By Seth Golden From Seeking Alpha

Summary

Wearables provide less solutions and more passive tracking results.

Apple Watch sales will peak with distribution saturation.

Fitbit’s attrition rate shows the level of usefulness for wearables.

Back in January, I offered readers and investors the following chart concerning Apple Inc. (NASDAQ:AAPL) that was published in my instablog.

The graph of AAPL indicates a possibility that shares of AAPL could decline into the $70 range over time. The chart and technical analysis was provided by Slope of Hope blogger Tim Knight. He goes on to say the following:

“Now here’s the going-out-on-a-limb part: I suspect that Apple is more likely to be down on Wednesday than up. I further think that, in the months ahead, Apple is going to find itself at a place no one dare imagine: in the 70s.”

While shares of AAPL have not yet found themselves in the $70s, shares did decline on the earnings release prediction made by Mr. Knight, even in the face of reasonably good results.

There is always a good deal of “hubbub” to do about Apple as the company and their executive teams have changed the world we live in. For better or worse, Apple is an iconic brand and producer of consumer goods that has achieved levels of sales and success not likely imagined possible by the masses in the 1990s. It is within its core competency, however, that the stock languishes from time to time and before advancing meaningfully in either direction, consumer goods.

And the consumer dictates the level of success Apple products achieve depending on the product’s usefulness. As such, and given Apple’s track record for identifying consumer needs, the foray into the wearables found myself with a good deal of consternation over the notion.

As of January 4th, I publicly issued my first of a series of publications on the wearables category through dedicated analysis of Fitbit (NYSE:FIT). While my official reports landed with the institutional investor a week prior to freely published materials, investors were alerted to many of the misnomers regarding the total addressable market for the category and its leading selling products by sales volume. Since alerting concerned investors about the real total addressable market for wearables, which has been greatly exaggerated by IDC, shares of FIT plunged from $39 a share to where they rest below $13 on this trading day.

The thoughtful and never before articulated analysis displayed in “Fitbit’s Total Addressable Market Hype May Leave Investors With Disappointment,” highlighted many shortcomings within investor consideration for the wearables category as well as a consumer good company with a relatively singular product offering.

Through my participation at the Consumer Electronics Show, I also published materials identifying just how crowded the wearables space had become with over 50 companies offering hundreds of wearables products. Barriers to entry in the category are easily hurdled over and retailers have only begun to discover the true rate of sales on the shelf that will inevitably depreciate over time. And it is with this consideration that I come to find myself better understanding the greater institutional shareholder concerns over Apple’s ability to achieve long-term success within the wearables category.

My concerns surrounding the Apple Watch are mirrored in dozens of articles that have proliferated since the launch of the product line. Ideally, Apple might have launched an un-tethered version, one that did not require dual device connectivity and forcing a wearables user to accommodate the functionality through smartphone usage. In doing so, Apple has unfortunately set a standard or expectation in the consumer’s mind that may prove difficult to overcome in the future and should future Apple Watch iterations become un-tethered to the iPhone.

As such, this was my first articulated thought when confronted with questions surrounding the Apple Watch when it was disseminated to the investor community. If the unit price wasn’t already a concern for analysts, functionality as a practical device in lieu of a smartphone became ever present in understanding the Watch’s potential longer term.

Moreover, that is the issue not just with the Apple Watch, but for the totality of the wearables category. If we understand what wearables like Fitbit and Apple Watch purport themselves to do for the consumer, these products are non-essential consumer goods. In short and as I’ve recognized them to be with great detail and support, nobody needs these devices.

Furthermore, their practical usage by the consumer is extremely limited. Where Fitbit is largely engaging those consumers with a health & wellness driven intent or consideration, Apple is targeting consumers with form, function and fashion intent by and large. Regardless of the target markets, one important detail has escaped many an investor and it is one that can’t be argued otherwise, “The consumer does not need a wearable device.”

This is not to suggest that wearables don’t have a purpose as they certainly do, but rather there is an existing and more simplistic way of achieving the usefulness of a wearable. In kind, this is the same problem that tablets have faced since their genesis and sales commencement. There was already a product that did exactly what the tablet purported to do for the consumer.

The Apple Watch is a great product, no better and no worse than a Fitbit, smart watch or simple fitness tracker. They all have great functionality at the end of the day and even if this functionality were to advance such a variable would still not find itself overcoming the fundamental flaw within wearables; they are non-essential consumer goods. As such and in kind with tablets, I would expect sales for the Apple Watch to do nothing but decline post distribution saturation.

