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Friday, 19 March 2010

What's smart about IT

Some people always face the wrong way. Take the case of the average IT analyst. Many come from an industry background, and as a result they cannot but help see the world through the lens of desktop PCs, servers, outsourcing and enterprise software systems. This is unfortunate, because over the last decade corporate IT growth has been meager and the prospects do not look that much brighter.
In 2000, $371 billion was spent on PC hardware. By last year, this had shrunk to $326 billion, according to estimates from Gartner, a US based market researcher. This number includes the value of PCs, servers, printers and storage. For further confirmation, I suggests you examine the 10-year price charts for Microsoft (MSFT), Dell (DELL), or Intel (INTC). They are not quite flatlining, but the pulse is weak.
By contrast, where we have seen growth is in emerging markets, consumers and mobile telephony: A decade ago consumers represented 33% of desktop computer sales; by last year this had risen to 38% of the total. In the notebook segment, the contrast between business and consumer is even more striking: A decade ago consumers represented 32% of total sales; by last year this had risen to 56%.
Mobility and consumers are what drives the IT market. This trend is accelerating as smartphone shipments overtake computer hardware sales over the next two to three years. This is the single most important fact in technology investing. Missing it is rather like wandering past Mount Everest in the fog.
The catalyst for the long awaited pick-up in IT expenditure is said to be the PC replacement cycle. By 2011, it is estimated that 84% of desktop computers used by business will be five years old. In addition, corporate IT sales are expected to get a boost from Microsoft's recently released Windows 7 operating system. There is merit to this argument, just as there was merit to it during the last decade, but don’t hold your breath.
Most of the profits from the PC market go to Intel and Microsoft. Both companies have a better grip on the computer market than any analyst. When speaking in January, Paul Otellini, Intel’s chief, answered a question about a likely pick-up in enterprise spending by stating that growth would continue to be dominated by emerging markets and consumers. Both trends, as Otellini pointed out, lead to lower average selling prices.
Over at Microsoft, the picture was similar. Peter Klein, the company’s CFO said, that growth had been driven largely by strong consumer demand. He went on to say, “While consumer growth remained healthy, we have not seen a return of enterprise spending growth." The problem with IT is that the price of hardware tumbles each year. You can best see this by comparing unit shipments to sales: in 2000, 146 million PCs were shipped; by last year this had risen to 306m. Over that time revenues between the two data points had fallen 12%. Then, when you examine the trends that so enamour the average IT analyst, it looks suspiciously as though they will add to deflation. First, off, Windows 7 needs less memory and raw computing power than its predecessor, Vista; second, cloud computing itself requires less hardware.
My gripe with the whole PC upgrade cycle argument is that it has not worked for more than a decade. The reason it has not appeared in all that time is that corporate IT stopped being innovative sometime back in the 1990s. The truly last innovative piece of software that businesses needed to buy were enterprise resource planning (ERP) systems, which required the move to client server computing. This move, coincided with the launch of Windows 95 and the Unix/Linux operating systems and was the reason that stocks like Dell rose several thousand percent over the course of the 1990s. As if the move to client server were not enough, after 1995 the rise of the internet and the Y2K problem added momentum to what was already a strong trend.
Nothing like that exists anymore.
Where you do see a strong product cycle is, of course, in the area of mobility and the internet. Last year around 200m smart phones were sold. A new research report just out from ABI estimates that smartphone shipments increased 30% in Q4 over Q3. Our recent visit to Asia suggests that the smartphone trend has just taken hold there too, which may cause further surprises for analysts following this market.
At some point over the next two to three years these devices will outsell personal computers. Looked at in terms of revenue, last year the pure PC market, net of servers, printers and storage, was worth $224 billion, compared to $165 billion for the handset market. With smartphones now the fastest growing part of the mobile phone market, they will soon over take PCs in value as well as in unit terms.
This rise is the confirmation of the single biggest trend taking place in technology: mobile internet access. In turn this is generating colossal demand for content, as we can see from the rise in video traffic, which is more than doubling each year. Cisco (CSCO) estimates that by 2013, video traffic will represent 70% of the volume on mobile networks. YouTube has just announced that 24 hours of video is uploaded to its site each minute of the day, compared to 20 hours of video six months ago.
In a recent report from Chetan Sharma Consulting, it has been estimated that there were 7 billion software application and content downloads to mobile phones last year and that this will rise to 50 billion by 2012. By then the market for applications supplied to smartphones is expected to be of the order of $17 billion. This market barely existed a couple of years ago. This is a tsunami that will result in surprisingly strong profit growth and share price gains for a number of device and component makers and maybe some software companies, such as Sybase (SY). Google (GOOG) and Facebook will also win from this trend, as advertisers will pay more for mobile viewers.
The next place that this move to mobile computing will manifest itself is in the rise of the tablet computer. On this score, investors might like to monitor what is happening with estimates for Apple’s (AAPL) iPad computer. When first announced, most analysts seemed rather underwhelmed. The range was somewhere around 4 million units.
More recently, at least one major US investment bank has increased its estimate to 6 million units. Meanwhile, the buzz in Taiwan, among component suppliers, is that Apple is looking at 10 million units. If this device proves a success, it will be emulated by other device makers.
ARM (ARMH), the UK chip company, is the leading European beneficiary of this trend, as is Imagination Technologies (IGNMF.PK), which provides graphics chip intellectual property. CSR plc [LON:CSR], the Bluetooth and Wi-Fi chip maker, should also benefit. Infineon (IFNNY.PK) and STM (STM) in Germany and France, as providers of radio and baseband chips, will also see some impact. In Taiwan, outside of obvious names such as Hon Hai (HNHAF.PK) and Foxconn (FXCNY.PK), investors ought to look at touch screen makers, such as Wintek (WNTSF.PK). The LED supply chain, which will provide the backlighting for these devices, will also gain. In America, this would include Cypress Semiconductor (CY) and Synaptics (SYNA).
So, the next time an IT analyst tells you that the Windows 7 PC upgrade cycle or the move to Cloud computing are the main events in the IT market, hit him over the head with your smartphone.