HPQ Q3 – Home to roost

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The fundamental flaw in HPQ is laid bare.

  • Things have been looking better at HPQ in terms of corporate governance and cost control but Q3 results show that it is time to address the real problem: The PC business.
  • Q3 revenues / EPS were in line at $27.2bn / $0.86 compared to forecasts of $27.3bn / $0.87.
  • However, forecasts were poor with the expectation of growth in 2013 compared to 2012 rescinded and FY13 EPS expected at $3.53-$3.57.
  • Although the mid-point ($3.55) remains the same, the street was hoping for better with a consensus estimate of $3.57.
  • The shares were off 8% in after-hours trading.
  • The main problem was personal systems where revenues declined by 11% (consumer down 22% and commercial down 3%) and Enterprise where revenues fell by 9%.
  • Compared to Dell and other PC makers / Enterprise suppliers these are very poor results and share is being lost.
  • This is the heart of the problem and HPQ currently seems to have no clue how to turn these businesses around.
  • Changing directors and shuffling management is a good start but it is time to address the real problem.
  • The issue that HPQ faces in its PC business is exactly the same as Dell: the computing device market is now driven by form factor, touch and innovation.
  • This requires R&D of which HPQ has very little given that the PC business has been a commodity for years.
  • Hence it must make a decision.
  • Either invest substantially to bring HPQ’s PC’s into line with market demands or sell it to someone who will.
  • While the company procrastinates, the business will shrink along with HPQ’s options to become a growth company once again.
  • HPQ is cheap but deservedly so.
  • I would look at Samsung, Asustek or Microsoft as ways to have exposure to a bottoming of the PC market (see here).

 

Firefox OS – Cheap is cheerful

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It’s a sell-out but for the wrong reason.

  • The first version of the Firefox OS device, “The Open” by ZTE, appears to have sold out in both the UK and the US.
  • The budget smartphone was selling for £60 in the UK and $80 in the US will now not be available until the next production run.
  • This is of course is great PR but it always raises the question of how many were actually made available in the first place.
  • This is a pretty common tactic in the Apple era that I am certain that almost everyone practices.
  • Whatever the supply, it’s a good sign that the device has sold out as demand has clearly been stronger than I expected.
  • The promise of Firefox OS is mid to high level smartphone performance at a mid to high feature phone price.
  • If this promise is fulfilled then I can see very meaningful volumes.
  • However, the first iteration of this platform does not fulfil this vital promise and so it must be something else.
  • I suspect that the answer to this question is price.
  • The device is super cheap.
  • Android devices at the same price point offer poor performance and the greater simplicity of this device means that it should perform somewhat better.
  • I suspect that these devices will generate very little in terms of data traffic and that the use case that they will be put to will be very simple.
  • Such a low price means that fairly low demands will be placed on these devices and hence they should perform reasonably against expectations.
  • Application availability is going to be an issue but again at this stage the kind of user buying these devices is unlikely to demand cutting edge applications.
  • This is a good start for getting the devices into the wild but I really need to see the vital promise fulfilled before I get excited about the prospects for this ecosystem.

 

Nokia – Big fish. Small pond

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WP is still a small pond but it has potential.

  • The latest data indicates that Nokia is making progress in smartphones.
  • Its slow progress but progress none the less.
  • A recent report by AdDuplex group indicates that Nokia’s share of the Windows Phone platform has grown to 86.9%.
  • More importantly sales figures have shown that the recently released Lumia 1020 is outselling the Lumia 928 which is a sign that shipments are beginning to accelerate.
  • This comes as no surprise to me and I expect that Nokia’s dominance of this ecosystem to continue to grow for four reasons:
    • First: Nokia offers the best hardware bang for the buck.
    • Second: Nokia’s Windows Phone applications are by far the best written for this platform.
    • Third: Nokia has the widest range of devices to meet different price points.
    • Fourth: The other manufacturers don’t seem to care and are just keeping a toe in the water of Windows Phone to offset IPR risk from the Android patents that Microsoft holds.
  • The problem is that ecosystem itself is still largely unknown to the wider phone-buying masses.
  • In store demonstrations are poor at best and users walk out of the store not having the first clue how Windows Phone could enable them to live a cool and fun Digital Life.
  • Consequently, they are still going with what they know: iPhone and Android.
  • Nokia is working hard to fix this problem but it’s a slow process and without Microsoft really lending a hand, its going to take a while.
  • The good news is that the bar is set very low.
  • Guidance for Q3 is wide with Devices and Services margins expected at +2.0% to -6.0% giving a midpoint at -2.0%.
  • Margins in Q2 were 1.2% and the developments I am seeing in the market indicate that they could be better in Q3.
  • This would set the company up nicely for good Q3 results in October giving a nice run into its seasonally strongest quarter.
  • The time is here to have another look at Nokia.

