Investing in the Future of Mobile Devices Part 2 – Components and Software

This article also appeared at The Motley Fool.

In Part 1, I covered a couple of device makers along with CPU and graphics chip makers. In Part 2, I’ll cover software and the components that matter the most.

After all nobody cares if they have a dual core or quad core or 1GHz or 1.5GHz processor other than geeks like me. What people care about is how cool the display looks and how easy is it to get to the features they use most or what software ecosystem.

Let’s start with screens. There are few screen manufacturers that can make mobile device screens in large volumes. They are Samsung, LG, Sharp and Japan Display. Japan Display is a jointly owned by Innovation Network Corp of Japan, Sony, Toshiba and Hitachi. Samsung is the largest maker of mobile displays amongst these, followed by LG. Sharp as a company is in trouble but they do have good screen technology and potential investment suitors in the form of HonHai/Foxconn and Apple. Samsung Display was recently spun off as an independent but still wholly owned subsidiary of Samsung Electronics. LG Display (NYSE: LPL) is a publicly traded company but it is 38% owned by LG Electronics.

Next up – memory. This is just one more category (NAND Flash) where Samsung is the largest manufacturer. This is getting to be a theme. Samsung is the world’s largest manufacturer of a lot of things. Anyway next in line after Samsung are Toshiba and Micron (NASDAQ: MU) and SK Hynix. Micron is quickly closing in on second place Toshiba as it breached the 20% market share barrier last year.

As for Flash cards, Sandisk (NASDAQ: SNDK) is the largest manufacturer followed by Samsung, Toshiba, Transcend and Kingston (2011 rankings). Flash manufacturer rankings are a complicated mess which is evident from the glaring absence of Sandisk from the general NAND flash rankings above. So it all depends on how you look at it.

Other than Flash Memory (the quoted number 8GB, 16GB, 32GB etc. for phones), phones also have RAM (which is similar to the memory on your computer). Another top spot for Samsung, followed by SK Hynix, Eplida and Micron. So the same old. Which is strange considering the top spot for all DRAM (including PCs) is held by Kingston.

 

The five year chart for all US traded companies mentioned above shows memory makers faring better than LG Display. However, looking at their income growth doesn’t look promising. The stock prices have been rising a lot faster than income.

 

Let’s look at operating system software next. Smartphones and tablets run mostly on iOS and Android. The other operating systems in the running are Blackberry, Windows, Symbian and Samsung Bada. Nokia still makes Symbian phones but is slowly turning that into the featurephone OS and Windows into their smartphone OS.

As iOS and Android dominate and Microsoft tries to muscle in, the future of anything else including Blackberry is uncertain. So investing in the future of mobile software presents you with the obvious choices of Apple and Google along with Microsoft. I would consider Research in Motion (NASDAQ: RIMM) a risky proposition until Blackberry 10 devices hit the market at which point the response to those would be a good judge of the continues survival of the company. If the reaction is anything like the reaction the Windows Phone 7, that would spell doom for RIMM. Symbian is officially being gimped as Nokia is betting on Windows. In fact as of now even the future of Nokia is uncertain, but they just might make it. I will not bother you with the depressing charts for either of them but lets just say you should avoid them unless you have a tolerance for risk. Let’s just say Apple, Google and Microsoft, all of which I’ve covered previously are your only real choices for investing in software.

In Part 3 I’ll cover more device makers and mobile applications.

Disclosure: Long AAPL, GOOG, NOK

Analyzing Apple’s Guidance

This article also appeared at The Motley Fool.

In Apple’s (NASDAQ: AAPL) Investor Conference Call, CEO Tim Cook and CFO Peter Oppenheimer talked about the company’s new method of issuing guidance. This is what their release said:

Apple is providing the following guidance for its fiscal 2013 second quarter:

• revenue between $41 billion and $43 billion
• gross margin between 37.5 percent and 38.5 percent
• operating expenses between $3.8 billion and $3.9 billion
• other income/(expense) of $350 million
• tax rate of 26%

When asked about the range as opposed to the point guidance, Peter Oppenheimer said that Apple will be within the range “as best as they can” so the range is no longer the conservative guidance that we are used to. This is a welcome change as it will hopefully end the guessing game every quarter.

The one thing missing compared to previous quarters is EPS guidance. But Peter Oppenheimer told Gene Munster of Piper Jaffray that he could figure out the EPS from the numbers above. Walter Piecyk of BTIG has done the math for us and come up with $9.23 – 10.23. This is a bad sign for Apple and not including the number was in poor form.

The conference call twice eluded to being able to sell more if they made more. Now personally I call that an ego problem at Apple causing them to shift away from Samsung. Steve Jobs is dead. Time to stop the war against Samsung (and Android in general). In fact there were several other ego related tidbits in the conference call such as

The iPhone 5 offers as you know a new 4-inch Retina display, which is the most advanced display in the industry and no one comes close to matching the level of quality as the Retina display. … So, we put a lot of thinking into screen size and believe we’ve picked the right one.

