Post by The Big Daddy C-Master on Apr 30, 2016 14:51:53 GMT -5
Investors generally emphasize the tech sector for the long haul because it promises to offer secular growth greater than that of the overall economy. In large part, this reflects the fact that technology innovation ultimately creates demand for its own products and stimulates economic growth through creative destruction as obsolete products are replaced with the deployment of new technologies.
Up until now, the cluster of several technologies have been supporting growth in this sector has been rising: smartphone penetration, online advertising, social networks, cloud computing, cybersecurity and mobile payment systems.
However, with Apple Inc. (AAPL)'s March 2016 results, the continued growth of the smartphone market has been put in doubt. According to third-party research firm Strategy Analytics, in the first quarter of 2016, 335 million phones were sold, marking a decline of 3% year/year, marking the first time the global smartphone market has ever declined on an annualized basis.
Industry leader Samsung with 79 million units in sales was down -4% for a market share of 23.6% versus the prior year’s 24.0%. Industry profit leader Apple with 51.2 million units was down -16% for a market share of 15.3% versus the prior year’s 17.7%. The Chinese government-backed telecommunications equipment vendor Huawei with 28.3mm units was up +64% for a market share of 8.4% versus prior year 5.0%. The balance of the industry with 177 million units was down -5% for a market share of 52.7% versus the prior year’s 53.3%.
With the apparent maturation of the global smartphone market, investors will need to consider how profit characteristics of the industry will change as mature markets typically see a greater emphasis on cost reduction to preserve profitability and fund research around demand-driving innovation. Along with greater cost reduction emphasis will come product market segmentation and other incentives to encourage consumers to trade in their current smartphone for a newer model. With the premium smartphone market saturated, industry growth will most likely occur at lower price points developing countries (e.g. India) represent the mass market where the unmet demand opportunities lie.
The immediate take-away for investors is that Apple's profitability will come under pressure as will that of the entire smartphone ecosystem.
When Industrial Policy Crowds Out Private Sector Competition, Profits Suffer
That Huwei has emerged in third place in the global smartphone market is not an accident. Not unlike Japan in the 20th century with its Ministry of International Trade & Industry (MITI), the PRC government is engaging actively in industrial policy. According to Bloomberg, the PRC government intends by 2020 to rely solely on China-domiciled technology vendors.
Aside from public sector purchasing--something that is not insignificant given the domination of state-owned enterprises (SoEs) in China--the PRC government is asserting control over a wider range of sectors such as media, where recently Apple's iTunes offerings in e-books and film were shut down by PRC edict.
As concerning as these developments may be, investors should first consider the impact a centralized industrial policy has on company profits. Note with particular interest how profitability in basic industry sectors (e.g. steel, textiles, light manufactured goods) collapses when the policy emphasis is on employment, with return on investment falling far behind in priority. For foreign companies, the PRC has become and promises to remain a far more difficult place to do business. For the technology sector as a whole, not just Apple, business plans and strategies need to be revisited and investors should reassess the long-term profit potential for a sector where PRC industrial policy intends to limit market opportunity.
Investors Should Focus On Dominant Companies To Own Long Term
While the tech sector has now underperformed the S&P 500 from the Feb. 11 2016 low (Tech (XLK) +8.8% vs. S&P 500 (SPY) +12.9%), investors nevertheless need to be cautious in considering valuation and should concentrate their analysis on those companies to own over the long term. In the present environment of growing recessionary concerns, investors should own large cap stocks first and foremost before going further out the quality spectrum. In this regard, best to consider those companies in the technology sector that are successfully supporting an increasing range of daily activities for consumers and businesses alike as these should be the companies to demonstrate superior growth relative to the overall economy as well as other companies in the sector. We view Amazon.com Inc. (AMZN), Facebook Inc. (FB), Alphabet Inc. (GOOGL), Microsoft Corp. (MSFT) and Paypal Holdings Inc. (PYPL) as companies that fall into this preferred category of dominant companies investors should buy at lower levels.
About the author: David Garrity is Principal of GVA Research, a New York-based consulting firm. He has more than 25 years of experience in the financial services industry. He has served in many senior roles including CFO and Board Director for both publicly-held and private companies, and has extensive experience in several disciplines including advisory, operating and research. David is a thought leader in technology sector developments and their application to the broadening of the financial sector, as well as in the areas of banking and finance, capital markets, and technology innovation. He is a sought-after advisor for technology companies and consults with The World Bank Group on financial inclusion and mobile technology, as well as the development of technology strategy for health initiatives in southern Africa. His paper on mobile money and disaster relief is published in "Technologies for Development: What is Essential?" (Springer Verlag, June 2015). You can find him on LinkedIn here and follow him on Twitter @gvaresearch.