 

 

LG – Glutton for punishment

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LG’s new tablet is likely to be a license to lose money.

  • It appears that one disaster and the travails of almost all of its peers is not enough to dissuade LG from launching another tablet.
  • The forthcoming G-Tab with an 8.3” screen, a 1920×1200 display and a Qualcomm Snapdragon 800 chipset is expected to be launched at the IFA 2013 trade show in Berlin between September 6th and 11th.
  • LG is expecting to sell 100,000 units a month or 0.3m units per quarter but whether it will make any money at those volumes is highly questionable.
  • To be frank I am not sure why LG should even expect to ship that many tablets as I can’t see anything that sets it apart from the competition.
  • The tablet market has become very concentrated with Apple and Samsung at the top with 50.4% between them and the cheap and cheerful white label tablets at the bottom 33.3%.
  • That leaves 16.3% or 7.3m tablets for everybody else.
  • LG has neither the brand power of Samsung, the money of Microsoft nor the PC volumes of Asustek, Acer and Lenovo to help push this device and consequently it looks doomed to failure.
  • This essentially means that LG’s margins are likely to be negatively impacted by this device.
  • This is something that LGE can ill-afford as its Android devices are un-differentiated and have nothing that makes them stand out from the competition.
  • Hence, volumes will be dictated by price meaning that margins will remain wafer thin at best.
  • Adding yet another loss-making device on top is something that the company can ill-afford.
  • I remain negative on the outlook for LG.

 

Dell Q2 – A long and weary road

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Q2 results make a breakup inevitable.

  • Dell reported difficult Q2 results as margins were sacrificed in order to cling onto market share.
  • Q2 revenues / EPS were $14.51bn / $0.25 broadly in line with estimates at $14.18bn / $0.24.
  • The one bright spot was revenues which came in ahead of expectations as PC sales fared better at -5% YoY compared to the industry decline of 10% YoY.
  • Enterprise, Services and Software all performed reasonably and saw growth in revenues YoY.
  • Margins in PCs continued their free fall with just 2.2% EBIT margins earned over the last three months.
  • Mobility also fared badly with revenues falling by 10% underlining the fact that Dell has no real idea how to face the change that it is facing in the computing market.
  • The company declined to guide for the coming period and did not hold a conference call.
  • This was presumably as a result of the much delayed vote to take the company public which is now expected on September 12th.
  • The share price (which I tend to agree with) is indicating that the Silverlake / Dell deal to privatise the company will be successful.
  • This will involve raising around $17bn of debt which will be held on Dell’s balance sheet.
  • This leaves the new owners of Dell with two options.
    • One: Invest massively in R&D to invent a whole new concept of computing combining form factor and software.
    • This would hopefully lead to a revival in margins if not sales growth from which the company can be re-IPO’d and a tidy profit made for the risk taken.
    • Two: Tidy up the PC business and sell it on realising the full value of the other parts of Dell. For this to work the entity needs to sell the PC business for at least $17bn in order to pay down the debt.
    • This would leave the equity holders with the Enterprise, Services and Software business all which are growing.
    • The valuation of these businesses is currently being heavily polluted by the presence of the PC business and I am pretty certain that a very high return will be made as long as the PC business can be tidily disposed of.
    • The risk of this strategy is that Silverlake and Dell are unable to get rid of the PC business, it continues to deteriorate and the debt starts to weigh on the value of the other businesses.
  • Either way, the new owners of Dell face substantial risks in realising the full potential of Dell and they should be rewarded accordingly.
  • As it is today, Dell is at a strategic cross roads and is lumbered with a large stagnating business that it has no idea how to fix.
  • Consequently, I think that at $13.75, shareholders are getting a very fair deal.
  • As it is today, the company is worth far less.