– Tim Cook

When other phones start getting 5″ 1080P screens, the retina display on the iPhone5 is outdated. In fact it is even outdated compared to old previous generation phones with 720P displays like the Galaxy Nexus. Also, whatever they believe, people want choice. The Apple attitude – “if you want the latest features get the biggest phone” is probably causing people who like smaller screens to stick with the older iPhone 4S. People want all sizes with the latest specifications. And people who are already used to and prefer larger screens will not convert to the relatively tiny iPhone screen with a lower resolution.

Also it is enough to mention it once that you make the best products. In the conference call Tim Cook mentioned “very best products in the world,” “best customer experience in the world,” “best work of their life,” “create the world’s best product,” “our best products ever,” “best products in the world,” “only the best products.” So best was used over and over. In addition to that we had “unprecedented,” “unmatched,” “stunning,” and other synonyms. Enough already. We get it.

If we are to believe this guidance, the exponential growth of Apple will not apply to next quarter at least as far as EPS is concerned. However the stock price reaction to the earnings is completely unjustified – I predicted a drop to $450 if Apple misses in my pre-earnings article. This would be a good time to buy some Apple stock. For a company that carries a cash pile of $137 billion and is expected to make a profit of around $45 billion in 2013, the stock is significantly undervalued compared to peers like Google and Amazon.

Growth at the midpoint of $42 billion in revenue would be 7% over the same quarter last year and EPS would actually be lower by 20%. That is what spooked investors even though the reason for this is simple – more growth in emerging markets means gravitation to lower margin products. This quarter was the first in at least 16 quarters where Apple’s EPS was lower than the same period in the previous year. And next quarter might be the first ever significant decline.

However with the introduction of newer generation products, I expect that the EPS will grow after next quarter. I still maintain that it is a good buy at the current $450 level.

Disclosure: Long AAPL, GOOG

Investing in the Future of Mobile Devices Part 1 – Hardware

This article also appears at The Motley Fool.

However, device makers are not the only beneficiaries of the ongoing smartphone and tablet boom. The companies that make the phone and tablet innards are worth looking at, and I’ve dug up the gems for you. Currently most mobile devices use processors based on technology licensed from ARM (NASDAQ: ARMH). Manufacturers like Apple and Samsung make their own ARM-based processors, like the Apple A series and the Samsung Exynos. However, most other device makers rely on processors from Qualcomm (NASDAQ: QCOM) and NVidia (NASDAQ: NVDA).

For 2013, Samsung expects to launch the first 8 core mobile processor called Exynos 5 Octa, based on ARM’s big.LITTLE technology, which pairs four low power cores with four performance cores to provide the best of both worlds–good battery life and performance–when required. Qualcomm announced their next generation of processors – Snapdragon 800 – which provide significantly better performance, including support for mind boggling image sizes like 55 megapixels, amongst other things, while consuming less power. NVidia also announced the Tegra 4, which also boasts significant performance boosts while consuming less power. So going forward we can expect more powerful phones with longer battery lives.

The CPU is not the only processor. Most of the mobile chips are systems on a chip where the GPU is also part of the same unit. The most common GPUs are based on PowerVR technology licensed from Imagination Technologies or ARM’s MALI Technology. The exceptions to this are Qualcomm, which makes their own GPUs called Adreno, based on technology acquired from AMD, and NVidia, which uses its own GeForce GPUs. They announced that the Tegra 4 has 72 GPU cores.

For now these are the big players, but there are up and coming Chinese processor manufacturers like MediaTek, who promises decent performance and cheap processors. In fact a ZTE-made phone with an 8 core processor made by MediaTek is rumored to be hitting the market in the second half of this year.

But there is one company that benefits disproportionately from the mobile boom, and that is Qualcomm, because you simply cannot make a phone without Qualcomm technologies. And with the proliferation of cellular communication into more devices like tablets, cellular hot spots, etc., it is all good for Qualcomm.

Another beneficiary of all this is TSMC (NYSE: TSM). TSMC is a contract chipmaker who actually produces processors for Qualcomm, NVidia, and potentially for Apple.

Here is a chart showing 5 year performance of the stocks mentioned in this article that are traded on the US markets. 

Other than NVidia, all of them performed admirably, especially ARM. Lets look at the income growth of these stocks.

 

ARM currently trades at a hefty P/E of 80, which may not be justified as the price has seriously outpaced income growth, especially when you compare it to Apple. Only Apple’s and Qualcomm’s profits grew faster than their stock prices, so I would recommend those two stocks. Samsung trades OTC as SSNLF, but is thinly traded. It also sports a low P/E in spite of spectacular income growth.

Stay tuned for Part 2 – software and more coverage on other device and component makers.

Disclosure: Own AAPL, INTC