Breakfast on Wall Street – 10 September 2013

MARKET COMMENTARY

The relief rally in the market yesterday helped the S&P move up 1% to end the day at 1,671.71, while the NASDAQ Composite closed 1.36% higher, at 3,706.18.The Dow Jones Industrial Average posted its largest gains in nearly two months; it was up more than 140 points, or 0.9%, and ended the day at 15,063.12. This is the highest level for the Index since September 2000.

As we have mentioned earlier, equity markets are erratic now and analyzing the markets has become increasingly difficult for the value investor. The definition of good news is far removed from the fundamentals and is in a constantly state of flux. As such, there were three surprising sources for the relief rally yesterday – Russia’s comments on Syria, the worse than expected employment reports and the rise in Chinese exports.

Russian Foreign Minister, Sergei Lavrov, announced in Moscow yesterday that Russia has proposed to Syria that it relinquish control of its chemical weapons in order to avoid unilateral strikes by the US military. Secretary of State, John Kerry, had stated earlier that the US government would reconsider its attacks if the Syrian government hands over its chemical weapons stockpile to international control. The markets reacted favorably to this possible resolution of the crisis caused by President Obama’s decision to militarily intervene in the region.

The markets were also relieved with the lower-than-consensus jobs report on Friday. The report, which further proves that the sluggish economic recovery is not creating enough employment, will pressurize the Fed against tapering its bond purchases from September, as it had announced earlier. We believe it is more likely that the Fed will taper slowly and even if the first moves come in during September, the pace will be muted in response to the employment data.

Good news from China also helped the markets on Monday. Though, as fundamental investors, we believe that rising exports in China should not affect the US markets, we do concede that it provides clarity from a global macro perspective. Chinese exports rose 7.2% in August year-over-year, far better than the consensus estimates of 5.5%. As China has become the global manufacturing center, rising demand for Chinese goods implies increasing demand across the globe.

While we wait for Apple (NASDAQ: AAPL) to make significant announcements tomorrow at its Cupertino, California headquarters and in Beijing, we have created a two-part study on the tablets and smartphones industry, with a special focus on Apple and its competitors. Today’s special will provide a broad outlook on the industry, concentrating especially on its global performance and trends. Tomorrow’s report will follow up with a closer look at the individual firms in the industry, with an eye on Apple’s announcements – and its success and failures with investors. While we will create a broader outlook, our sister publication Hot Off the Wire (HOW), will provide commentary on any updates that the Apple provides in their announcements tomorrow.


Today’s Menu


TODAY’S SPECIAL: TABLETS AND SMARTPHONES OUTLOOK – PART I

Apple Inc. (NASDAQ: AAPL) has scheduled crucial back-to-back events this week. The first event will be held tomorrow at their headquarters in Cupertino, California, where the company is likely to announce its deal with NTT DoCoMO and launch a new series of iPhones and iPads. Rumor has it that Apple is going to reveal a cheaper iPhone and more sizes and colors for its iPad. There are possibilities that Apple will also announce a buy-back offer for iPads and the release of a smart iWatch. The second meeting has been scheduled at Beijing where Apple is likely to announce new strategy/products for China and a much-discussed deal with the world’s largest mobile phone company, China Mobile Ltd. With so much attention, conversation and rumor centered on Apple, our team at Wall St. Analyst has decided to give you a broad picture of the tablets and smartphones competitive market landscape and provide you with our best strategies for this market. While we provide a big picture outlook, our sister publication, Hot Off the Wire on WallStAnalyst.com will provide live views and analysis of the announcements, as they happen.

The Big Picture

mm pic 1

According to IDC, following a 91% growth in tablet shipments last year, shipments are expected to grow at 58% this year and subsequently, at more than 25% in the next. The graphic above illuminates the upsurge in tablets as the primary medium of computer use as both desktop and laptop sales have shrunk across the globe. The growth of the tablet market has been phenomenal with 19 million tablets being sold in 2010 and an estimated 229 million expected sales in 2013. The forecast is that this number will nearly double by 2017, despite the concern of saturation in developed markets.

However, if we compare the tablets data to the number of smartphones sold and the expected shipments in the next five years, we realize why there is space for a new launch every few days.

Source: IDC
Source: IDC

The graphic above (from Statista, with data from IDC) shows the exceptional rise in smartphones, with total shipments expected to go beyond the 1 billion mark. For those investors concerned that we have reached saturation in tablet and smartphone sales, these simple charts should help them realize that we are far from it. According to IDC, like tablets, smartphone shipments are going to more than double between 2012 and 2017. The window of opportunity to invest in this growth is still open, albeit narrower than before.