NFC – A step closer

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The biometric craze is here but the place to invest is NFC

  • I have long believed that there are two barriers to the take-off of NFC and mobile based payments.
    • First:  Device security. Using devices as wallets remains hideously limited at the moment because device security is so poor.
    • The advent of isometric sensors in devices looks set to change a lot of that.
    • Second: NFC is a horribly fragmented standard meaning that many devices won’t work with many touch points.
    • Hence the dream of NFC taking over the world remains just that; a dream.
  • Last year Apple purchased AuthenTec, a finger print sensor maker, for $350m fuelling speculation (including my own) that it would release a product including this component.
  • Since that acquisition, the rest of the biometric world has gone ballistic making investment in this theme a very dangerous game.
  • It now looks like Apple will be including a fingerprint sensor in its next iPhone.
  • This is important because it means that everyone else will have to follow suit.
  • This effectively removes one of the big hurdles to the take-off of NFC and mobile based payments.
  • At the moment one can pay with NFC but unless it’s a very small transaction, (like a metro fare) one also has to enter a PIN code.
  • This completely destroys the use case for NFC bases mobile payments and users just can’t be bothered.
  • With a fingerprint sensor, the user authenticates every time he unlocks the phone, meaning that NFC can be used for much larger transactions and the use case really is; touch and go.
  • If Apple also includes NFC in its devices, that too, would be give a lift to NFC, but at the moment this looks less likely to happen imminently.
  • This would effectively leave the standardisation problem as the only remaining hurdle.
  • While demand outside of travel cards has been pretty muted, there has not been much incentive to solve this problem.
  • Hopefully, with better visibility on demand, the NFC industry will realise that it is only harming itself and will get together to create a working standard.
  • This is one of the few cases where openness and interoperability is likely to result in a much greater opportunity for all the players.
  • From an investment standpoint, I would argue that instead of losing one’s shirt in playing the biometric game, look slightly ahead and take a look at the lateral play; NFC.

BlackBerry – Circling vultures

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The smell of blood is in the air.

  • BlackBerry has announced (again) that it is open to considering strategic options for the company other than remaining an independent listed entity.
  • Everything is on the table including acquisition, joint ventures, going private or strategic alliances.
  • The problem is essentially that BB10 has not taken off nearly as well as hoped and the prospects of the handset business delivering value have taken a nose dive.
  • The handset business has always been a scale game and as it is today BlackBerry is not large enough to justify all of the in house development that it does.
  • A joint venture or an alliance that would increase the number of handsets shipping on its platform and thereby give it the scale it badly needs.
  • However I think that there are only two realistic options.
  • First. A straight acquisition.
    • If another handset maker such as Huawei, ZTE or Lenovo wants to scale up and increase access to developed markets, BlackBerry would be an option.
    • There will be security problems but the US government is now a much smaller customer than it was.
    • These companies could move all of the development to China and the platform onto a secure variant of Android.
    • The combination of greater scale and lower R&D costs could make an acquisition worth considering.
    • However, all of these companies will have in mind BenQ’s catastrophic acquisition of Siemens’ handset business and will think hard before any commitment.
  • Second. A buy-out by private equity.
    • To me this is the most likely option as it is the only one where I can see a fairly straight road to actually making some money.
    • As of yesterday BlackBerry’s EV was $2.8bn. (50% of the market cap of $5.6bn is net cash).
    • Assets such as the service business, patents, BBM and other fixed assets could be worth around $5.7bn.
    • The handset business is contributing substantial negative value and if that can be neutralised via an asset sale or close down then the true value of the other assets could be realised.
  • A buy-out is a much more interesting a realistic proposition and where I expect the vast majority of interest will be from outside parties.
  • I doubt that management relishes the idea of vultures carving up the carcass of its beloved endeavour but shareholders are likely to much less picky.

