demand for the two main lines of the watch among different age groups and calculate the revenue stream. Finally, we project the revenue for the third, most expensive “Edition” line of the watch separately. As a sanity check we use global sales of Swiss watches and sales of smartwatches by Apple’s competitors.

To begin with, we estimate the current number of active iPhone users as 480m. That is about 70% of the cumulative number of iPhones to be sold after Q3 2015 (about 680mn) and is in line with the ratio of active iPhone users to the cumulative number of devices sold in December 2013. Next, we multiply the 480m by 80%, which is the estimated percentage of iPhones compatible with the new Apple Watch, obtaining the potential overall market size for the Apple Watch of roughly 390m users. Taking into account the age distribution of iPhone users, we estimate the market share the Apple Watch can potentially gain in the first year in each age segment of customers.

(Our assumptions are in italics)

Age groups 0-21 22-30 31-40 41-50 51-60 61+
iPhone market share 20% 45% 26% 13% 6% 5% 100%
Predicted AW penetration (optimistic estimate) 3% 4% 4% 2% 1% 0%
Percentage of total potential users’ base 0.60% 1.80% 1.04% 0.26% 0.06% 0.00% 3.76%
Number of AW sold (m) 2.34 7.02 4.06 1.01 0.23 0 14.7

 

Assuming the average prices for the “Watch” and “Sport” editions to be in the middle of their respective price ranges, and assuming a constant product mix across age brackets of 70% for the Apple Watch and 30% for the Sport, , we reach an average price of 70% * $370 + 30% * $800 = $500. Given the projected number of users, the two main lines are projected to generate $500 * 14.7m users = $7.35bn of revenue in the first year of the launch.

To estimate revenue from the exclusive Edition line, we assume that the potential customers will include only the heads of households with annual income of over $250,000 that constitute 2% of households. Dividing by the average family size of 2.5 we get 0.8% of potential customers for the “Edition” line. Assuming that an average purchase of an expensive watch takes place once in 5 years and that only 1 in 5 of those customers would decide to buy the Apple Watch, we estimate that only 0.03% of the overall customer base will buy the most expensive watch line. With an average price of $14,000, this would result in a revenue stream of 0.03% * 390m * $14,000 = 1.3m users * $14,000 = $1.64bn revenue. We assume that only 1 in 5 potential buyers of expensive watches will go with the Apple product for the reason that although the 18k gold Apple Watch is priced at around 50% of its Swiss counterparts, it cannot be treated as a long-term investment because of the speed with which technology becomes obsolete.

Overall, we end up with an optimistic estimate of 16m users for all Apple Watches in the first year and an overall revenue potential of $9bn.

Implications

Considering other existing predictions ranging from as low as 7m to over 30m of units sold for this year, our estimation seems reasonable and fits in the lower part of the range. With 16m Apple watches sold, Apple would dominate the current smartwatch market, which registered only 4m users in 2014. Compared to the market for Swiss watches, which totals $25bn annually, our $9bn prediction seems very high. However, acknowledging past instances where Apple had entirely changed the markets it entered, our estimation might not be a far-reaching one.

Given Apple’s immense efforts in development and marketing as well as the fanfare surrounding the launch, the Apple Watch is well on its way to becoming the new big thing in technology. Aside from its lack of immensely useful services and some design perks, what makes the Apple Watch truly different is its golden appeal. And while a $17,000 price tag may be an excess by even Apple’s standards, the company’s push into luxury with the Edition collection can be seen as a hedge for the launch of a product which serves little purpose and offers little else than convenience. The watch’s price tag and its luxury appeal may attract the high-end consumer thus strengthening the Apple brand while helping to market the rest of the line in making the watches at the lower end look like a bargain. The golden watch may also be a part of a wider strategy, aimed at increasing prices and testing the customer’s willingness to pay more than premium prices for Apple products. After all, bridging the almost $300bn gap standing before the $1 trillion valuation is more easily done with gold.

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