Disclosure: Zepp Health Corporation has paid FRC a fee for research coverage and distribution of reports. See last page for other important disclosures, rating, and risk definitions.
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Founded in 2013, and headquartered in China, Zepp is a smart wearable/health technology company offering a diverse range of products such as smartwatches, wristbands, earbuds, hearing devices, blood pressure measurement systems, and treadmills. Smart wristbands, and watches, make up 90%+ of Zepp’s revenue. Europe & the Middle East account for 50% of its sales, followed by North America (25%), China (10%), and rest of the world (15%).
We estimate that Zepp's self-branded products account for 1.3% of the global wearables market by volume. When including Xiaomi's products, Zepp's share increases to 4.1%. Zepp commands an 8% market share in the smartwatch category.
Global shipments of wearables were up 46% p.a. from 2018 to 2021, but declined 8% in 2022 due to subdued demand, and chip shortages. However, shipments rebounded in 2023, driven by a resurgence in demand, and as chip supply shortages were largely addressed. It is estimated that shipments will rise by 6% in 2023, followed by 5% p.a. growth through 2027 (Source: IDC).
At the end of Q3-2023, working capital, and investments, net of long-term debt totalled RMB2.12B (US$296M) vs Zepp’s MCAP of US$67M, implying that its shares are trading below liquid assets.
Zepp is trading at just 0.03x forward revenue vs the sector average of 1.9x, implying a 99% discount. Given Zepp's strong foothold in the wearables space, and its shares trading at exceptionally low multiples, we believe the company is a compelling acquisition target for larger players such as Xiaomi.
Risks
- Competition and innovation
- Supply chain vulnerabilities
- Reliance on third-party manufacturers
- Data security concerns
- Need to always allocate substantial budgets for marketing
Background
Zepp is a smart wearable/health technology company that provides smartwatches, physical fitness monitors, activity trackers, and pedometers. These devices serve the dual purpose of tracking fitness goals, and managing chronic conditions. Powered by a proprietary health management platform, which comprises the Zepp OS, AI chips, biometric sensors, and data algorithms, Zepp has shipped 200M+ units in 90+ countries since its inception. Zepp’s devices are compatible with iPhone, Samsung, and other Android devices.
Similar to Apple, and Xiaomi, Zepp does not possess manufacturing capabilities, and instead, relies on contract manufactures for production.
Formed in 2013
Listed on the NYSE in 2018
Headquartered in Hefei, China
1k+ employees, including 550+ in R&D, and 450+ in sales / marketing / administrative positions
900+ employees in China, and 100+ in the U.S./Europe/Asia
Products/Sold Under Brands Amazfit & Zepp
Smart wristbands, and watches, constitute 90%+ of Zepp’s revenue. These products cater to diverse audiences, addressing various needs such as ruggedized versus everyday use, or sports versus fashion.
Zepp’s smart watches can be categorized into three – lifestyle watches, sport watches, and value/affordable watches.
In the lifestyle category, Amazfit competes directly with Apple, and Samsung watches
We note that Amazfit is a lower priced option
While the brands offer varying designs, our research suggests that their features are largely similar
In the sport watch category, Amazfit competes directly with Garmin (NYSE: GRMN), and other Chinese brands
We note that Amazfit is competitively priced
In the value/affordable category, Amazfit competes directly with Xiaomi, Huawei, and Garmin
Amazfit prices are relatively low in this category as well
In addition, Zepp offers a wide range of products including the following:
These products account for <10% of Zepp’s revenue
Partnership with Xiaomi
Zepp is a manufacturing partner of Xiaomi. Since 2017, Xiaomi has outsourced the production of some of its models to Zepp. The current agreement is set to run until January 2025. We anticipate an extension, considering Xiaomi's significant shareholding in Zepp. Xiaomi is responsible for handling the distribution, and sales, of products manufactured by Zepp. We believe Xiaomi’s reliance on Zepp reflects a significant vote of confidence in Zepp's capabilities.
Xiaomi is the second largest wearables company in the world, behind Apple
Unit Sales & Other Key Metrics
Source: FRC/Company
Shipments of Xiaomi units have been declining since 2021, largely attributed to softer demand for the models assigned to Zepp
As a result, Zepp's dependence on Xiaomi has been waning, as evidenced by the declining share of total revenue contributed by Xiaomi
In line with standards, Zepp garners 70% of the retail prices of its products as revenue, with the remaining 30% going to retailers/distributors
Source: FRC / Company
Revenue per self-branded unit was up 9% YoY to RMB408 in 2023 (9M) vs the five-year average of RMB401
Revenue per Xiaomi unit was down 31% YoY to RMB87 in 2023 (9M) vs the five-year average of RMB107
Geographical Distribution – Zepp does not provide segmented results; however, through our discussions with management, we have gathered the following information:
Total Unit Sales – 50% from China, and 50% from international markets
Self-Branded Products – Europe & the Middle East (50%), North America (25%), China (10%), and the rest of the world (15%)
Xiaomi Products – 70% from China, and 30% from international markets
Product distribution encompasses major retail chains, electronic stores, Amazon (NASDAQ: AMZN), and a diverse array of both small, and large retail, as well as e-commerce outlets. On Amazon U.S., we noticed that Zepp's products consistently earn 4-5 star ratings on listings with a minimum of 1,000 reviews. These ratings are on par with those of Apple and Samsung watches, even though the latter two have significantly higher numbers of reviews.
