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Searching For Ideas in the QFON Smart Phone Index

On April 12, 2010, the NASDAQ OMX Group and the Consumer Electronics Association announced the Smartphone Index (QFON),  a new benchmark for the telecommunications sector focused on wireless, mobile devices and advanced communication functionality.  It is a modified market-capitalization index and includes companies that are primarily involved in building, design and distribution of handsets, hardware, software, and mobile networks associated with the development, sale and usage of smartphones.

“Investors, thanks to this index, can now easily track companies that are working diligently to combine the benefits of the phone and computer in a single device,” says NASDAQ OMX Executive VP John Jacobs.

The Smartphone index is currently comprised of 84 companies that are screened by the Consumer Electronics Association, includes companies like Apple, Google and Research in Motion.  I am fairly certain that several ETFs will soon be created to emulate this index.  In the mean time, I have decided to take a look at the components to see if there are any stocks that have escaped my radar.  Here is the complete list.

To my dismay there were no undiscovered jewels in the index. I have been following the mobile industry fairly closely, so that shouldn’t have been a surprise.  What was surprising in a negative way was that  contract manufacturers like Jabil and Flextronics were  in the index.  They are certainly critical to the cell phone manufacturing process, but will do little to add alpha (excess performance) to the index.  Matter of fact, I quickly decided that this index wasn’t for me.  There were simply too many great companies/ crappy stocks in the index.  As an investor, it is paramount to separate the company from the stock.  Alcatel-Lucent is a great company (that may be a stretch), but its stock has been a chronic under performer.  All wasn’t lost as I decided to look at the index from another point of view.

I organized each company by industry – defining eight groups: Mobile Devices, Cell Towers, Communication Equipment, Components, Manufacturing Services, Wireless Carriers and Test Equipment.  Then I calculated each group’s performance year to date.  The results made this little exercise completely worthwhile and supported my conclusion in my blog “For Investors the Smartphone War is Over.”

My bottom line in that blog was there are more profitable ways to benefit from the mobile computing cycle than buying stocks of the mobile device makers.  People are fanatical about their phones and the debates I have had are well chronicled on this blog.  However, I believe the greatest stock price appreciation will be rewarded to companies that help solve the “big problem” – people want to be connected 24/7 and want their data now.   The mobile holy grail is ubiquitous high-speed wireless connectivity.

The best performing industry in this analysis was Communication Equipment +26.0% year to date.  That’s some serious alpha when compared to the S&P 500 +6.9%.  Mobile Devices ranked last (#8 out of 8 groups) with a year to date performance of -3.5% .  A large part of that was due to Palm’s pathetic -44.3% performance.  Excluding Palm, Mobile Devices still only ranks #4 out of 8. Take a look here for the breakdown.

Although I didn’t find any jewels in the Smart Phone Index, I received further confirmation that the diamonds are in the guts of the mobile internet (the infrastructure plays).  My favorite play in this sector is NetLogic Microsystems +44.7% year to date.  They supply Application Specific Integrated Circuits (ASICs) to companies like Cisco, Alcatel-Lucent, Ericsson and others.  Guess what –  they aren’t included the Smart Phone Index.  That’s good for us.  Let’s buy it before smart guys wise up.

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How I am Playing the Smartphone Craze

Since reading the Morgan Stanley Internet Report in December ’09, I have put a great deal of thought into how to best make money investing in mobile.  Up until then I had primarily invested in the mobile device makers like Apple and Research in Motion.  The report reminded me that new companies often win big in new cycles while incumbents often falter.  That has become a guiding principle for me and has led to some contrarian viewpoints. I have decided to list my calls in this blog and update as appropriate.

I. My first play is not very controversial.  APPLE should be the cornerstone of any mobile portfolio.

Blogs:

How am I playing it:

Long or out.

Stock Price:

Stock Price on Close of 1st mention on this blog 3/24/10: $229.37
Price as of 4/16/10: 247.40
Performance since 1st mention: +7.9%
Performance Year to Date: +17.4%

Status:

Long Apple.  Have been  for awhile
As of 4/16/10: Still Long

II. Now I start to ruffle a few feathers. RESEARCH in MOTION will struggle transforming from a mobile phone company (Phase I – before 6/07)  into a mobile computing company (Phase II – post 6/07).

