One of my key themes of 2013 is that the intensity of the smartphone
Yet as we’re seeing at both Google (GOOG)’s Motorola business and at HTC, the smartphone business is a tough one. Motorola continued to be an overall drag on Google’s profitability during 4Q 2012 given continued operating losses. Meanwhile, preliminary results show HTC squeaked out a modest operating profit of NT$0.6 billion on revenues of NT60.0 billion - that’s an operating margin of only 1% for 4Q 2012. While that sounds “eh” a bit of context shows that HTC’s operating margin was 7% in the September 2012 quarter. Now that’s not a pretty picture and underscores the competitive pricing environment as well as the downward pressure on profits as smartphones migrate from the upper-tier price points to mid- and low-tier ones.
While there is much talk about the turnaround efforts at both Nokia (NOK) and Research in Motion (RIMM) we have to differentiate between smartphone shipment growth and operating profit generation. As an investor, I focus on a company’s operating margins as it tends to paint the picture of the company’s ability to generate profits after manufacturing, sales and marketing efforts, R&D and other overhead. As operating margins expand or contract so does EPS cash generation, all things being equal.
Not only will Nokia, Research in Motion and others have to contend Google/Motorola and HTC as well as Sony (SNE), Apple and Samsung vying for market share but two new players gaining traction according to IDC could pressure margins even further. Those two players are Huawei and ZTE, which took the #3 and #5 spot for 4Q 2012 smartphone shipments. While those two companies had respective market shares of 4.9% and 4.3% in the quarter, they were ahead of HTC, LG, Nokia, Research in Motion and a host of others. While Nokia, HTC and RIM shipped the third, fourth and fifth most smartphones during all of 2012, those three companies were absent from the top five for 4Q 2012. What helped Huawei vault into the top five for 4Q 2012 - according to IDC it was Huawei’s emphasis on less expensive handsets.
With China becoming an increasingly important smartphone market as the U.S. and Western European markets see smartphone penetration mature, it likely means that we've not heard the last from either Huawei or ZTE. According to the Chinese calendar, in 2013, February 9 is New Year's Eve, marking the last day of the Year of the Dragon, while the 10th ushers in the Year of the Water Snake. The key point is that Chinese New Year is one of the most popular gift giving seasons in China and that likely means further market share gains for Huawei and ZTE in the current quarter.
Looking at all of this from a 10,000 foot view, its says that the competitive environment will only worsen in the coming months. While not a breakthrough revelation -- many were already expecting this as Research in Motion looks to take back share with its new Blackberry and BB10 offerings as well as HTC, LG and other smartphone manufacturers looking to claw back share.
As an investor, I’m less inclined to invest in many of these companies for the long-term. Rather, I’m far more interested in the shares of those companies like Qualcomm (QCOM), Skyworks Solutions (SWKS) and RF Micro Devices (RFMD) that are poised to gain incremental share and dollar content as the industry transition to smartphones and tablets continues.