By Jack Fuller, Guest Editor
We touched on telecom mergers a few weeks back, and the article prompted a question – who is king of the smart phone market?
Here are a few stats: Nokia (NOK) maintains the largest user base of mobile phones in the world, Research In Motion (RIMM) is first choice among corporate users, and Apple (AAPL) and Google (GOOG) have the two hottest devices on the market. So who is number one? Here is our analysis from an investment perspective:
Apple Inc.: Apple disclosed stellar second quarter results, with 83% increased revenue driven by increases of 126% in iPhone revenue growth, 32% in Mac revenue growth, $2.8 billion in iPad sales, 23% in iTunes revenue, 17% in software sales, and 23% from peripherals revenue.
From the 10K, the only area that did not see growth was iPod revenue, which fell 14%. Net income for Apple’s second fiscal quarter was $5.99 billion, up 95% from $3.07 billion a year ago. The phenomenal numbers were spurred by record iPhone sales, and mean Apple has overtaken Nokia to become the world’s largest handset vendor in terms of revenue. According to Strategy Analysts’ calculations, Apple sells the iPhone for an average of $638 each compared to Nokia’s $87 average per phone. All these numbers confirm what we already knew - Apple is indeed the king of tech devices. No one has innovated as much in the past decade as Apple, transforming itself from a niche computer company into the consumer electronics and media juggernaut it is today.
Apple has caused a revolution with each handheld product it has released: the iPod, the iPhone and now the iPad. And that doesn’t even include Apple’s success with the Macbook, iTunes and App Store. We expect phenomenal revenue intake to continue based on stronger iPhone sales with Verizon (VZ) (many consumers reportedly did not purchase the iPhone 4, instead opting to wait for iPhone 5 on the network), continued success of the iPad, and an upcoming cloud service that should help increase revenue for smart phones and tablets.
So why has Apple’s stock only hit $336.14 at the time of this writing? The main questions about the company’s worth surround its cash holdings. With $65 billion in cash, Apple holds more cash than Nokia and RIM’s market caps combined, and is on track to generate over $80 billion in cash by the end of the year. Herb Greenberg at CNBC says Apple could “generate $100 billion in cash by the end of the next fiscal year – or nearly one-third of its current market value.” Investors would typically salivate at such numbers, so why are they so hesitant on Apple? We pin-pointed a few reasons:
A) Steve Jobs’ health hangs like an ominous cloud over the company, with investors twitching to sell as soon as his health prognosis turns south; B) people simply don’t know how to view the cash; any other company would typically pay dividends or look to make an acquisition, but Apple is no typical company and seems content to sit on its mountain of green, Wall Street be damned; C) the high stock price turns away many investors, something a stock split would solve, but that is extremely unlikely to happen; D) investors simply don’t pay attention to Apple’s cash anymore because they don’t expect to see dividends; and E) Apple has had to deal with multiple mini “crises” over the past year that have turned attention away from their stellar earnings, including “Antennagate," supply issues with the Japanese tsunami, and iPhone tracking issues.
The bad press Apple has received would be enough to leave any other company shaking (hello Sony (SNE)), but Apple (and its earnings) have held strong through it all. Still, we’re baffled that Apple’s stock price is so low. When you consider results of Apple’s most recent quarter, it’s clear that the company is in robust health and will be for the foreseeable future. We expect earnings and share price to increase, and only see the stock going up. We recommend a strong buy on this king of the smart phone market.
Google Inc.: Google doesn’t actually manufacture handheld devices, but its Android software has taken the mobile phone market by storm, and the astoundingly successful operating system arguably wields the greatest influence in the smart phone market today.
The first Android device released in late 2008, and the operating system took a modest 2% of market share in that year. It held just 7% market share as recently as January 2010, according to comScore, but Android has since exploded. The OS has nabbed about 31.2% of the U.S. mobile subscriber market as of April 2011 according to comScore, while Nielsen places Android at 29%, still ahead of the 27% market share Apple and RIM maintain.
The NPD group says Android has gobbled up as much as 53% of the U.S. consumer smart phone market, outselling all its competitors combined. Nokia’s 14% drop in share prices when it didn’t partner with Google speaks volumes about consumer and investor confidence in the Android operating system.
From the 10K, Google posted year-over-year revenue growth of 27% in April, and we expect its growth to continue based on an ever-increasing base of Android users, maintained strength in the search engine market, and increased spending by online advertisers. We also think Google isn’t expensive in terms of valuation. The stock trades at $535.05 compared with the Wall Street average and median price targets of $701.54 and $700, respectively, and has a forward P/E Ratio of 13.3 with a trailing P/E Ratio of 20. The stock currently has 35 “buy” ratings on Wall Street.
