Watchmaker Fossil (NASDAQ:FOSL) has had a difficult year: shares have fallen more than 65% in 2015. A series of disappointing earnings reports have taken a toll, but the company's multiple has also contracted, likely fueled by persistent fears that Fossil's core market -- affordable watches -- will be devastated in the not-too-distant future. An onslaught of smartwatch competition, including the multitude of Android Wear devices from Alphabet's (NASDAQ:GOOG)(NASDAQ:GOOGL) many partners, poses an obvious risk.
But Fossil is fighting back.
Last month, the company acquired wearable and fitness tracker specialist Misfit for $260 million. Fossil intends to integrate Misfit's technology into many of its products over time, which could make them stronger alternatives to the growing number of smartwatches.
Making dumb watches smart
On Fossil's earnings call back in August, CEO Kosta Kartsotis spoke of a desire to build what he called "smarter watches". These watches would resemble Fossil's traditional offerings, but come equipped with a variety of chips and sensors. They'd offer fitness and sleep-tracking capabilities, but would still, essentially, remain traditional watches.
"When we talk about wearables, it's not just smartwatches...there [are] actually...different categories...probably the most significant long-term, is what we call smarter watches, which is just adding chips and additional functionality to existing watches...over time, by us adding additional functionality, sensors -- as technology changes, we think that we can add this across our platform and have additional functionality in [our] watches..."
Fossil's recently released Q Grant is a perfect testament to that strategy. From the outside, it's almost indistinguishable from any of Fossil's other watches -- but it's a Bluetooth-connected activity tracker, able to monitor steps taken and calories burned. It can also provide notifications in a limited way: a light on the watch will display different colors (for different contacts) and vibrate.
The Misfit acquisition appears aimed at furthering Fossil's focus on smarter watches. On the company's most recent earnings call in November, Chief Strategy Officer Greg McKelvey drew particular attention to Misfit's use of traditional watch batteries.
"A big part of the value of the Misfit platform...[is that] their technology is built on replaceable coin cell, or watch-type batteries...their whole software runs on those. What that allows us to do is very quickly scale both smarter watches and activity trackers that use those coin cell batteries...across all channels without having to worry about putting power and expensive fixtures in place."
Fossil will be able to fold Misfit's technology into its traditional watches, and perhaps more importantly, make use of its app and its data. "The Misfit acquisition is really about owning the cloud on the app platform," McKelvey added later in the call.
It's better to own the platform
Fossil also makes an actual smartwatch, the Android-Wear powered Q Founder. During the November call, management reiterated its commitment to that product and to its partnership with Alphabet's Google, but it's easy to see why it would prefer to sell customers smarter watches rather than actual smartwatches. McKelvey explained on the call:
"It's really too important to outsource that [connectivity] to somebody else...we want to own that customer experience; own the platform...just a pure economics of scaling our product size, breadth, number of brands across the fixed cost of the development of that platform makes for much more attractive margins, ultimately than we'd get if we fully outsourced it."
Fossil's Q Founder is as much a product of Google and Intel as it is a Fossil -- Google provides the software platform and Intel provides the chips. Given their digital displays and touch screens, Fossil's designers are limited in what they can offer with a smartwatch. And it introduces all sorts of uncertainty to Fossil's business -- if it becomes primarily a smartwatch vendor, it has to compete with a variety of tech firms and retool its business.
Two different sorts of products
Fossil's Q Founder and Fossil's Q Grant are two radically different sorts of products. They compete for the same wrist space, but they're giving two different answers to the same question. Do consumers want a standard watch that doubles as a fitness tracker? Or do they want a real smartwatch, with support for third-party apps, an interactive display, and voice commands?
Fossil investors should hope it's the former rather than the later.