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Can This Fashionable Underdog Challenge the Apple Watch?

By Leo Sun – Mar 23, 2016 at 4:30PM

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Fossil launches new Michael Kors watches to challenge the Apple Watch.

Fossil (FOSL 2.94%) recently unveiled two new smartwatches it produced under the Michael Kors (CPRI 1.23%) brand -- a gold-plated timepiece for women and a sportier black one for men. That starting price for both devices is $395, and both will arrive in department stores and Michael Kors stores this fall.

Source: Michael Kors.

Both devices run on Alphabet's (GOOG -0.12%) (GOOGL -0.04%) Android Wear, so they'll work with both Android devices and iPhones. Like other full-featured smartwatches, they'll also offer app notifications, fitness-tracking data, push notifications, and access to other Google services. However, Fossil and Kors' devices are entering a fairly crowded market dominated by a single device -- the Apple (AAPL -0.08%) Watch. Will these fashionable new smartwatches stand a chance against the tech giant's timepiece?

Why Fossil needs smartwatches
Fossil sells licensed watches from a wide variety of licensed luxury brands, including Kors, Burberry, Tory Burch, and Armani. Fossil pays these companies royalties equal to 10% to 20% on sales of those branded watches. Nomura analyst Simeon Siegel estimates that Fossil pays Kors around 10% for its current deal, which expires in 2024. Therefore, sales of Kors watches matters a lot more to Fossil than Michael Kors, which generates most of its revenue through handbag sales.

Last quarter, Fossil's revenue fell 7% annually to $993 million -- marking its fifth consecutive quarter of year-over-year sales declines. Fossil attributed much of that decline to currency headwinds, but total sales still fell 2% on a constant currency basis. On that basis, watch sales -- which accounted for 77% of its revenue -- dipped 2%. The company noted that rising sales of its Skagen and Fossil brands was offset by declining revenue from its licensed watches. That's why Fossil developed Kors-branded smartwatches -- to boost sluggish demand for those licensed brands. Earlier this year, the company pledged to launch over 100 wearable devices throughout 2016.

In addition to licensed smartwatches, Fossil has already launched a first-party line of Q wearables, which currently include the Q Dreamer and Reveler fitness trackers, the Q Founder display smartwatch, and the Q54 and Q Founder analog smartwatches. Fossil recently announced that it will expand that lineup with seven more devices in the near future. It also agreed to acquire fitness tracker maker Misfit last November.

Fossil's Q wearable devices. Source: Fossil.

But can Fossil catch up to Apple?
Research firm IDC estimates that Apple sold 13 million smartwatches last year, which fell short of its original forecast for 21 million shipments. For 2016, IDC estimates that Apple will ship 14 million units and capture nearly half the overall market. But the firm only expects 6.1 million Android Wear devices to be shipped, which would account for just 21% of the market.

This means that even if Fossil captures a fourth of the crowded Android Wear market with its scattergun strategy, it would only equal sales of about 1.5 million devices this year. Assuming that its average Android Wear device prices stay between $200 and $400, Fossil's smartwatch sales might generate between $300 million to $600 million in revenues -- roughly 10% to 20% of its projected sales for 2016.

But like the saturated Android handset market, the Android Wear market is already crowded with an increasing number of similar-looking wearables running the same software. By comparison, Apple is the only manufacturer of watchOS devices, and the Apple Watch is closely tethered to the almighty iPhone. Therefore, instead of wondering if Fossil can compete against Apple, the real question is whether or not its devices can stand out against high-end Android Wear devices like the Huawei Watch or LG's Watch Urbane.

The smartwatch market might be slowing down
Lastly, Fossil investors should note that the smartwatch market probably isn't growing as fast as some bullish analysts had anticipated. Apple's lower-than-expected Apple Watch sales and its recent $50 discount on the Apple Watch Sport both indicate that the market still hasn't gained enough mainstream momentum yet. A Samsung spokesman also told Computerworld that smartwatch sales had been weaker than expected during CES this year.

Therefore, Fossil's new Kors and Q smartwatches represent interesting new additions to its portfolio, but I don't think investors should consider them magic bullets that will solve Fossil's lackluster sales of licensed watches anytime soon.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Apple. The Motley Fool owns shares of Michael Kors Holdings. The Motley Fool recommends Fossil. 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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