The Financial Times has just published a survey of the world’s top global brands. The world’s three most valuable are Google (GOOG), IBM and Apple (AAPL). Microsoft (MSFT) made it into fifth spot, behind Coca Cola (KO). Tech companies took seven of the top ten positions and most of the top twenty positions. We live in a technology dominated world, yet you often come across professional investors who would rather take a bath in battery acid than buy a tech share.
The problem is that tech is two faced. On one side you find dozens of companies that look, for a moment like winners, then flare out. Others, like Sun, Compaq and Palm do well for years before evaporating. Then there is tech’s other face, the totalitarian one. In its day, IBM controlled between 60% to 70% of the mainframe computer market. Intel (INTC) takes around 90% of the microprocessor market, and there is not much worth fighting over in the PC software market that isn’t owned by Microsoft. Google rules the hill in search, and Amazon (AMZN) has cornered the electronic sale of books. These are businesses with moats around them, the kind of brand names that a young Warren Buffett would buy ahead of Coca Cola, or the Washington Post.
The frenzy for iPhones in Asia suggests that Apple (AAPL) is well on the way to becoming the largest consumer brand on the planet. Its stranglehold on the smartphone market will tighten. In the first quarter of this year we estimate that the iPhone took 40% of the profits available from smart phones. To grasp what happens next we must look at where we are in the tech cycle. In a world of billions of connected devices, we are entering a content centric age. As such, media giants like Disney (DIS), News Corp (NWS), Time Warner (TWX) and others, are becoming more valuable. Apple, meanwhile, is the only IT company that has mastered the combination of media and content. Don't be surprised if Apple becomes the Coca Cola of the 21st Century.
Over the last week we have seen Corning (GLW) increase sales by 57%, citing strong demand for flat screen TVs and computer monitors, particularly out of Asia. Likewise, Samsung Electronics (GM:SSNLF), Asia’s largest technology company, has just reported that Chinese consumers are showing a keen interest in higher specified flat screen TVs. A few weeks ago it was Apple’s turn. Analysts had expected around 7m iPhones to be shipped, instead the company sold 8.7m and earned nearly 30% of its profit from Asia. In the previous quarter, 20% of the company’s profits came from Asia.
The strength of demand in Asia is the thread linking each of these results, but there is a noted change in the pattern of this demand. Chinese consumers, on the eastern seaboard, were the first to ship in container loads of high ticket luxury items and high tech goods. About 300 m live in eastern cities such as Shenzhen, Shanghai and Beijing. What has changed is that the 1bn or so Chinese consumers in the more Western provinces have begun spending. CLSA, the specialist Asian broker, estimates that these consumers have, when it comes to tech goods, close to the spending power that those on the eastern seaboard enjoyed in 2005.
Salaries are rising in China, while at the same time the price of tech goods is falling. Since 2004, the price of notebooks, PCs and handsets has been falling at 12% a year. For LCD TVs the rate of decline is more like 20%. If these trends continue then, by 2013, it has been estimated that China will be the largest market in the world for high tech goods. By 2012, when it comes to electronic goods, rural China will have the same buying power as those on the eastern seaboard have today. By 2013, China could account for close to 30% of the world’s LCD TVs and smartphones and one in five of the computers made.
The ability of the average Indian to afford such tech products will reach those that existed in China over the last couple of years, by 2014. Just as Western consumers have driven the purchase of PCs and smartphones during the first decade of the century, Asian consumers will take the lead during this decade. The song, therefore remains the same: consumers buying -- not corporate expenditure-- is what drives IT sales. Microsoft’s most recent results are further confirmation of this trend and were explained in an earlier piece, which examined consumer and corporate IT spending.
The challenge for investors
One of the challenges facing investors will be to find the stocks that benefit most from this colossal shift in consumer spending. While the American consumer represents about $10.35 trillion dollars, compared to just $2 trillion for both China and India, Asia will dominate the growth in demand. This, of course, is the same pattern we saw in the oil market, as explained in the Energy Anomaly. Emerging markets represent 95% of the growth in demand for oil. Therefore, even as demand for oil dropped in the West the price rose because countries, like China, increased consumption. This shift will gain momentum just as Western consumers and governments enter the Great Contraction and cut spending to reduce debt.
If you want a sign of the times then here is one. In the UK, the Governor of the Bank of England has just warned that whichever party wins next week’s general election, it is likely to be out of power for a generation after. The reason, because the decisions needed to reduce debt are going to be so harsh and unpopular.