Blogs:

How am I playing it:

Short or out.

Stock Price:

Stock Price on Close of 1st mention on this blog  3/3/10: $70.83
Price as of 4/16/10: $72.03
Performance since 1st mention: +1.7%
Performance Year to Date: +6.6%

Status:

3/31/10: Short on earnings report using April 70 Puts
4/1/10: Closed Puts +35% gain
4/1/10: Short thru Jan ’11 60 puts
As of 4/16/10: Still holding puts

III. This call has the highest probability to be a miss, but I believe that PALM will file for bankruptcy or sold be for less than $6/share.

Blogs:

How am I playing it:

Short or out.

Stock Price:

Stock Price on Close of 1st mention on this blog 3/20/10: $4.00
Price as of 4/16/10: $5.59
Performance since 1st mention: +39.8%
Performance Year to Date: -44.3%

Status:

4/13/10: Short Palm thru May 6 Puts
As of 4/16/10: Still holding puts


IV. A hot smoking OS and plenty of cash; most will think I am far off base on this one.  GOOGLE has the best chance to challenge Apple, but will struggle.

Blogs:

How am I playing it:

Simply an observer. Google may struggle in mobile, but remains a dominant player in internet advertising.

Stock Price:

Stock Price on Close of 1st mention on this blog 4/11/10: $566.22
Price as of 4/16/10: 550.15
Performance since 1st mention: -2.8%
Performance Year to Date: -11.3%

Status:

As of 4/16/10: Still no position

Update:

4/16/10 – Google reported earnings after the market closed on yesterday.  Results met consenus earnings and revenue, but not whisper numbers.  The only data Google has released on its mobile performance is that Android is shipping on 60,000 devices per day. According to a mobile analyst Tomi Ahonen, Android is being shipped on 34 devices, 12 manufacturers and 4 OS versions.  That is a ton of fragmentation and is costing Google real dollars to support. Google’s hiring was up in this quarter and I wouldn’t be surprised if much of it was to support mobile.  Expenses going up with no revenue to support is trouble.  If Google had something worthwhile to say about mobile – it would have said so on the conference call.

The stock was taken to the woodshed and closed down 7.6%.  Some of that may have been attributed to the SEC filing a case against Goldman Sachs.  Since the overall market was only down 1.6%, Google gets most of the credit for its thumping.

V. I got 5 words for you Ubiquitous High-Speed Wireless Connectivity. It’s a mouth full, but it will be more rewarding than the device makers. Mobile Infrastructure may be the best way to play mobile.

Blogs:

How am I playing it:

Searching for companies in the mobile infrastructure space.  Many of the stocks played in this area may be shorter term trades.  Following me on twitter (@TrendRida)  will be the best way to keep up with these positions.  My favorite play as of 4/16/10 is NetLogic Microsystems (NETL).  NetLogic designs semiconductors for communication equipment companies like Cisco, Alcatel-Lucent and Ericsson.  As the equipment companies battle for design wins at the carriers, NetLogic provides the “bullets for their guns.”  NetLogic wins no matter whose guns the carriers choose.

Stock Price NETL ( follow my Twitter stream for other plays):

Stock Price on Close of 1st mention on this blog 4/4/10: $29.40
Price as of 4/16/10: 32.69
Performance since 1st mention: 11.2%
Performance Year to Date: 41.3%

Status:

Went long on 2/12/06 and have added several times since
As of 4/16/10: Still long

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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 Unveiled, Samsung 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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Navigating the Social Media Noise: My Research in Motion Call

I really don’t want to get into my reasoning for my bearish position on Research in Motion – it is well documented (RIMM Rant I, RIMM Rant II, RIMM Rant III).  Needless to say, I have taken a lot of heat from the RIMM disciples over the past few months.  The market is the final arbiter and it looks like we are getting in sync.  As always, a picture is worth a thousand words.

Read Palm’d a New Verb for the definition of a palming.

