Apple Watch Demo Reveals 1 Key Chip Supplier

According to the folks at Chipworks (via MacRumors ), Apple's upcoming Apple Watch will feature a Broadcom BCM4334 connectivity combo chip. The chip supports 802.11n and Bluetooth 4.0, and was also found inside the iPhone 5 and 5s. This means the Apple Watch should deliver pretty good Wi-Fi performance at a fairly low cost (since the BCM4334 is several generations old now).

The question, then, is what financial impact this could have on Broadcom's connectivity business.

How much does a BCM4334 cost?
Broadcom has signaled during various analyst days that connectivity combo chips tend to sell for between $3 and $6. In searching the Web for prices on the Broadcom BCM4334, I found a vendor selling a lot of five for $24.50, indicating a per-unit price of $4.90.

Keep in mind that Apple buys these chips by the millions, so it is likely to pay Broadcom much closer to $3 per unit than $5 per unit. So let's assume Broadcom would receive $3 per unit for the connectivity chips to be featured in the Apple Watch.

What about gross margin?
The next question is that of gross margin, or what percentage of the selling price the company actually keeps as gross profit.

Broadcom guided to a corporate gross margin of 52.5% (give or take 75 basis points) for its most recent quarter. My guess is that the connectivity chip business is lower margin for Broadcom than its infrastructure and broadband businesses, so let's assume the company's gross margin percentage on chips sold into the Apple Watch is about 45%. This works out to $1.35 gross profit per unit.

The million-dollar question: How many Apple Watches will Apple sell?
Now that we have a pretty decent handle on how much Broadcom can actually profit from the chips that go into the Apple Watch, the most important question is simply, how many will Apple actually sell?

Smartwatch sales for other vendors haven't exactly been inspiring. Samsung, which has iterated its Galaxy Gear line of smartwatches at a rapid clip, reported shipping 800,000 watches in two months back in November 2013. However, The Verge noted that the 800,000 units shipped were to retailers and not necessarily representative of sell-through to end customers. The Verge also raised a great point that Samsung has probably spend oodles of money in marketing the watches.

That being said, while the Apple Watch has its fair share of critics, I would argue that if any smartwatch has a chance of succeeding, it's this one.

Piper Jaffray analyst Gene Munster believes Apple will sell 10 million Apple Watch units during the first year of availability. If this number proves correct, that would mean an incremental $30 million in revenues and a $13.5 million increase in gross profit for Broadcom.

Is this a big deal?
To put this into context, Broadcom is expected to do about $8.32 billion in sales this year and $8.39 billion in 2015. So $30 million represents just 0.35% of Broadcom's expected fiscal 2015 sales.

In other words, it won't move the needle.

However, while the Apple Watch in itself won't be a big deal to Broadcom in its first year, some (pretty lofty) projections claim that smartwatch sales could grow to 373 million units by 2020. If that turns out to be true, then that's a pretty large total addressable market that Broadcom could go after. While I wouldn't expect the company to have overwhelming market share in smartwatches (I anticipate pretty brutal competition from the other connectivity vendors), even 20%-25% share of a 373-million-unit market isn't chump change.

Foolish takeaway
Whether Broadcom is actually in the Apple Watch or not (though the evidence is very convincing) isn't the big issue to focus on. For Broadcom, and other chipmakers like Broadcom, the real question is whether the smartwatch category will actually become significant.

The answer to that question will probably become much clearer once the Apple Watch has been in the marketplace for a couple quarters.

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Ashraf Eassa has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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