In other words, once the Apple Watch finds retail distribution saturation, sales will fall and do so in a precipitous fashion. Presently, NPD Group data (subscription based reporting) shows the totality of the wearables category exhibiting weaker sales for same-sku-sales on a YOY basis. A great majority of the data comes through Fitbit tracking devices I would concede.

Having said that, it would be imprudent and impractical to assume that the leader in the wearables space would be an outlier with regards to the inevitability of declining sales for a consumer good post distribution saturation. It’s just one of the most important and telling reasons products go through several cycles of product iterations. It’s also one of the most important reasons Fitbit has indicated sales will grow in the 30% range after exhibiting sales growth in the triple-digit range in previous years. Distribution sales gains are always, 100% of the time, greater than consumer takeaway or sell-through as it is known.

For all of Apple’s worth, cash flow and asset valuation that could and has meaningfully benefited shareholders, investors of greater magnitude understand the company to be one of the greatest consumer goods companies of our time. Within that understanding are pros and cons if you will and the cons sometimes become magnified beyond the ability of Apple to dissuade with buybacks and dividends.

A consumer good company is sometimes only as good as its last product or product iteration. The Apple Watch is, in my expert opinion, an ill advised upon product. I speak in those terms as it pertains to its ability to sustain the AAPL multiple long term. If I were to speak of the Apple Watch in terms of the short term, I would be forced to recognize and articulate it’s billion-dollar sales generation.

This will likely improve until saturation points are achieved. But long term, and the business cycle for the Apple Watch will likely be shorter than that of predecessor products, the Apple Watch will fail to increase the multiple and add to the bottom line for Apple Incorporated. While many might extrapolate my statements to be little more than opinion-based, I would suggest a more dedicated approach to understanding why a consumer would purchase an Apple Watch as well as the attrition rate for wearables.

The attrition rate for wearables is deeply concerning and highlights exactly why these products render themselves obsolete in short order. Fitbit’s recently reported results identify the attrition rate as not only a reason for concern, but in an increasing fashion. Fitbit’s attrition rate had been in the low 40% range prior to releasing its latest quarterly results, which now show the attrition rate close to 50% with the 2-year attrition rate above 40 percent.

As stated earlier, nobody needs a wearable device and for many a good reason. If the device doesn’t mimic or replicate every aspect of a smartphone, the passive activation of a fitness tracker finds users easily disengaged in a relatively short period of time. For early adopters, the device becomes novelistic and unnecessary and never purchased again and for any iteration.

The Apple Watch, for all of its touted form factor and fashion forward aesthetics will not likely find itself in a different market position than Fitbit or its many marketplace competitors. Fitbit presently boasts a distribution network of roughly 50,000 retail doors and with Apple Watch having only 12,000 or so retail doors, the runway for the Apple Watch is seemingly robust. Having said that, retailers are quickly recognizing same-store sales results for the wearables category and are likely to curtail their inventory levels in the future.

A wearable is not a cell phone, smartphone or any other phone we’ve come to adopt and accept as a device that has changed our lives. Where Apple Inc. investors clambered for an iPhone of greater screen size in the past, these same investors have to recognize the paradox of a smartwatch I would have to think. “But I don’t have to take my phone out of my pocket to check it periodically.”

When being offered such a limited benefit that the Apple Watch proposes to offer, I easily retort with why the cell phone became an essential part of our daily lives. “That’s not the same as seeking out a pay phone off the beaten path or in some random shopping center.” Additionally, what will remain less expensive and easier to maintain or achieve mass adoption, the Apple Watch or a cell phone, smart or otherwise?

The cell phone changed our lives because of the benefits to the consumer with respect to the existing technology it proposed to supplement at the time and replace over time. A wearable device doesn’t offer that same ability and within a price point that can supersede that of cell phones, at least not to date. But even if it were to, the screen size… don’t forget that important point.

It’s not a matter of should or shouldn’t Apple Inc. have ventured into the wearables space. Retailers are always the earliest of early adopters and vendors are always the marketers of greatest significance when it comes to retail buyers. They can easily and often fool all of the buyers all of the time, but long term they can’t fool all of the consumers all of the time.

The Apple Watch will likely find itself in a dubious position of market laggard in the coming 12-24 month period and the company will continue to find itself under the thumb of investors that continue to focus on the iPhone product line. As such, shareholders of record would be wise to do the same and focus their long-term investment thesis accordingly.

Disclosure: I am/we are long FIT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

For more on this story go to: http://seekingalpha.com/article/3945206-apples-watch-presents-less-potential-investors-think?