Apple's (NASDAQ:AAPL) latest gadget, the Apple Watch, piggy-backs on the connectivity provided via an iPhone in order to be completely functional. However, some competing smartwatches out there today, such as the Samsung (NASDAQOTH: SSNLF) Galaxy Gear S, feature on-board cellular modems.
It has been widely rumored that future iterations of the Apple Watch won't need to be paired with an iPhone to be completely functional. Cowen analyst Timothy Arcuri thinks that Apple will free the Apple Watch from iPhone-dependence with the second generation Apple Watch.
I believe that in order for Apple to do this, it will need to integrate a cellular baseband into future Apple Watch applications processors.
Why is integration necessary?
There are a couple of reasons that integration of the cellular baseband with the applications processor is important for a device like the Apple Watch. Integration means fewer discrete components on the package, which means a smaller footprint compared to a discrete solution. For a device as tiny as the Apple Watch, a smaller footprint is better.
In order to integrate, Apple needs the modem IP
Unlike many other chip building blocks, like CPU cores and graphics processors, cellular modems can't be licensed off the shelf. That is, Apple would likely find it very difficult go to one of the major modem vendors and license the modem design so that Apple can integrate it into their own home-grown chip.
This means, then, that Apple will need to develop its own cellular modems so that it can integrate them into future Apple Watch applications processors. Apple hasn't yet deployed its own cellular baseband, but there's a lot of evidence out there to suggest that Apple is working on it.
Apple Watch seems like a reasonable place to deploy an Apple-designed baseband
It is very hard to compete with market leaders such as Qualcomm (NASDAQ:QCOM) at the leading edge of the cellular baseband market. There's a good chance that it would take Apple many years and many iterations of basebands before it could conceivably displace Qualcomm from, say, iPhones.
However, for something like an Apple Watch, my guess is that the baseband technology requirements are far less demanding than for a phone. For example, the aforementioned Galaxy Gear S comes with only 3G cellular connectivity -- that's far less sophisticated than what modern high-end smartphones feature today.
If you think about it, though, this makes sense. On an iPhone, a user is likely to download fairly large apps and multimedia content; the data needs of something like an Apple Watch seem as though they will be much less intense.
To that end, I think Apple can use the Apple Watch as a place to deploy its initial baseband efforts. Once Apple builds enough confidence in its ability to put together competitive cellular solutions, it can start deploying them in more critical products such as the iPhone and the cellular variants of the iPad.
So, about that huge R&D budget...
Analysts asked Apple's executive team about the company's ongoing large increases in research and development spending. CFO Luca Maestri said that the company is "developing some core foundational technologies more in-house" than it had in the past. I wouldn't be surprised if the development of a cellular baseband were part of Apple's now much-larger research and development budget.