HTC’S Future Lies With Windows Phone

Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Taiwanese smartphone manufacturer HTC Corp, once a leader in Android-based smartphones has seriously stumbled in the past two years, ceding that title to the Samsung juggernaut. Its recent earnings release for the fourth quarter showed the business’s profits sliding by 90% to just $34.47 million or NT$1 billion, which fell from NT$10.9 billion ($134.44 million) in the same quarter a year ago. Revenues fell from $3.49 billion a year ago to $2.07 billion, a greater than 40% drop.  They have lost the upper end of the Android market and now will need to compete in the smaller but growing Windows Phone arena.

HTC’s income has now dropped in five consecutive quarters. The fourth quarter was particularly harsh due to the introduction of new smartphone models from HTC’s rivals Apple (NASDAQ: AAPL), Samsung and Nokia (NYSE: NOK). Like Nokia did with its Lumia Windows phone, HTC is also counting its success on a new model codenamed M7 due to be released this year to reverse the impression of bleeding edge technology and shoddy build quality.  In a market dominated by subsidized handsets with two year contracts, eventually phones that fall apart in 18 months with batteries that last half a day will come back to haunt you.  The user experience is extremely important when someone is trapped into a $800-$1,000 relationship on a device they love to hate.

Samsung’s rise has come at the cost of HTC’s fall. Until 2010, HTC was the best-selling Google (NASDAQ: GOOG) Android smartphone manufacturer. Samsung's entry into the market, with its iconic Galaxy series, pushed HTC to the boundaries when Samsung became the primary vendor of Android based smartphones in the U.S in 2011. Moreover, Apple’s iPhone has been able to maintain its market share. HTC’s CEO Peter Chou had admitted that both Samsung and Apple were “too strong” for them to compete but 2013 is will tell the tale. 

As of September 2012, HTC’s smartphone market share had fallen to 4%, placing it behind ZTE. Within one year, HTC has gone from being the third biggest smartphone vendor with 10% of the total global market share to a small player in the industry.

HTC’s earnings give no clue as to the geographic breakdown of revenues but analysts have suspected that in its last fiscal year, HTC earned around half of its sales from the U.S. With rising competition from Apple and Samsung in that market, HTC’s focus turned towards the emerging economies but in China, the most important of all the emerging markets, Lenovo, ZTE and Huawei have already established their foothold. In the rest of Asia, Nokia’s new phones, such as the Asha series, blur the boundary between a smartphone and a traditional phone, and the initial sales reports for the Windows Phone 8 Lumias has put HTC in a real bind.  Samsung’s dominance has left little room for HTC.   

The company needs a successful model badly, and its new phones, such as Droid DNA and J Butterfly, with an impressive 5-inch-1080p display and equipped with a 1.5GHz Snapdragon S4 Pro chipset, look promising. The Japanese-only phone J Butterfly has shown moderate success in the country.  There is no doubt that HTC still has the capability to pull off an amazing piece of hardware, but it doesn’t have the marketing muscle like its bigger rivals. 

The best chance HTC has at this point is to concede defeat versus Samsung in the Android space and ride whatever wave Windows Phone can create.  So far, the wave looks like it’s building nicely, but this is a long game for Microsoft (NASDAQ: MSFT) and its partners in Windows Phone.  Redmond has thrown a couple of marketing bones to HTC, which has helped.  Also both of their initial WinPhone 8 devices, the flagship-level 8X and the entry-level 8S, have been well-received.  HTC is doing itself a serious disservice not offering the 8S on T-Mobile in the U.S.  I’ve had the same criticism of Nokia as well, and I suspect the plan was dictated by Microsoft to only play in the top of the market at launch -- a tactical mistake that the superiority of Windows Phone and the hardware released by Nokia and HTC have overcome.

The modest success of Windows Phone in Europe is a path out for HTC.  The market is there for the platform at a significant level of penetration.  By shifting its focus there they are executing a turnaround in a sparse environment.  Next quarter’s earnings will be telling as that will be the first full quarter with a rising Windows Phone market share. But Samsung is coming back to Windows Phone -- and quickly -- and we could easily see a replay of the past.

Operationally, the company is not as bad as Research In Motion (NASDAQ: BBRY), but that’s like saying that you are the 50th best heavyweight in Georgia.  It’s the trend, and the future that matters.  Although its stock has been down, they have been offering attractive yield and a healthy return on equity.  However, with the continuous decline in sales and income, these returns would be impossible to sustain even in the mid-term. I wouldn’t be buying HTC as a revenue play based on the dividend.  At this point, buying into HTC is buying into Windows Phone and the company’s ability to ride Nokia’s coattails, as small as they are right now.  The damage done to the brand and the enormous rise in competition means someone has to lose. 

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p>HTC*</p> </td> <td> <p>RIMM</p> </td> </tr> <tr> <td> <p>6m Stock</p> </td> <td> <p>-6.13%</p> </td> <td> <p>+68.98%</p> </td> </tr> <tr> <td> <p>Market Cap</p> </td> <td> <p>$8.27B</p> </td> <td> <p>$6.05B</p> </td> </tr> <tr> <td> <p>P/E</p> </td> <td> <p>8.96</p> </td> <td> <p>N/A</p> </td> </tr> <tr> <td> <p>EPS</p> </td> <td> <p>1.08</p> </td> <td> <p>-1.67</p> </td> </tr> <tr> <td> <p>Yield</p> </td> <td> <p>14.23%</p> </td> <td> <p>N/A</p> </td> </tr> <tr> <td> <p>ROA</p> </td> <td> <p>11.97%</p> </td> <td> <p>-1.68%</p> </td> </tr> <tr> <td> <p>ROE</p> </td> <td> <p>31.44%</p> </td> <td> <p>-8.67%</p> </td> </tr> </tbody> </table>

* HTC Corp (TPE:2498)





PeterPham8 has no position in any stocks mentioned. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple, Google, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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