All of the major smartphone players face big questions in 4Q. Media types gushed over the new iPhones and existing customers stood in line to buy them in record numbers, but by resolutely ignoring the global consumer’s preference for larger screens and lower prices, has AAPL just traded another swath of market share for six more months of superior margins? On the Android side, leadership in smartphone specs has zoomed Samsung to leading share and enviable margins, but have high-end competitors like LG and Sony leapfrogged Samsung’s flagships and can shockingly low-priced, “good enough” products from emerging markets rivals, like Xiaomi, Lenovo, ZTE, Huawei, Spice, Karbonn, and Micromax, dominate the fast growing emerging markets and bite into Samsung’s profits? Google is taking a different tack with the design forward Moto X, which emphasizes personalization, a smart interface, and long battery life – does it have a chance to be a game changer? Microsoft is taking its only real OEM in house, but with NOK’s non-Windows products poised for a free fall and the Lumia line making only slow progress, can this deal possibly workout longer term? Finally, QCOM’s been on a big winning streak with its newest SOCs, but its bread-and-butter high-end products face a decelerating market, while Asian upstarts MediaTek and Spreadstrum are already dominant in the fast growing low end – can QCOM sustain its earnings growth against those trends? We believe that the answer to all of these questions is yes.
New iPhones driving upgrades not share gains. 9M launch weekend iPhones are a great start, but note that 1-2M units were 5C channel fill and that the 5M iPhone5 compare did not include the 2M unit Chinese launch a few weeks later. Still, with as many as 40M loyal iPhone users eligible for upgrade before year end, strong sales for the coming quarter appear well in hand. Nonetheless, 2014 will bring a fresh crop of Android “must-haves”, exacerbating the seasonality that has plagued AAPL the past two years. High-end smartphone sales are decelerating and the iPhone’s share has plateaued. Given an unequivocal denial of interest in the hot low-end market, at least a year’s delay with increasingly popular large screen models, and glacial progress on revenue-generating cloud-based services, it’s hard to make a case for a sustainable reacceleration in sales growth. That said, the high-priced new models do support near term stability in margins, although increasing competitive pressures and an ongoing mix shift toward lower profit products will be a continuing drag.
High end Android rivalry heating up. Samsung has led the spec wars, but new smartphones from LG and Sony have leapfrogged the Galaxy S4, with better processors, screens and cameras. Meanwhile, GOOG’s Moto X eschews this one-upmanship with pedestrian “specs” but well-praised ergonomics, battery life, personalization and proprietary software features. With another round of new models due for 1Q14, price pressures appear on tap, with platform provider GOOG, increasingly dominant SoC vendor QCOM, and HW licensor ARMH the only obvious beneficiaries.
Red hot low-end smartphone makers all chose Android. Total smartphone unit growth of nearly 50% has been partly offset by a 9% YoY drop in ASP, as demand for sub-$250 devices in China, India and other developing markets explodes. This dynamic has shifted global market share from 1st-world leaders, like Apple, Samsung and HTC, toward emerging market rivals, like Lenovo, ZTE, Huawei, Xiaomi, MicroMax and Karbonn. ABI projects the low-end segment to rise from 29% of the global market today, to more than 46% in 2018, fuel for continued growth of these brands, which can be expected to flex their increasing clout by moving further upscale to challenge today’s market leaders in developed markets as well. This will add to the price pressures already starting to play on AAPL, Samsung, and others, while favoring GOOG’s Android ambitions.
MSFT forced to buy NOK while waiting for enterprise to go mobile. MSFT knows that mobile devices will eventually take over its bread-and-butter enterprise market, and it wants to be prepared. So, when NOK, Windows Phone’s only champion, threatened to go Android, management was forced to act. In the end, we expect MSFT’s phone-to-server Windows 8 strategy to pay off, but keeping the smartphone platform viable in the near term will be very expensive. Ultimately, we expect the clunker RT platform to merge into Windows Phone, leaving MSFT with 2 related platforms bridging from smartphones to cloud-based VMs, and for enterprise adoption of Windows 8 to improve its reception in the consumer market.
QCOM can more than hold its own vs. MediaTek and SPRD. We believe QCOM is consolidating its leadership in mobile silicon, positioning itself to deliver sustained growth and profitability. In the high-end, market share gains on superior new SoC offerings, tablet design wins, and adding RF to the addressable market should more than offset deceleration in the end market. At the low-end, QCOM’s scale and design integration excellence have it profitably winning business from its Asian rivals. Moreover, market concerns about LTE royalty rates are misplaced.
BBRY circling the drain. Fairfax has made a bid, but without secure financing, investors may not be safe yet. Horrific 2QFY14 results reflect the death throes of the smartphone business, while the flash flood of messaging apps, particularly in the growth markets in Asia, Latin America and Africa, is killing the once valuable Blackberry Messenger franchise. BBRY’s patents have been widely cross-licensed to device OEMs, negating their value in the smartphone IPR wars – note the lack of royalty revenue and litigation success. Even the cash holdings are suspect – trapped overseas and burning at an accelerated pace. The long slow death of BBRY has been good to GOOG and AAPL, but the biggest beneficiary may prove to be MSFT, once the enterprise market finally goes mobile.
We favor components and software over devices. AAPL may ride its replacement cycle to strong Holiday sales, but product cyclicality, high-end smartphone deceleration, and new price competition loom in 2014 against buoyant expectations. Samsung, HTC, LG and Sony will be in an increasingly ugly scrum for global market share with signs that pushing processor and display specs may have hit the point of diminishing returns. The upstart Asians should have their first developed world successes in 2014, while they continue to build their dominance in China and India. MSFT will show modest incremental share gain with Windows Phone while it bleeds from the necessary death of NOK’s still sizeable feature phone franchise. The big winners are GOOG, QCOM, ARMH and a range of other component makers.
For our full research notes, please visit our published research site.