A Coca Cola for the 21st Century

The Financial Times has just published a survey of the world’s top global brands. The world’s three most valuable are Google, IBM and Apple. Microsoft made it into fifth spot, behind Coca Cola. 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 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 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 Coco Cola, or the Washington Post.

Now, I am going to make a crazed, typically top of the market prediction, within ten years Apple will be the largest consumer brand in the world. Furthermore, some media giants, it could be Disney, News Corp or Time, will ride the same jet stream. The key has to do with understanding where we are in the tech cycle and the rising power of the Asian consumer.  

Over the last week we have seen Corning increase sales by 57%, citing strong demand for flat screen TVs and computer monitors, particularly out of Asia. Likewise, Samsung Electronics, 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 been expected around 7 m 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. 

Asian Demand

The strength of demand in Asia is the thread linking each of these results, but there is a noted change to 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 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. 

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 which ever 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 life style that they withdraw from society. In Japan such youths are referred to as Otaku. Otaku culture is spreading rapidly across Asia. 

How best then to play the Asian high tech Tsunami? This is where 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 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 per-centage 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. Yet, at Cykepartners, we estimate that Apple took around 40% of the smartphone sector’s operating profit. 

Apple is rampant while other smartphone makers, such as Nokia and even RIM, are finding it tough to stay with the pace. Don’t therefore be surprised if there are more rescue missions like the one that HP launched for Palm. 

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. 

Therefore, as we saw in the age of the PC, power is being concentrated in a few hands when it comes to the smartphone. By 2012 there could be more than 500m of these devices on sale - which will be well ahead of the combined sales of laptop and desktop PCs. Besides Apple, and a handful of specialist chip and software companies, we still haven’t answered how will investors make money?

One answer is to look at content. 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 subscribes and by 2012 there will be around 3 bn, close to half the population of the globe.    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, 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 world wide, which is a tenth of the number of mobile subscribers worldwide.

We have entered the content centric age and history shows that American content plays well around the world. Check out the performance of content shares over the course of this year. Stocks like News Corp (producer of Avatar), Disney and Time 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. The iPhone and more lately the iPad point the way to 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 Coco Cola of the 21 st Century.

Blackberry Crush Time

The dramatic arc that RIM is following is now clear for all to see. It goes like this. In 2008, RIM achieved an average selling price of around $400; by the middle of last year this had fallen to $356, and by the last quarter of 2009 it had fallen again to $311. Next stop will be closer to $305. Yet, as Best Buy has just confirmed, the fourth quarter of last year was an exceptionally strong one for smartphones, Apple’s average selling price rose above $600. If you are a seller of smartphones, life had never been better, so why did ASPs drop for RIM?

RIM is following the same path beaten by Nokia at the beginning of the last decade. Average selling prices will continue dropping because RIM’s product is becoming passe, just as Nokia’s did. The next step will be that RIM’s market share in the US will drop as Apple picks up Verizon and Google’s Android operating system gains momentum. As they say in the pantomime, it’s curtains.

The latest results from Apple and others highlights the problem. On our estimates, Apple has taken about 40% of the smartphone industry's profits. But the REALLY big news, as highlighted by me in a SeekingAlpha piece back in January http://seekingalpha.com/article/185090-apple-s-real-big-news-massive-growth-in-asia is that Apple is now sweeping through Asia. For the quarter just reported, Asia represented close to 30% of Apple's profits. Asia had been Nokia's last hiding place and RIM was hoping to move into the same fox hole. Not any more, because Asia is developing a crush for Apple.

Or maybe we should call that Blackberry Crush. On the one side you have Apple rampant, on the other you have the Android. In the middle there is the Blackberry. Let's face it, Google’s Android is really aimed more at the Blackberry than the iPhone. The Android is a device that offers businesses the secure email that the Blackberry offered them. Secure email has, so far, been the Achilles heal for iPhone, which is a product that is largely focused at consumers.

 A recently published survey by Crowd Science, a US based market researcher, found that 40% of Blackberry users would make the iPhone their next smartphone. However, coming up quickly on the inside, Google’s Android operating system appealed to a third of Blackberry users.

Another recent survey, this time from ChangeWave, specifically looked at US corporate IT budgets. A total of 1,702 respondents involved in IT spending replied. Importantly, the Apple iPhone saw a five per centage point rise in share, while Google’s Android device saw a 4 per centage point rise. The Android is at an earlier stage of development, so as hardware vendors and Google continue to enhance the design it will become more competitive. In particular, there are more than 20 companies supporting the Android, so we can expect prices to fall rapidly, which will bring further pressure on RIM.There will come a day when even Apple has to drop prices.

Smartphone Ecosystem

 Smartphones are computers first and phones second, which means that applications and content are more important than the quality of voice calls. This is where RIM comes unstuck. There are now seven smartphone operating systems out there: iPhone, Symbian, RIM, Google, Windows, Palm and Meego(Nokia and Intel). This presents a headache for the hoards of developers who are, in reality, the people who decide which smartphones become successful. The developer has limited resources so they have to make a carefully considered decision over which operating system to commit resources to. The phone that gets the developers’ attention becomes the phone that has most to offer subscribers; more subscribers then buy the phone; result: a virtuous circle. The release of Apple’s iPad will make this even more apparent.  At present there are 75 million users of the iTouch and iPhone users, within a year another 6m or so million iPads will be sold. These three devices all share the same operating system, which in turn is supported by Apple’s wildly successful Apps Store. From the point of view of developers, Apple offers you a great environment to write for, a tremendous storefront from which to sell your software and a large and fast growing user base.