Zepp allocates significant resources to its marketing initiatives
In 2022, Zepp spent 11% of revenue in sales/marketing expenses, while Apple spent <5%
Management anticipates revenue growth through the introduction of new products, and international expansion.
Competition and Market Overview
Wearable Devices by Shipment Volume (Millions)
Hearables lead the wearable product categories, followed by smartwatches and wristbands
The smart wearables market is dominated by Apple, Xiaomi, Huawei, Samsung (KOSE: A005930), and Fitbit (Google/NASDAQ: GOOGL). Fitbit (founded in 2007) was acquired by Alphabet for US$2.1B in 2021. Fitbit had generated $1.2B in revenue in the same year, implying a valuation multiple of 1.8x vs the current sector average of 1.9x.
Apple accounts for 20% of global shipments, followed by Xiaomi at 10%
We note that Zepp’s self-branded products account for 1.3% of global shipments
Including Xiaomi’s products, Zepp accounts for 4.1% of global shipments
In 2019/2020, Zepp's growth lagged behind that of the sector. In 2021, with sustained traction, and the introduction of new products, Zepp experienced a growth rate 3.1x that of the sector. However, in 2022, the sector contracted for the first time, and Zepp underperformed the sector. Overall, we note that Zepp's historical growth rate has averaged 1.6x the global growth rate.
Management and Board
Source: FRC / Company
Zepp's founder and Chairman, Wang Huang, owns 36% of Zepp’s outstanding shares
Before founding Zepp in 2013, Mr. Huang was a R&D engineer at Huawei
A co-founder of Xiaomi serves as a director of Zepp
Financials
Source: Company, FRC
In 2023 (9M), revenue was down 39% YoY, driven by a 59% YoY decline in revenue from Xiaomi units, and a 19% YoY decline in revenue from self-branded units
We anticipate revenue from Xiaomi will continue declining, unless Xiaomi engages Zepp to manufacture additional models. Revenue from self-branded units were up 13% QoQ in Q2-2023, and 8% QoQ in Q3-2023. We believe Zepp should be able to maintain the upward momentum in sales of its self-branded units, mitigating the negative impact of declining revenue from Xiaomi products.
Source: Company, FRC
However, gross margins surged 5 pp to 24%, primarily driven by Zepp’s decision to suspend production of low-margin units
In Q3-2023, gross margins on self-branded units spiked by 19 pp to 40%, exceeding the sector average of 24%, and approaching Apple's 44%
On average, Zepp spends 9% of revenue on R&D vs 7% by Apple, highlighting Zepp’s commitment to innovation
Source: Company, FRC
In 2023 (9M), softer revenue led to a 44% YoY decline in EBITDA
EPS remained negative
FCF deteriorated
At the end of Q3, Zepp had RMB1.28B in working capital, RMB1.70B in investments, and RMB0.86B in long-term debt
Working capital, and investments, net of long-term debt was RMB2.12B (US$296M) vs the current MCAP of just US$67M, implying that ZEPP is trading below liquid assets
We believe the company will not have to pursue any financings in the near future
FRC Projections and Valuation
For Q4-2023, Zepp is projecting RMB600M-RMB860M in revenue
We are conservatively projecting RMB612M
We note that Zepp's revenue has consistently landed on the lower side of management's guidance over the past few quarters
Our models are based on the assumption that Zepp’s revenue will grow 1.6x the forecasted global growth rate, in line with the historical trend
Source: FRC
Our DCF valuation is US$3.83/share
Source: FRC/S&P Capital IQ
ZEPP is trading at 0.03x forward revenue vs the sector average of 1.9x, implying a 99% discount
ZEPP is the most undervalued stock on this list
Applying 1.9x to our 2023 revenue forecast for Zepp, we arrived at a comparables valuation of US$6.34/share
Zepp retains equity in various suppliers and partners including a 30% interest in Jiangsu Yitong High-Tech (SZSE: 300211/MCAP: US$449M). The value of Zepp's interest in Jiangsu amounts to US$135M vs Zepp’s current MCAP of US$67M.
We are initiating coverage with a BUY rating, and a fair value estimate of US$5.08/share (the average of our DCF and comparables valuations). Upcoming catalysts include new product launches, international expansion, and the potential for an uptick in sales of self-branded units. Given Zepp's strong foothold in the wearables space, and its shares trading at exceptionally low multiples, we believe the company is a compelling acquisition target for larger players such as Xiaomi.
Risks
We believe the company is exposed to the following key risks (not exhaustive):
1. Competition and innovation
2. Supply chain vulnerabilities
3. Reliance on third-party manufacturers
4. Revenue dependency on Xiaomi has been declining, though there is still some reliance at this point
5. Data security concerns
6. Officers, directors, and principal shareholders hold 95% of total voting power
7. Need to always allocate substantial budgets for marketing
