A Leading Smartwatch Maker Trading Below Liquid Assets

Report Highlights

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