Like Nokia before, RIM has been slow to recognise that the market has changed. The Blackberry’s operating system is old, the web browser primitive and the device itself is still largely keyboard based.  Meanwhile, the market and even Nokia, has moved to touch sensitive screens. Eventually, RIM will launch a proper touch sensitive Blackberry and will improve its operating system, but by the time it does the market will have moved on. RIM is in catch up mode, it is not a leader.

What Blackberry does have going for it is market share. It has about 20% of the global smartphone market compared to Nokia’s 39% and Apple’s 20%. Mobile operators like the Blackberry device because it uses less bandwidth than either the iPhone or Android and, as we have seen, corporate like the email function. Kids like the Blackberry messaging function and, for the time being at least, the device is popular in emerging markets.

RIM is not yet in a dire state. However, from the point of view of investors, the stock has a half life, despite the recent share buy back.  Before feeling more confident about this stock I think we need to wait  until there is evidence that ASPs have become stable.  That is unlike to happen anytime soon because it looks ominously as though RIM’s market share in the US is poised to implode.   

Apple and the future of publishing

We wanted shock and awe, instead we got shock and confusion. What to make of the launch of the iPad? The first rule for the folks who live at Infinite Loop, Cupertino, is that great products create their own market. Second, Steve Jobs actually knows quite a bit about publishing and print. With that in mind we shouldn't get too fixated on the iPad as a Kindle killer.


When it comes to divining the the future of publishing  activate the link. It will take you through to a fascinating mock up of what an e-magazine or e-newspaper could  look like. Think National Geographic, Life - um maybe Playboy - with high quality graphics, some of which mutate into speaking videos when you click on them. This is surely the kind of thing that someone would watch on the iTab. The Kindle is better suited for long reading sessions, but the iTab still has great potential  in the publishing arena.


As for its prospects in other markets, we will have to wait and see what the Apps  Community make of it. My guess is that the ITab will take off slowly but will then build considerable momentum a year or more out. Video traffic, which is already growing at 130 compound, according to Cisco is the real market for this device. I think a number of vertical markets, such as medical, could also run with the iTab.


The really big news out of Apple this week though has to be the astonishing breakthrough the company has made in Asia. Asia as a per centage of profits, doubled to 20%. Sales in Taiwan and Japan were up several fold and in China, 200,000 legal iPhones have been activated. I say legal because several hundred thousand have been smuggled into the country. China Unicom confirms that 70% of those buying an iPhone are switching to 3G. 


To put that number in context, the iPhone sells for $1000 dollars in China, a country were per capita income is around $3,400. Furthermore, you cannot use WiFi on the official iPhone, though you can if you smuggle one in. The new official number for 3G users in China is 13m. That could double this year. Chinese operators are a accident prone as their Western cousins. 3G wont be big there unless they embrace a device like the iPHone. Apple growth in Asia will be the single most important event of the coming year.


A few days after Apple announced, LG Electronics published a 70% drop in mobile profits. I think we have seen the high water mark for Asian handset makers. It used to be possible to travel the length and breadth of Asia without seeing an Apple product but that is now changing. Asian handset makers compete on hardware design, but that doesn't count for much in the Smart Paradigm. Apple can now fight on its own terms - applications and content. Asian handset makers and Nokia will struggle to equal the richness of the Apps Store. I wonder what Good Night Vienna is in Mandarin

Sipping a can of Dead Bull

Google's Andy Rubin has been talking to the Wall Street Journal's Walter Mossberg about the new Nexus smartphone. Apparently, Google is planning to open some retail stores to sell the Nexus direct. 

Get the picture? First,  Google launches the Android platform and encourages the world's mobile companies to support it. Good thinking, that way you raise brand awareness and suck in legions of developers. Without developers the Android has as much fizz as a can of Dead Bull - which by all accounts is the favourite tipple of portfolio managers these days.

Then, as momentum builds you do what you were always planning to do anyway. Knee cap your customers by launching your own handset. None of this should come as a surprise. There has been a lot of hot air expended on the subject of smart phones. But one thing should, by now be clear. The Apple way - which is to be vertically integrated so you can control the product like a crazed control freak is the best way.

Microsoft might like to sing the old tune about horizontal value chains and how that worked best in the PC space. It is whistling in the wind. The smartphone is an embedded device, the PC by contrast is a generic device. A generic device is open, you can do with it what you will with it. You can run any software you want on a generic device. That's not the case with smartphones. You and I cannot take the lid off and write our own code. Instead, we have to get it from a registered supplier. Therefore, Apples plays the role of gate keeper in a way that Microsoft never could in the PC world.

The Apps Store has become the game changer. Just the other day LG Electronics' CEO said that the company was in a state of panic.   Finally, the penny has dropped even in Asia. We are living in the Smart Paradigm: content and applications is the key to hardware sales. Giants like LG and Samsung will thrive or die over the coming years on their ability to replicate the Apps Store. Don't hold your breath though, this is a fiendishly difficult trick to pull off. 

This is what makes Google's play so interesting. An Apps Store is really the marriage of software and content development with social networking. Therefore, the bigger your apps store becomes the less likely it is that a competitor will be able to build a successful one. Apps Stores, like any other networkable entity follow a power law - a tiny number will generate most of the revenue and control the market. Maybe just one or two - besides Google and Apple who are the other challengers? Nokia - possible but unlikely. A mobile operator - no way. 

As a character in the Wire might say - mobile handset industry has been played.