Returning to the 10K, with $36.7 billion in cash and cash equivalents, Google has plenty of room to invest. Google plans to inject large amounts of cash into improving Youtube, the Chrome browser, Chrome operating system, and search engine, investments that we believe will pay off by increasing user traffic and warding off competitors like Facebook and Bing in social media and online search. The one major skepticism we have concerns Chromebooks. The essentially dumbed-down netbooks sell for $350 - $500 a pop, but give no compelling reasons for consumer purchase. The laptops don’t improve user experience, and are in many ways inferior to netbooks selling for hundreds less. Still, we believe the R&D loss from Chromebooks will be a blip on the radar compared to the increased revenue we expect to see in other areas, and the stock should rise in the short and long term. Google is a buy at $530.46 per share.
Research in Motion Ltd.: The handheld device maker has been losing market share to Android and iOS, and it’s easy to see why.
Compared to the gorgeous touch screens and intuitive user interfaces of the iPhone or Droid, the Blackberry seems a thing of the past. RIM’s handhelds still maintain leading email and messaging functionality, but their multimedia browsing capabilities remain well behind competitors due to smaller screen size and less intuitive software. RIM lost 4.6% of market share between November 2010 and February 2011, and has dropped to 27% overall market share as of April after controlling nearly 34% late last year.
Ed Snynder, an analyst with Charter Equity Research, wrote in a note to investors in April of 2010 that he expected RIM to maintain its lead in e-mail based smart phones, but that it had little chance of maintaining its market share, pricing or margins long-term because of RIM’s failure to address consumer appetite for touch-screen phones. RIM CEO Jim Balsillie recently countered claims that RIM is faltering, stating that its slip in U.S. market share was because of a greater company focus overseas. The strategy explains some of the U.S. market share loss, as global unit sales were up 38.2% over the previous year, but not all. Fourth quarter results of last year point out a distressing trend – RIM’s global market share fell from 19.5% in the same quarter of the previous year to 13.7%. It means the loss of market share RIM experienced in the U.S. is beginning to occur globally as well.
In order for RIM to have a fighting chance, it has to release a hit touch-screen phone – and soon. We remain skeptical of RIM’s ability to remain competitive in the smart phone arena considering its previous failures with touch-screen phones such as the Storm. We also don’t see RIM making up sales in the tablet arena; the Playbook opened with delays and lackluster reviews, and has sucked up much of RIM’s cash flows. It also had to recall 1,000 Playbook tablets because of defective operating software, news that doesn’t inspire confidence in the infant tablet. As Android continues to chip away at RIM’s market share, and we expect profit and stock prices to drop. We recommend a sell on RIM based on current market trends. Shares trade at $43.78 at the time of writing.
Nokia Corporation: Nokia still dominates the total number of cell phone units sold throughout the world, but is struggling in the lucrative high-end smart phone market. Analysts and consumers widely agreed that Nokia needed to take the company in a new direction after the introduction of CEO Stephen Elop in 2010. The partnership with Microsoft (MSFT) wasn’t necessarily what they had in mind. Share prices dropped 14% upon news of the announcement, and thousands of staff members reportedly walked out of offices.
From the last few years' 10K reports, Nokia’s market share has fallen from 39% in 2007 to under 30% today, reflecting the weakness of the Symbian platform, and underlining how far Nokia has fallen from its dominant position over the last two decades. Nokia does maintain some positives. Its scale (it still holds almost a third of the world handheld market) and manufacturing capability give it pricing flexibility. It can easily distribute products into almost every global market. And it holds 50% of consumers in markets where entry-level phones are in demand.
But with the massive success of the Android platform, the steady strength of iOS, and RIMM’s efforts to get back in the game, we don’t see much room for Nokia to expand in the high-end market. The struggles of the Windows Phone 7 platform before the Nokia partnership (Windows Phone 7 only gained 3% market share since launch despite huge marketing initiatives) also don’t inspire much confidence. As they say, two wrongs don’t make a right; with Microsoft, Nokia becomes a king of the past.
We believe competitors will continue to erode Nokia’s market share, profits and stock price, especially considering that we won’t see a Nokia-Windows product until at least the holiday season. We’re also beginning to hear rumors that Microsoft will acquire Nokia’s mobile division from Eldar Murtazin, a Russian analyst with strong connections to the Finnish phone maker. A simple partnership between Microsoft and Nokia caused share prices to drop nearly 14%; we don’t want to see what will happen to the stock price if a merger is announced. We recommend a sell on Nokia. Shares trade at $8.56 at the time of writing.