 

 

Apple vs. Samsung – Eternal see-saw

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The ban won’t be overturned but it is irrelevant.

  • The endless back and forth continues with Apple now having a ban on Samsung products but it lacks bite.
  • The final ruling on Apple’s July 2011 complaint against Samsung has found that select Samsung products do infringe two patents.
  • One is related to the user interface and the other regarding the detection of headphones when plugged into the device.
  • On the basis of infringement, an import ban has been ordered which will come into force after a 60 day period within which the White House can issue a presidential veto.
  • In this case it almost certain that no veto will be issued.
  • This is because these patents are not Standard Essential Patents (SEP) and therefore not subject to FRAND.
  • Please see IPR. – The weakness of essential (part VI) for more details on the issue of SEPs and import bans / injunctions.
  • Apple may feel some sense of victory as a result of this but that’s all it is going to get for two reasons
    • First. The affected products are now so old that they make up less than 1% of Samsung’s US revenues.
    • Second. Samsung has demonstrated and the judge has accepted that subsequent products have implemented workarounds that no longer infringe the patents.
    • Apple of course is contesting this but is yet another battle to be fought another day.
  • I very much doubt if this will bother Samsung much or affect its willingness to capitulate in its on-going war with Apple.
  • In fact the share price is actually up today which I think it’s a reflection of the irrelevance of this issue.
  • At some point (I am hopeful this year) something will happen that will push the two sides closer together.
  • Typically, it will be the way a trial is progressing or a something pieced together during the pre-trial discovery phase that shifts the balance.
  • When this happens, a deal usually swiftly follows and suddenly the war will be over.
  • I remain of the opinion that a deal is in the interest of both Apple and Samsung and that Samsung will end up a net payer to Apple.
  • This is because the crippling legal fees that both sides are running up are likely to be greater than any potential royalties paid.
  • It is only in the interest of the lawyers to keep the war going.

 

Acer – Point of capitulation?

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Capitulation often marks the bottom of the market.

  • Acer has reported another set of rotten results and at the same time seems to be throwing in the towel on Windows 8.
  • Acer looks to be prioritising products using Chrome and Android which it expects to grow 30% to become 10-12% of revenues in 2014.
  • Acer along with HPQ and Dell are the underdogs in the PC market lacking the R&D capability to deliver innovative hardware form factors to take advantage of the touch capability of Windows 8.
  • This is what I believe has led Acer to look to Android and Chrome to bail it out of its current predicament.
  • The market for tablets is still growing very quickly with Q2 showing 80% YoY growth to 45m units.
  • However, the QoQ story is more sanguine with -4.3% QoQ growth in Q1 13 and -8.4% QoQ growth in Q 13.
  • This is a sign that the PC market may be about to bottom (see below).
  • This market can be carved into three pieces: iPad, Samsung and the cheap and cheerful segment.
  • Of Android tablets Samsung commands 26.5% share with other players (cheap and cheerful white label) taking 49%.
  • Acer managed to win just 4.5% of the market in Q2 13.
  • The message in Android is very clear: branded tablet buyers buy Samsung and everyone else buys the cheapest tablet they can find.
  • This leaves Acer with the prospect of competing against the white box tablet makers which history has shown is a license to lose money.
  • Hence I think that Acer has come much too late to this market and as such Android and Chrome devices are not going to pull it out of its current nosedive.
  • The interesting point to note that when the laggards in a market throw in the towel, it often marks the bottom.
  • Slowing iPad and Samsung tablet growth over the last 2 quarters is pointing to the beginnings of saturation in the top half of the market.
  • This leads me to believe that most casual PC users (who can just as easily use a tablet) have now given up their computers.
  • This has been a major factor in the weakness of the PC market and I am hopeful that this transition is reaching an end.
  • This would mark the bottom of the PC market’s recent decline.
  • Both Microsoft and Asustek have suffered badly at the hands of the PC market and its stabilisation could cause a spike in sentiment.
  • Acer, HPQ and Dell look set to continue suffering but I am looking at Microsoft and Asustek as a way to play the stabilisation story.