Up until now, the cluster of several technologies have been supporting growth in this sector has been rising: smartphone penetration, online advertising, social networks, cloud computing, cybersecurity and mobile payment systems.
However, with Apple Inc. (AAPL)'s March 2016 results, the continued growth of the smartphone market has been put in doubt. According to third-party research firm Strategy Analytics, in the first quarter of 2016, 335 million phones were sold, marking a decline of 3% year/year, marking the first time the global smartphone market has ever declined on an annualized basis.
Industry leader Samsung with 79 million units in sales was down -4% for a market share of 23.6% versus the prior year’s 24.0%. Industry profit leader Apple with 51.2 million units was down -16% for a market share of 15.3% versus the prior year’s 17.7%. The Chinese government-backed telecommunications equipment vendor Huawei with 28.3mm units was up +64% for a market share of 8.4% versus prior year 5.0%. The balance of the industry with 177 million units was down -5% for a market share of 52.7% versus the prior year’s 53.3%.
With the apparent maturation of the global smartphone market, investors will need to consider how profit characteristics of the industry will change as mature markets typically see a greater emphasis on cost reduction to preserve profitability and fund research around demand-driving innovation. Along with greater cost reduction emphasis will come product market segmentation and other incentives to encourage consumers to trade in their current smartphone for a newer model. With the premium smartphone market saturated, industry growth will most likely occur at lower price points developing countries (e.g. India) represent the mass market where the unmet demand opportunities lie.
The immediate take-away for investors is that Apple's profitability will come under pressure as will that of the entire smartphone ecosystem.
When Industrial Policy Crowds Out Private Sector Competition, Profits Suffer
That Huwei has emerged in third place in the global smartphone market is not an accident. Not unlike Japan in the 20th century with its Ministry of International Trade & Industry (MITI), the PRC government is engaging actively in industrial policy. According to Bloomberg, the PRC government intends by 2020 to rely solely on China-domiciled technology vendors.
Aside from public sector purchasing--something that is not insignificant given the domination of state-owned enterprises (SoEs) in China--the PRC government is asserting control over a wider range of sectors such as media, where recently Apple's iTunes offerings in e-books and film were shut down by PRC edict.
As concerning as these developments may be, investors should first consider the impact a centralized industrial policy has on company profits. Note with particular interest how profitability in basic industry sectors (e.g. steel, textiles, light manufactured goods) collapses when the policy emphasis is on employment, with return on investment falling far behind in priority. For foreign companies, the PRC has become and promises to remain a far more difficult place to do business. For the technology sector as a whole, not just Apple, business plans and strategies need to be revisited and investors should reassess the long-term profit potential for a sector where PRC industrial policy intends to limit market opportunity.
Investors Should Focus On Dominant Companies To Own Long Term
While the tech sector has now underperformed the S&P 500 from the Feb. 11 2016 low (Tech (XLK) +8.8% vs. S&P 500 (SPY) +12.9%), investors nevertheless need to be cautious in considering valuation and should concentrate their analysis on those companies to own over the long term. In the present environment of growing recessionary concerns, investors should own large cap stocks first and foremost before going further out the quality spectrum. In this regard, best to consider those companies in the technology sector that are successfully supporting an increasing range of daily activities for consumers and businesses alike as these should be the companies to demonstrate superior growth relative to the overall economy as well as other companies in the sector. We view Amazon.com Inc. (AMZN), Facebook Inc. (FB), Alphabet Inc. (GOOGL), Microsoft Corp. (MSFT) and Paypal Holdings Inc. (PYPL) as companies that fall into this preferred category of dominant companies investors should buy at lower levels.
About the author: David Garrity is Principal of GVA Research, a New York-based consulting firm. He has more than 25 years of experience in the financial services industry. He has served in many senior roles including CFO and Board Director for both publicly-held and private companies, and has extensive experience in several disciplines including advisory, operating and research. David is a thought leader in technology sector developments and their application to the broadening of the financial sector, as well as in the areas of banking and finance, capital markets, and technology innovation. He is a sought-after advisor for technology companies and consults with The World Bank Group on financial inclusion and mobile technology, as well as the development of technology strategy for health initiatives in southern Africa. His paper on mobile money and disaster relief is published in "Technologies for Development: What is Essential?" (Springer Verlag, June 2015). You can find him on LinkedIn here and follow him on Twitter @gvaresearch.
