All good things must come to an end. Assets effectively begin as mere sketches on a drawing board that builds upon a series of prior ideas. From there, innovators revise prototypes before releasing finished products to market. To the masses, game-changing technology quickly becomes indispensable. Amid revolution, this movement is described as "cool," and consumers will happily pay top dollar to remain part of the "in crowd." Demand far outpaces supply amid the business cycle growth stage.
This scenario, of course, attracts competition hell bent upon leveraging supply / demand inefficiencies for profit. To do so, the competition will offer similarly fashioned products that increase aggregate supply and drive prices lower. In time, supply and demand meet at equilibrium, and product is commoditized. At this point, multiple players will compete on price, rather than quality. Production will inevitably peak and stall out, while trendsetters await the "next big thing." Technology investors take heed. Peak smart phone arrived amid Apple (AAPL) versus Samsung (SSNLF.PK) patent infringement litigation.
The Smart Phone Revolution
In 1999, Research in Motion (RIMM) introduced the Blackberry phone to the marketplace. Heading into the twenty-first century, Research in Motion engineers were to integrate web browsing and email capabilities within the Blackberry platform. In retrospect, the Blackberry may now be acknowledged as the world's first smart phone handset leading into today's Web 2.0 era. In this case, a smart phone is defined as a telecommunications device that offers limited computer processing power.
The 2007 launch of the iPhone built upon and transformed the Blackberry concept alongside the Apple Way. At the time, the Apple Way called for a consumer-friendly approach, at the expense of cultivating IT professional wonks. The Apple Way remains notable for the closed and horizontal integration of telecommunications, computing, music, and entertainment outlets. The Apple iPhone is the focal point of a revolutionary product line including the iPod, iTunes, iMac, and iPad platforms. For the most recent fiscal year, Apple reported sales of 125 million iPhones. This sales performance accounted for $80 billion of Apple's $157 billion in 2012 total net sales.
Beyond Apple, the smart phone revolution and a multitude of diverse applications anchor a Web 2.0 movement that includes Facebook (FB), Yelp (YELP), GroupOn (GRPN), and, of course, Google (GOOG). Customization underpins Web 2.0, as technically savvy consumers effectively create personalized online footprints for socializing, researching raw data, sharing files, and trading goods. Popular websites serve as broker-dealers matching advertising dollars to corresponding bases of Internet traffic. The May 2012 Facebook initial public offering crystallized the Web 2.0 capstone event, as a social networking site debuted on Wall Street with reportedly more than 800 million monthly active users on the rolls. Immediately after this IPO, Web 2.0 complex stocks collapsed towards zero amid reports that more than 10% of alleged Facebook accounts were fraudulent sketches.
The fusion of Apple iPhone popularity alongside ubiquitous Web 2.0 technology undergirds peak smart phone theory. Going forward, intense competition for the supply of entertainment can only diminish the marginal utility and profitability of ongoing smart phone production. At the Federal level, looming tax increases and government spending cuts will quell demand for technology products that offer little in terms of differentiation.
In terms of popularity, the Google Android operating system has already overtaken Apple iOS. According to research firm comScore, Google Android and Apple iOS account for respective 53% and 34% shares of the smart phone subscriber market. Research in Motion Blackberry, Nokia (NOK) Symbian, and Microsoft (MSFT) Windows operating systems effectively battle over remaining table scraps left over from the current smart phone duopoly. Google and Apple are actually consolidating power, as evidenced by their collective 3% increase in market share above the prior quarter. On the other side of the ledger, Samsung and Apple occupy respective first and third positions, according to handset unit sales.
Over the past year, Apple and Samsung have taken to the courts to defend their positions above the telecommunications hierarchy. Contradictory lawsuits and rulings allegedly implicate both parties of patent infringement on the Asian and North American continent. Samsung literally serves as a stand-in proxy for Google during these series of hearings. Despite Android's popularity, Google generates minimal revenue from its share of this open-source software platform. Google is technically dumping Android on to the market, in exchange for saturating the market with applications that support Search.
Last May, Google closed out its $12.5 billion Motorola acquisition, as a proactive move to acquire patents that can defend the Android portfolio against litigation. Ongoing patent infringement claims are symptomatic that the majority of smart phone product is already commoditized. Unique technical specifications are of lesser importance at this stage within the business cycle. Goodwill will drive sales performance, before consumers begin haggling over prices and smart phone production declines.
The Nokia - Microsoft partnership indicates that industry rivals are poised to undercut the Apple iOS and Google - Samsung Android oligarchy on price. AT&T (T) offers the 32GB Nokia Lumia 920 Windows 8 phone for $100, while pricing out the 8GB Lumia 820 at $50, if you agree to the terms and conditions of a two-year contract. For the sake of comparison, AT&T offers the 16GB Apple iPhone 5 for $199, in conjunction with a contractual agreement. Service providers follow a subscription format, where they subsidize up-front handset sales, in exchange for ongoing service revenue. AT&T sales representatives will aggressively market Windows handsets, in calculated attempts to save $100 in subsidies on each Lumia phone sold at the expense of the iPhone.
The arrival of technically superior smart phones at lower price points than the premium Samsung Galaxy SIII and Apple iPhone 5 further develops peak smart phone theory. Marginal sales and production will decline further, as consumers grow cynical of any premature anointment for game changing handsets. AT&T now offers the 8GB iPhone 4 for a mere ninety-nine cents. In June 2010, this phone launched amid Apple's now typical nightclub atmosphere and grandiose pomp.
The Bottom Line
Smart phone sales growth may peak by year-end 2012. Going forward, total annual smart phone handset sales are likely to begin a slow decline from 600 million units. After peak smart phone, digital and telecommunication operatives will literally play a game of musical chairs, where each firm rushes product to market to maintain positioning within a shrinking market. Microsoft, Verizon (VZ), and AT&T shareholders have become accustomed to beta stock performance. A beta investment identifies business performance that tracks the S&P 500 Index and aggregate domestic economy returns. Utilitarian corporations generate stable cash flow and return relatively large portions of profits to investors via dividend payments.
Traditional growth stocks, such as Apple and Google, are likely to correct, before transitioning into more conservative risk versus reward profiles. Both of these stocks have lost more than 10 percent in value over the past two months, upon speculation of weakening smart phone sales and total profits. Apple is fundamentally cheaper than Google, as the Cupertino company trades for twelve times trailing earnings. Peter Lynch, retired Fidelity Magellan mutual fund manager, considers a stock cheap if it maintains a one-to-one price / earnings to growth ratio. Apple shares remain well within this value metric, considering the fact that this business is averaging 72% net income growth over the past three years. Today, Apple operates with more than $121 billion in cash and marketable securities on the balance sheet. For Apple shareholders, this position breaks down to $130 in liquid assets within each individual $570 share outstanding.
Nokia and Research in Motion shares now effectively trade as call options amid peak smart phone theory. Both of these positions are too risky for conservative investors, as Research in Motion and Nokia valuations are likely headed for zero, prior to bankruptcy and reorganization. For the latest quarterly period ending September 30, Nokia reported a sharp, 63% decline in year-over-year smart phone unit sales. This deterioration in activity resulted in an $863 million quarterly operating loss. Nokia must now "float the note," or stave off creditors with the help of a dwindling $4.6 billion cash pile to back quick fix debt refinancing negotiations. Only a blockbuster product release can salvage this business over the long term.
Proponents of peak smart phone theory, however, would argue that the latest days of industry transformation are beyond finished. The smart phone is now a commodity.
Disclosure: I am long AAPL.