RIMM has a fanatical user base and the phone is often referred to as the crackberry for its addictive qualities.  That was great in the old mobile world, but it’s a new day.  Morgan Stanley in its Mobile Internet Report essentially said that mobile computing began when Apple released the iPhone in June 2007.  Over the past 2 1/2 years, in this new era, RIMM has failed to deliver the kind of experience Apple has created.  I really don’t won’t to go into that either, but 150,000 iPhone apps to the 5,000 Blackberry apps makes my point.

The reason for this blog is an article I recently read “Social Media and the Need for Solitude” by abnormalreturns on StockTwits.  It is almost as if it was written for me.  The title captured my attention and its content has been on my mind since.   The article discusses the greatest trades in recent history.  Those trades were made by people who bet against conventional wisdom.

Abnormalreturns hits a home run with the following:

In recent history the greatest trades, primarily those betting against the subprime markets, were in direct opposition with conventional wisdom.  They required not only unconventional thinking, but the emotional fortitude to withstand the constant barrage of mainstream thought.  The intellectual capital needed to make and continue with this thesis was in all likelihood formed in some moment of solitude.

Over the past 6 weeks, nearly every brokerage firm on the Street has upgraded RIMM.  With each upgrade, the giddyness on StockTwits went up.  How could these firms with teams of analyst be wrong?

In most cases, probably 99 times out of a 100, Wall Street analysts will know far more than I. However, if they get it wrong – a fat paycheck still awaits them at the end of the week.  In my case, my paycheck depends on the decisions I make.  For the most part, those decisions are made in solitude.  Long after the market has closed – away from the tick by tick analysis on the stream.

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Palm’d a New Verb

On March19, 2010,  Palm Inc. announced its earnings.  Expectations were already low, since it had pre-announced poor earnings.  However, the actual results were poorer than poor and Jon Rubinstein, CEO, didn’t reassure investors on the conference call.  Matter of fact, the call had to be one of the lamest conference calls in the history of conference calls. This combination simply shifted the train wreck into overdrive and the stock was crushed to the tune of 30% on 5X its normal volume.   It  may not be added to Websters, but CEOs of mobile phone companies now know exactly what is means to be palm’d.

Palm’s report showed that it shipped more phones in the quarter ending on February 26 than in the previous quarter.  However, the phones weren’t in customers hands – they were sitting on its suppliers shelves. Rubinstein blamed the lack of “sell through” on poor training of Verizon sales reps. You don’t have to be a Harvard MBA to see through that BS.  Investors know that whenever a CEO blames a situation on anything other than its own poor execution – it is time to run for the hills.  That’s exactly why 125M shares traded hands.

I recently spent some time chatting with a sales rep at my local Verizon store.  We talked for over 45 minutes about all of the latest phones.  Over the course of that entire conversation, Palm’s name didn’t come up once.  Maybe it is the job of the rep to discuss all of their products, but a little of that is on the customer.  I had completely forgotten that Verizon sells Palm’s phones.  This points right back to Rubinstein and company.  Brand awareness shouldn’t be the carriers responsibility – it should be Rubinstein’s.

Many analyst have accepted the fact that there is a pre-iPhone mobile world (before 6/07) and a post-iPhone world.  In the pre-iPhone world, IMO, mobile phone manufacturers were not complete companies.  They depended on the carrier to do marketing, sales and customer service.  The carriers owned the customer relationship.  The mobile company’s customer was the carrier.

Thankfully, Apple wanted no part of this business model and changed the dynamics.  The carrier still plays a significant role, but the mobile phone manufacturer owns the customer relationship.   This has sped up   innovation tremendously.  Mobile phones aren’t thought of in the same manner anymore.  It has become more of a mobile computer than a phone.  While the pre-iPhone manufacturers are struggling with this new world order, post-iPhone entrants, like Google, are greatly benefiting and are creating some exciting products.

Palm won’t be the last mobile phone maker to be palm’d.  I am on record of saying that Research in Motion (RIM Rant I, RIM Rant II, Rim Rant III) is in line for a palm-ing.  This has not been received well by RIM fans. My call may turn out to be premature.  We are so early in the mobile computing world that RIM and others may have time to adjust.

That being said, I am fairly certain that every cell phone CEO witnessed PALM’s palm-ing. I am also certain that not one wants to be the next in line.  Do they have what it takes to succeed in the post-iPhone world? Who knows, but the clock is ticking.