We’re updating our Apple Wearables, Home, and Accessories model. This category includes two signature products, Apple Watch and AirPods. While Apple does not report details on those segments, the company has made 24 unique comments since Dec. 2014 related to trends in the category, typically in regards to growth rates and trailing revenue.
- Growth accelerating. While Apple does not report a wearables number, we now believe the segment’s growth accelerated for the 4th consecutive quarter in Sep-19 to 65%, compared to Jun-19 at 60%, Mar-19 at 48% and Dec-18 at 32%. Previously we expected Sep-19 growth of 39%.
- AirPods more than doubles. We now expect AirPod units in CY19 of 59.9m, up 110% over CY18. Previously we had modeled 50m units up 75%.
- Watch. We’re now expecting 28% Watch unit growth in CY19, compared to our previous estimate of 20%.
Rolling out 2020 Wearables Estimates
- Wearables bigger than Mac. We now expect wearables to account for 11% of revenue in CY20, up from 8% in CY19, slightly exceeding Mac revenue at 10% of total next year. Our model suggests wearables growth of 45% next year down from 58% in CY19.
- AirPods. We expect CY20 AirPod unit growth of 60% with 95.8m units, down from 110% growth with 59.9m units in CY19. Revenue growth of 80% is faster than unit growth (due to higher-priced AirPods Pro), compared to 131% in CY19.
- Watch. We expect CY20 Watch unit growth of 30% with 36.8m units, up from 28% growth with 28.4m units in CY19. The acceleration in unit growth is attributed to the Sep-19 price reduction of Series 3 to $199. Revenue growth of 21%, is down from 30% in CY19.
Beyond 2020, Watch has Significant Room to Grow
Overall Watch adoption remains nascent, which we believe supports 20-30% unit growth for the next five years. We estimate at end of Sep-19, 8% of iPhone owners used a Watch (based on a 3 year expected life). Long-term, we believe the attach rate could reach 40%, which implies about 125m units a year (compared to our 36.8m estimate for Cy20). This implies in 2025 about 12% of Apple’s overall revenue will be Watch (assumes $48B in $385B in overall revenue in 2025).
In May, we wrote that the fear of tariffs was leading investors to make false predictions, causing distortion to the financial markets. We suggested taking the approach of sober analysis based on what is known rather than speculation. At the time, there were questions about how Apple would be impacted.
Now we have more facts. Apple does pay tariffs today, some that went into effect before September and others started in September. That said, the company does not comment on tariff offsets that it continues to receive that lessen or eliminate the impact of the tariffs on Apple’s cost of goods.
The anxiety around additional Apple tariffs has abated since May but still lingers with investors as evidenced by AAPL’s 2% decline this week following comments from President Trump that the China trade dispute would likely be prolonged, along with the reiteration that potential new tariffs are scheduled for December 15.
These proposed 15% tariffs include smartphones for the first time. Given the inclusion of smartphones, the December additions represent the greatest tariff risk to date for Apple. iPhone will account for about 52% of revenue in FY20, down from 55% in FY19 and 62% in FY18.
Indications Suggest Apple Has Little Risk
The key question of course is will Apple be exempt from the next phase of tariffs? Our answer is ultimately Apple will be exempt or provided levers to offset the impact of tariffs. This is based on five indications (in order of importance):
- Dec-19 guidance. At the time Dec-19 guidance was issued, Apple was aware of the proposed December tariffs. Cook talked about his “positive” December view when answering a question related to tariffs. Given the company’s conservative nature, if there was a risk of new tariffs impacting iPhone profitability, that view would have presented itself in Dec-19 gross margin guidance. Instead, Apple guided the gross margin midpoint to be flat from Sep-19 to Dec-19 at 38%.
- Recent comments from Trump. President Trump’s Nov 20th comments at the Apple Austin event seem to publicly all but rule out additional Apple tariffs. Specifically, the President said that he’s “looking into” whether Apple should be exempt from tariffs on Chinese imports in an effort to level the competitive playing field with Samsung, which benefits from a US-South Korea trade agreement.
- Trump respects Cook. Cook’s unique status and relationship with Trump has been well documented but is worth mentioning. At the Austin event, Trump commented, “Tim Cook is somebody that I greatly respect — a great leader, a great businessman.” It appears, at a personal level, Trump wants Cook to succeed, and the President can advance that goal by providing an exemption or offsets to limit their impact.
- September precedent. The fact that Apple was provided offsets in the previous Sep-19 tariff rounds sets a small precedent that they will receive future offsets.
- Macro softness. General macro softness suggests that tariffs and the resulting pressure on Apple, the US’s largest consumer tech company, during the critical holiday buying period would be ill-advised.
Timing of Clarity
Using the Sep-19 tariffs as a benchmark, Trump will likely announce the tariffs around December 15th, but it will likely be a couple of months before we get clarity on their impact on Apple’s business. We expect the first material update at the end of January when Apple reports its Dec-19 earnings.
Looking back to Apple’s Sep-19 earnings call, Tim Cook first addressed tariffs in response to an analyst question, stating “we’re paying some tariffs today, as you know, some that went into effect pre-September and some others that went into effect in September. So we are paying some. That’s been comprehended. But in general, my view is very positive in terms of how things are going. And that positive view is obviously factored in our guidance as well”.
We patiently await Cook’s response to the question on the company’s late January earnings call.
As one of the world’s leading enablers of technology addiction, Apple also walks the fine line of helping to curb it. Features like Screen time, Downtime, Quiet Hours, App Limits, and Do Not Disturb represent Apple’s efforts to equip customers with the tools they need to use devices responsibly — and make their products better by helping people use them less.
Apple’s holiday ad for 2019, The Surprise, walks this very line, showing both the downsides of two young girls on a stressful holiday trip full of screen time and the upsides of the magic and creativity these devices unlock.
Great Products that Enrich Lives
This same tension is evident in Apple’s mission to make great products that enrich people’s lives. Great products are behaviorally engineered to drive engagement and usage, which has led to technology addiction. We’ve written much on the topic of tech addiction here.
But these products also enrich people’s lives. They are the tools with which innovators change the world, make it more connected and more productive, create art and beauty, solve the world’s biggest challenges, and save lives.
We believe that technology itself is not the culprit; people’s use of technology, however, can be destructive. The magic is made in the balance of using these tools for good and not letting them consume us. They impact the world most when they aren’t being used.
Face Time vs. FaceTime
Tim Cook himself has said that it’s wrong to look at your device more than you look in someone’s eyes.
“We made the phone not so that you’d use it all the time; we made the phone to make your life better.” – Tim Cook
In the spirit of making someone’s holiday, remember that simple rule. More face time than screen time. Allow these devices and the magic they create the room they need to breathe and impact the world for good.
Recreation recreates us — literally, re-create. Give yourself the time and space you need to be with the people in your life that matter the most.
Happy holidays from Loup Ventures. We believe that technology cannot replace the human capacity to be creative, communal, and empathetic. These are the gifts that will make someone’s holiday!