How to Play This Trend
Asia has a special affinity for technology. After all, tech products and computer games played an influential role in the rise of the Japanese economy. Accenture, the consultancy, has conducted research globally into consumer buying patterns and concluded that Asians are twice as likely as a westerner to have bought a computer, or mobile phone. Asia led the West in the use of the internet for building social communities and in the adoption of massively multi-user role playing games - MMPG. Across Japan, South Korea, Taiwan and now in China too, there is a problem with Asian youths becoming so addicted to the cyber lifestyle that they withdraw from society. In Japan such youths are referred to as Otaku. Otaku culture is spreading rapidly across Asia.
How is it best to play the Asian high tech Tsunami? This is why we need to revisit the secret of those global brand names and reacquaint ourselves with the two faces of tech. History shows us that it is fiendishly difficult to make money from hardware companies. With a few exceptions hardware shows us the wrong side of tech. The pace of innovation is destructive and margins are atomized.
The 1980s were the decade of the personal computer and it was also the decade that Sun, Microsoft, Compaq and names who would become leading tech companies went public. Yet, if you look at a chart of the market capitalization of US tech shares, as a percentage of the overall market capitalization of US shares, you will see that as a group tech fell over the course of the decade. How can that be, when Sun, Microsoft, Intel and others were among the best investments of the 20th Century? Part of the answer is that most of the profits that were available in the PC industry were taken by two companies: Intel and Microsoft. The same pattern appears to be happening today with the PC’s replacement, the smartphone.
Have you noticed that it is becoming harder to find smartphone stocks to make money from? In the first quarter of this year, smartphone sales probably rose by around 50% in unit terms. HP (HPQ) has launched a rescue of Palm, which is almost certainly misguided. Mobile operators are not benefiting from the surge in mobile data traffic because the bulk of their revenues come from comparatively high priced voice charges that are falling. Research in Motion (RIMM) can't live with the iPhone's pace of growth despite cutting prices. Meanwhile, at Nokia (NOK) the rise of Apple in greater China and other emerging markets is probably too painful to face, because this is the region that Nokia has dominated. Maybe it's time for a stiff vodka and a sauna.
The reason that Apple’s growth has gone up a gear is because of Asia. Sales in China, Taiwan, Japan and South Korea rose several hundred per cent. Nonetheless, skeptics will point out that a competitor might emerge with a cooler device that will topple the iPhone. They might also argue that the new iPad might yet underwhelm. The latter, though unlikely, might be true. As for another device wasting the iPhone, that would be a tall order. Apple only spends 3% of its sales on R&D, and apart from a few cosmetic changes, the iPhone hasn’t been fundamentally altered since it was launched in 2007.
Increasingly, the key to its success is the Apps Store. Just as hundreds of thousands of developers were really the key to Microsoft’s dominance, those Apps developers are Apple’s foot soldiers. To beat Apple now, someone is going to have to find a way of inducing those foot soldiers away. Google’s Android has the best shot, but I am not convinced it will be able to pull it off. The momentum looks unstoppable and like Intel, Microsoft and Google before it, Apple has a good chance of establishing a hammer lock on what is the fastest area of growth in consumer electronics.
A Content Centric Age
We now live in an age of ubiquitous broadband, often it doesn’t feel that fast, but mostly we have access to it. By the end of last year there were 1.7bn internet subscribers and by 2012 there will be around 3 bn, close to half the population of the globe. In the same year there could be close to 600m smartphones sold. Households around the world will increasingly have WiFi and a broadband connection. With these networks in place the desire for electronic devices will multiply. Ericsson (ERIC), the world’s leading telco equipment maker, believes that by 2020 there might be as many as 50 billion devices. If that sounds incredible, try counting how many digital cameras, music players, games consoles, PCs etc you have in your house; well over 20 would be my guess.
In a world of devices and widespread networking, the stage is set for the consumption of digital content. Each minute of the day 24 hours of video are uploaded to Youtube. By December of last year mobile data traffic overtook mobile voice traffic, despite there only being about 400m mobile broadband accounts worldwide, which is a tenth of the number of mobile subscribers worldwide.
Check out the performance of content shares over the course of this year. Stocks like News Corp (producer of Avatar), Disney and Time Warner are out performing Google. With advertising rates rising and a revolution in high definition and 3D underway, media stocks are cheap and facing the benign version of a perfect storm. As the rise of 3D demonstrates, US media companies are closer to the technological heartbeat than their competitors around the world. The iPhone, and more lately the iPad, point the way to a future where digital content becomes pervasive and some of the big content names will shine as a result. My guess is that over time Apple itself will mutate more towards content, which is one reason why its recent move into mobile advertising is so interesting.
Apple’s Xen like coolness, is appealing to aspiring Asian consumers in a way that no other high tech brand appears to be able to rival. It is early days but I think Apple’s first quarter revenues, where Asian sales leapt points the way to the future - this is the Coca Cola of the 21st Century.
Disclosure: No Stock Positions held