While speculation as to how well the Apple Watch will sell is kicking into high gear, I wanted to frame the discussion a bit differently by publishing EPS matrices covering approximately 50 different Apple Watch sales scenarios. While the definition of success is largely subjective, and mostly dependent on how Apple frames the Apple Watch story, the device's impact on Apple's financial picture, given a set of parameters, is less open to debate.
The easiest way to read a matrix is to start at one axis (margin or average selling price), and then move down the column, or across the row, until aligned with the alternative metric (margin or ASP). For example, if I wanted to see the EPS impact from Apple selling 10M Apple Watch units at $550 ASP and 40% margin, I would start at the 40% margin column in Exhibit 1 and then move down until I reach the $550 row, leading to $0.28 of EPS.
Exhibit 1: Sample EPS Matrix
In Exhibit 2, the first set of matrices depict Apple Watch's impact on EPS assuming 10 million units are sold in the first 12 months. Depending on average selling price (ASP) and margin, Apple Watch would contribute $0.17 to $0.58 of EPS (add 2% to 7% to 2015 EPS).
Exhibit 2: EPS Matrices for 10 Million Apple Watch Units
In Exhibit 3, the second set of matrices depict Apple Watch's impact on EPS assuming 25 million units are sold in the first 12 months. Depending on ASP and margin, Apple Watch would contribute $0.44 to $1.45 of EPS (add 5% to 17% to 2015 EPS).
Exhibit 3: EPS Matrices for 25 Million Apple Watch Units
In Exhibit 4, the third set of matrices depict Apple Watch's impact on AAPL EPS assuming 40 million units are sold. Depending on ASP and margin, Apple Watch would contribute $0.70 to $2.23 of EPS (add 8% to 28% to 2015 EPS).
Exhibit 4: EPS Matrices for 40 Million Apple Watch Units
The easiest way to interpret these matrices is that at sales of 10M, Apple Watch's overall impact on AAPL EPS will be relatively modest (approximately 4% of 2015 EPS.) At 25M, Apple Watch would represent around 10% of 2015 EPS, still modest and easily overshadowed by iPhone sales fluctuations. If Apple shipped 35-40M Apple Watches, the impact on EPS becomes more sizable, potentially reaching 15-20% of overall EPS.
These matrices also make it easier to convert consensus Apple Watch unit sales into an estimated level of EPS "built" into consensus EPS. If consensus is around 20-25M Apple Watches sold in the first year (I'm at 20-30M), then that implies analysts have around $0.70-$0.90 of Apple Watch EPS built into consensus EPS estimates. If Apple were to ship 40M Apple Watches instead of 25M, this would lead to Apple Watch EPS of around $1.20-$1.30, $0.40-$0.50 higher than consensus. Vice versa, if Apple Watch sales are weaker than 20-25M and instead closer to 10M, then this would imply EPS is overstated by about $0.40/share.
Over the coming weeks as the debate regarding how many Apple Watches Apple could sell continues, I will be relying on these matrices to help frame how various sales scenarios will impact Apple.
For this exercise, 2015E EPS represents Above Avalon's FY3Q15 - FY2Q16 EPS to match the probable first 12 months of Apple Watch sales, and EPS figures are after-tax (assuming a 25% tax rate). I view R&D and SG&A costs as sunk costs in this report. I also include continued share buyback through 2015 to obtain shares outstanding estimates. This report was produced by Neil Cybart on January 5, 2015 and is not meant to be used as investment advice. I publish a daily email about Apple called AAPL Orchard.