For Investors the SmartPhone War is Over

New smartphones are being released everyday. Sprint just announced the world’s first 4G smartphone (Sprint, HTC Unveil First 4G Smartphone).  Nokia, Samsung, Motorola all have new phones released in March (Nokia C5 UnveiledSamsung Announces Galaxy S Android Smartphone, Motorola and Sprint Announce World’s First Push to Talk Smartphone).  Over the next few years these manufacturers will fight for market share, but from an investors perspective the smartphone game is over.  That being said, I assert that the smartphone war is over for investors?

The stock market pays for current profits and future expectations of profits.  In the PC market, Apple commands 7 percent of overall revenues and 35% of the operating profits (Apple Leads PC Industry in Profit Share). Wall Street has rewarded it with a market cap 7 times its rival Dell and 70% greater than Hewlett Packard.    Apple’s doing it again in mobile.  Its profit share has grown from 3% in 2007 to an estimated 37% in 2009 (Estimated Share of Profit Among Mobile Phone Manufacturers).  The momentum is definitely on Apple’s side, but that is only one of the reasons I am declaring the war is over.

The primary reason is due to a huge chasm between mobile phase I (before the iPhone) and mobile phase II (post iPhone).  In phase I, the carriers handcuffed the manufacturers in many ways.  Apple refused to play under those rules and dictated their own terms.  To the industry’s benefit – innovation has sped up tremendously under the new rules.

All of the phase I manufacturers have legacy issues that are proving to be difficult to carry across the chasm.  Palm imploded two weeks ago (Palm’d a New Verb).  Research in Motion troubles are deeper than its CEO wants us to know (RIM Outlook Dims). Several will eventually make it to the other side, but for investors – it will be too late.  By that time, Wall Street will be looking for profits from tablets and connected HDTVs (What Separates Apple from the Rest).

Of all of the competitors, Google being a post phase I company, has the best chance of taking profits from Apple.  In late 2007, Google announced Android its mobile phone OS. It planned to make Android available to any manufacturer that desired it.  Similar to Microsoft’s strategy of having Windows on Dell, HP and others.  If Android’s adoption was successful  – Google would profit by leveraging its position in search advertising.

Sounds good, but advertising on mobile is playing out differently than on the desktop. The ads are smaller and less effective.  Very few companies are achieving a favorable return on investment. Business Week reported that Steve Jobs hopes to “overhaul mobile advertising in the same way they had revolutionized music players and phones.” Both, Apple and Google, have made recent acquisitions in mobile advertising.  So, the leverage Google was banking on is not materializing.  On the other hand, the financial impact of supporting Android across numerous vendors is real.

At some point, Google began rethinking its Android strategy.  In January 2010, Google announced its own branded phone – the Nexus One.  I believe Google concluded the best mobile experience would be created by controlling the hardware and software ala the iPhone.  Taking this approach meant that it effectively began competing with its partners. I remember how uncomfortable the Motorola exec looked at the Nexus One launch.

From afar, it doesn’t appear as though the new strategy was well thought out. Google significantly underestimated the support burden and the sales to date have been underwhelming (Nexus One Sales lag Apple & Motorola, Five Reasons Google’s Gonna Kill the Nexus One). Thus, Apple’s only unencumbered competitor in mobile phase II appears to be unsure of its strategy.

The troubles of phase I manufacturers are highlighted in their stock charts.

Nokia’s troubles don’t look as significant as the other phase I companies in isolation.

but when contrasted with Apple – Nokia’s troubles are apparent.

A well know analyst Don Coxe says that one should “never invest on the base of a story on page one, you invest in a story on page 16 on its way to page one.”  Google “smartphone war” and you will find thousands of articles.  Smartphones are clearly a page one story.  A better mobile investment approach may be holding a core position in Apple and then adding other companies in the mobile chain.

I recently read an interesting article called Mobile Backhaul Buzz.  The carriers must invest heavily in the plumbing needed to transfer data to and from the mobile towers.  Calix a freshly minted IPO plays in that space.  Mix in a gem like NetLogic Microsystems – it  provides semiconductors to the major mobile infrastructure companies like Cisco, Ericsson, Huawei and others (see NetLogic’s Corporate Presentation).  Throw in a cell tower company like Crown Castle International or American Tower Corporation and now you have the makings of a winning mobile portfolio.

I realize that it sounds crazy to say that the smartphone war is over.  I also realize that people will continue sinking money into Palm – praying for a buy out or RIMM – praying for a turn around, but my money is going into the Net Logics of the world.

A few other closing thoughts:

Just as I believe that Google concluded that the best smartphone experience will be delivered by a company providing both hardware and software, other manufacturers will conclude the same.  With Palm and Research in Motion clearly struggling, Nokia may have the next best shot.  Nokia is the number one smartphone vendor in the world by market share, but remember as investors we care about profit share.  Nokia’s share of profits has fallen from 60% in 2007 to 31% in 2009.

Finally, manufacturers are already removing Google as the default search engine in their Android implementation for various reasons.  Google’s interest will wane if it doesn’t receive a return on its investment.  Also, with so many different companies involved – Android is getting confusing and fragmented .  Motorola released the Droid in November running Android 2.0 and the Google released its phone in January using 2.1.  The neat features on the Nexus One aren’t available on the Droid.  Customers are confused. Sales people are confused.  Developers are confused.  This has the potential to be a giant failed experiment.

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