‘Peak Smartphone’ Slams Tech Hardware

‘…we are reaching ‘peak smartphone’ and the upgrade cycle is lengthening as new features prove less than compelling – the mobile app landscape has certainly become stagnant. Heavy discounting of the Samsung S8 ($150 plus) is apparent already in the US and the recent profit warning by the UK’s largest phone retailer highlighted a consumer behavioural shift. While the hype cycle will intensify ahead of this month’s launch of a premium advanced OLED screen model with facial recognition security, if the queues outside Apple shops for the new iPhones prove surprisingly short (or short lived), watch out below.’ Weekly Insight, September 6th, 2017

‘The ‘Peak Smartphone’ theme justified an underweight stance back in Q4 across the most heavily exposure Asian supply chain stocks, with DDR4 DRAM prices down about 20% from its January peak and NAND flash down a third. Many DRAM bulls put premature faith in AI and AVs as incremental demand drivers, certainly valid medium term, but not on a scale to offset smartphone/PV weakness this year while for chip makers the end of the crypto mining frenzy is starting to impact. TSMC said this week that sales will rise by only a ‘high single-digit’ percentage in USD terms, down from a previous (reduced) projection of 10%.’ Weekly Insight, July 20th 2018

The smartphone saturation risk we covered over a year ago has gone mainstream and rippled through the global hardware supply chain, with NAND flash prices crashing this year, DRAM also now peaking while production volumes for premium new phone models have disappointed across the sector. It’s hard to believe that most tech analysts missed this pretty obvious inflection point, when even the IMF noticed the industry had topped out as an Asian growth driver (smartphone shipments were about a sixth of global trade growth last year), but mindless extrapolation of the prevailing trend remains the default setting of bottom up analysts.

Smartphones have seen little innovation beyond camera quality and biometric security since 2016; the lack of compelling new hardware features (or new apps requiring them), and the growing ‘digital detox’ trend as awareness of the adverse productivity impact of notification addiction rises have both dragged on demand growth. Tighter network upgrade policies as well as limited ‘must have’ innovation have seen US and European consumers replacing phones every 2.5 plus years, a rise of 7-8 months since early 2016.

As we highlighted a year ago, the refurbished market has seen explosive growth and was the fastest growth segment last year, reaching over 140m units and is still growing at a mid-late teens pace. Three-year old ‘as new’ iPhones and Samsungs have been flooding emerging markets at typically a third of the price but nearly all the functionality of new. The weak outlook was confirmed by several Apple suppliers this week including Lumentum, Japan Display and UK chipmaker IQE this week – Apple as a ’luxury’ tech brand has finally succumbed to wider sector dynamics, although higher ASPs and the shift to services mean that the component supply chain takes a bigger hit.

Until 5G rolls out at scale from 2020 (and compelling new use cases beyond watching Netflix on the move have yet to appear), it’s hard to see the wireless sector regaining much impetus. While Samsung and Huawei plan foldable screen launches next year, initial volumes are likely to be modest at a price point above $1,000. Valuations now certainly look far more reasonable and expectations more realistic, but the downgrade cycle looks set to run into Q1 19. Our view remains to focus exposure  on stocks with high exposure to the nascent autonomous vehicle/automation sensor and emerging consumer segments such as smart speakers.

However, there will be an opportunity in the 5G rollout in niche areas such as high-end optical chips/dark fibre as well as smart antennae. Chinese producers will have a head start and gain critical mass, as the country embarks on the telecom equivalent of the hugely impressive high-speed rail network, which I used several times on a research visit last month. There will certainly be opportunities in China for specialist foreign vendors like Nokia, but the ‘full strength’ 5G being implemented via a new national core network is a critical component in the effort to drive domestic suppliers up the hardware value chain, in both phones and wireless infrastructure.

China Gatecrashes Smartphone Market With Cheap Clones…

The smartphone market has had five years of turbocharged growth, but success will increasingly be determined on selling price rather than device branding as the key hardware technologies become commoditised. Last week, Apple’s share price decline from its September peak reached over 35% on underwhelming revenue and margin guidance, while Samsung also expressed caution on average selling prices for its smartphones.  As developed markets reach 50% plus penetration rates (over 60% in the UK and Spain), the incremental buyer will come from an emerging economy and be inherently more price sensitive. A key technology trend which will pressure margins is the launch of cheap ‘system on a chip’ processor designs from vendors including Qualcomm and MediaTek, which level the playing field for aggressive Chinese entrants like Huawei and ZTE. Meantime, the 4G networks being rolled out globally have been designed primarily for data rather than voice and use the same TCP/IP protocols that underpin the internet, so that the new generation of 4G/LTE (long term evolution) phones are optimized for streaming video and even multiplayer online games.

Value investing in technology can be dangerous, given ever faster product cycles and tumbling barriers to entry. When RIM’s share price hit over $60 in early 2011, it had PER, P/B price/sales ratios very similar to Apple recently, just as margins and revenue dropped as it followed Nokia in missing a rapid market shift and the stock slumped 90% over the subsequent 18mth period. The fast accelerating growth in Android focused mobile apps reduces Apple’s ‘user experience’ competitive advantage, but will benefit Chinese handset manufacturers as much as Samsung, as they are device agnostic.

The rise of the ultra-cheap smartphones from upstart vendors like China Wireless which run on Google’s Android OS and use off the shelf chip designs is going to transform the industry over the next couple of years, which will see the sort of price and margin pressure experienced in LCD/LED TVs, where sustaining a sustained brand premium has proved impossible amid endless discounting. Apple faces a tricky decision in how far it risks diluting its brand premium by introducing a lower cost ‘iPhone Lite’. Samsung’s overall growth in Q4 was driven by the handset business, which accounted for well over half the group’s operating profit for the year. Sales in the division rose 58% in the final quarter y/y and profits 89%, driven partly by strong uptake of the Galaxy series devices. The total smartphone market reached about $240bn in 2012, up 34% y/y, and smartphones now comprise of 83% of the global market by revenue (or 40% by unit volume). Apple’s share of global handset revenue is 29%, but only 7% of global handset units as Apple charges $618 per phone vs. the industry average of $149, given most basic mobile phones are priced below $50.

However, the company highlighted an uncertain outlook by breaking from its usual practice of giving a target figure for capital expenditure this year, but indicated that it would be similar to last year’s $21.5bn. The key line from the statement was that: “In the first quarter, demand for smartphones in developed countries is expected to decelerate.” That slowdown was inevitable given the typical pattern of penetration rates for new technology. Most independent analysts estimate that LTE smartphones with wholesale ASPs under $200 will account for the bulk of smartphone shipments within four years.

The market has plenty of unit sales growth potential as feature phones get upgraded; smartphone shipments will account for 50% of all handset shipments by 2014 and become the largest handset segment in the world, according to the latest market forecasts by market intelligence firm ABI. By 2018, smartphones will account for 69% of all handset shipments, and LTE handsets half of that smartphone total. It’s feasible that at the premium end of the market, Apple will be chasing Samsung’s technology leadership in 2013 through the foreseeable future. Since 2010 Samsung has grown its smartphone market share from 8% to over 30% in 2012; meanwhile Apple’s market share is expected to peak in 2013 at 22%; remaining flat through 2018. However, both companies face growing pressure from new entrants competing on price, as well as Nokia and RIM’s efforts to restore their lost market share (with a combination of the latter with Lenova an intriguing possibility).