HTC Q2 15A – Virtual Reality

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Hopes for recovery exist in virtual reality.

• HTC reported Q2 15A results that were in line with reduced expectations but admitted that there is far worse to come in Q3 15E.
• Q2 15A revenues / EBIT was NT$33.0bn / LOSS NT$5.1bn which was in line with the guidance given at the beginning of July.
• EBIT losses contained a one-time asset write down for idled assets and prepaid expenses of NT$2.9bn.
• Adjusting for this figure gives gross margins of 19.3% and EBIT margins of -6.6%
• However, Q3 15E will be considerably worse with revenues / EBIT of NT$19-NT$22bn, gross margins of 19.0%-19.5% and EPS of LOSS NT$5.85 – LOSS NT$5.51.
• This is very far from consensus which was looking for Q3 15E revenues / EPS of NT36.8bn / LOSS NT$1.17.
• HTC’s revenue guidance is some 44.2% adrift of expectations and reflects how difficult things have become.
• At this run rate, I would estimate that Q3 15E EBIT losses and cash outflow will be around NT$4bn. (-20.7% EBIT margin)
• HTC’s problems are not difficult to identify.
• It has long since lost its competitive edge and as a result is suffering from the ravages of commoditisation.
• Now it is one of the smaller players, it does not have the scale to compete and now must either do something to differentiate itself or go out of business.
• The one thing HTC has is a reasonable cash balance.
• This is currently standing at NT$47bn meaning that the company can withstand 10 quarters at this new run rate of losses before being forced to close its doors
• Unfortunately, the strategy for recovery is not inspiring.
• Substantial further costs cuts, a reduced number of models, and a new trendy flagship device for Q4 15 is pretty much all there is.
• HTC also intends to launch a virtual reality device in 2016 and is pinning some of its hopes on this while its larger, better financed competitors are looking at this area as experimental.
• This trendy smartphone looks unlikely to be the next must have device as Samsung has already shown that there is only so much that can be done with a slab of black glass and a home button.
• Consequently, I fear that there is worse to come and that the shares should trade at a discount to HTC’s cash balance in the best instance.
• This means that the shares should be at a level of NT$49 or lower (based on Q3 15E cash balance) as there is no sign of anything that will stem the red ink.
• It is not too late to sell.