Apple's IWatch Could Boost Yearly Profits By $8.6 Billion

  • Apple iWatch may have further contribution to Apple’s top and bottom line due to an increase in ASP.
  • Higher component costs due to sapphire will be offset through higher pricing, thus improving the profitability of the device.
  • The iWatch may be a much bigger contributor to net income and revenue than what the street is anticipating.

Update: Our latest Apple analysis shows that iWatch gross margins will expand 50% eventually. Read on to see how much it will contribute to Apple's profitability in the coming years.

Apple iWatch profit potential

Based upon new information, I raise my full-year estimates for iWatch sales from $15 billion to $16.8 billion. I estimate that profit contribution will increase from $5.5 billion to $8.6 billion. I have high conviction that the enthusiast base of Apple (NASDAQ:AAPL) users will buy the product, and that the profitability of the device will increase significantly due to low component costs, and the synergies in R&D and SG&A costs that apply across Apple’s entire ecosystem of products. The recognition of revenue may exclude a single quarter due to a late early 2015 launch. Lets do an Apple stock analysis to determine how much the iWatch will contribute to Apple profitability.

Apple Earnings From iWatch In Year One?

The below breakdown is my prior estimate, however, upon new material information I have decided to update my estimates.

Breakdown Per Unit in $(unless otherwise specified)
iWatch Revenue 300.00
Cost of Revenue 77.00
Gross Profit 223.00
Operating Expenses (estimate) 53.43
Income Tax (35% rate) 59.35
Net Income 110.22
Net profit Margin 36.74%
Profit assuming 50 million units sold at $300 ASP 5,511,025,000.00
Apple FY 2015 Net Profit (Analyst Estimates) 41.28 billion
Apple FY 2015 Net Profit (inclusive of iWatch) 46.79 billion

Source: AlexLeAnders

Based upon further information leading up to the rumored product introduction of the iWatch, I’m making some key changes to assumptions that I have had about the product. In my prior article, I used a cost of revenue figure that may have excluded the impact of sapphire screens, which when I add the impact back in, I think the cost of revenue per watch should be significantly higher at $82. I use figures from the Taiwan Topology institute to figure out the base cost, and add in the cost of sapphire screens using Matt Margolis’ estimate.

Furthermore, there are rumors of a $400 ASP, Apple’s first generation products are a little pricier, and so I think that this case scenario may actually play out. However, I’m going to move my unit shipment assumption closer to my original estimate of 42 million, for first year iWatch shipments, versus the 50 million I had originally estimated based on production run figures.  I think that because the supply chain is flexible, I don’t think Apple will over-produce; therefore over-supply shouldn’t be too much of a concern, so it’s unlikely that there will be an inventory charge in future fiscal reporting periods.

Breakdown Per Unit in $(unless otherwise specified)
iWatch Revenue 400.00
Watch cost + Sapphire ($77+5) 82.00
Gross Profit/td>

318.00
Operating Expenses (estimate) 53.43
Income Tax (35% rate) 59.35
Net Income 205.22
Net Profit Margin 51.31%
Profit assuming 42 million units sold at $400 ASP 8,610,000,000.00

Source: AlexLeAnders

In my updated breakdown, I estimate that the net profit margin on the device will be 51.31%. These kinds of margins are high, but given the small screen size, and limited space for internal components, the cost of revenue figure may make sense. The primary cost drivers going into the iWatch will mostly be driven by R&D and SG&A. I come up with the operating expense figure, when averaging the SG&A and R&D on all device unit shipments, in the case of Apple the OPEX per unit is $53.43, which I then apply to the iWatch. I also apply the U.S. corporate tax rate, just to add further conservatism to my estimates, even though the tax mix from foreign countries is likely to lower the actual income tax that Apple will pay on earnings from its new product category.

Conclusion

When making these adjustments, I think that Apple’s new iWatch will contribute $8.6 billion in net profit and $16.8 billion revenue to consolidated results over a full calendar year. However, the iWatch may not be released until the beginning of calendar year 2015, which makes revenue recognition difficult to predict, because iWatch will not receive the seasonal benefit of a CY fourth quarter launch.

Since we’re anticipating a iWatch launch sometime in the beginning of FY Q2 2015, Apple will have 3 full quarters to recognize sales for iWatch. So the actual impact to FY 2015 results may be 3/4th of what I calculate for a full calendar year. Therefore I arrive at the conclusion of $6.475 billion in profit contribution in fiscal year 2015. This figure may be smaller due to seasonality.

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