China and the new ‘New World’ of Emerging Markets

mm pic 3

The smartphone forecast (shown above) geographically divides the market and helps us conclude that despite its fantastic growth over the past few years, the smartphone market will continue to expand. While the Asia Pacific region is already a larger market for smartphones than North America, smartphone growth in emerging markets is projected to expand at a 21% CAGR from 2012 to 2017. The Asia Pacific region is expected to grow by 20% with estimations of 850+ million phones shipped in 2017. This statistic makes the announcement in China very crucial for Apple’s future.

mm pic 4

As can be seen from the revenue change graph above, Apple’s performance in China and the APAC has been dismal in the recent quarter and year. The market for smartphones in China is still dominated by Samsung and other smaller Chinese local players like Lenovo, Coolpad, ZTE and Huawei. All of these firms have moved ahead of Apple in the last year and together control for more than 40% of the Chinese market.

Source: IDC, Bloomberg Industries
Source: IDC, Bloomberg Industries

The table shows the falling market share of Apple, while Samsung’s market share has been mostly stable. With more than 700 million users, China Mobile, the largest mobile company in the world, has been driving a hard bargain with Apple over access to its near-captive pool of users. If Apple announces a tie-up with China Mobile, it will bring about a definitive, positive and much-needed change in its Chinese performance.

The Competitive Space – It’s not local, it’s Global

The global tablet and smartphone industry is led by two fiercely competitive multinational behemoths, which—despite some sharp new arrivals in the industry—together control more than 50% of the market.. The firms have allegedly stolen each other’s codes and patents, created various products to poach the other’s customers, created advertising to undermine the other, and have sued each other in multiple global courts.The rivalry between Apple Inc. (NASDAQ: AAPL) and Samsung Electronics Co. Ltd. (KSE: 005930) will go down in corporate history as a legend of its times.

A close look at the market share of the top firms will allow investors to realize why this intense rivalry has cropped up. And it seems like it is a game that Apple is losing—for now.

The pie chart on the left shows global market share for smartphones in 2012. The chart on the right shows the same data from Gartner for 2013.
The pie chart on the left shows global market share for smartphones in 2012. The chart on the right shows the same data from Gartner for 2013.

While Apple has lost over 4% in market share, Samsung has gained over 3%. Smaller players like LG, HTC and ZTE have also gained at Apple’s expense.

mm pic 7

While it is true that Apple has come out of its $400 lows, we still believe that the market is looking at it as a low growth, value stock – with mature offerings. We believe that Apple has a lot more to offer and we see both PE ratios and EPS grow with their new strategies. In tomorrow’s continuation of the same theme, we look at how Apple has lost out on market share in the low and medium cost smart phones to Samsung. We also analyze the statements put forth by Apple later today.

THE LAST 24 HOURS

Obama welcomes Russian Proposal on Syria

President Barack Obama, who has been campaigning for military action against Syria, has stated that Russia’s proposal to Syria to surrender its chemical weapons stockpile to international control, if successful, would withhold, at least temporarily, the planned U.S. military strike. While the President is vigorously trying to gain support from the Congress, the American public is not in favor of the President’s planned military invasion. Thus, any serious diplomatic effort that would resolve the current crisis would work out in favor of all parties concerned.

Carl Icahn Withdraws from War Against Michael Dell

Carl Icahn, the activist investor and second-largest shareholder in Dell, has brought his protracted battle against Michael Dell’s $25 billion offer to take the company private, to an end. This might now lead the way to the largest buyout since the financial crisis. Dell’s founder seeks to transform the company from a maker of personal computers into a provider of innovative computing services, while Icahn has repeatedly argued that this offer undervalued the company’s shares.

Biggest Sale of Emerging-Market Debt

Even after months of chaos, investors seem to have continued interest in the emerging markets. On Monday, Russia and South Africa released bonds in the biggest sale of emerging-market government debt this year, although they will now have to pay considerably higher to entice investors. For the past four months, anticipated withdrawal of U.S. Federal Reserve stimulus plan has made U.S. Treasury yields increase, while, at the same time, emerging-market currencies, stocks and bonds have plummeted.

Banks Cut Jobs as Interest Rates Rise

A falling-off in refinancing and a rise in interest rates are instigating US banks to caution investors of deteriorating revenues in the home-loan business and to cut jobs. Rising interest rates —a result of concerns that the Federal Reserve will soon decrease an $85-billion-a-month bond-buying program—have significantly reduced homeowners’ demand for mortgages. Since July, Wells Fargo has already laid-off 3,000 employers in its mortgage division, which is about 1% of the bank’s total workforce.

Epic Sale at Verizon

In relation to its $130 billion acquisition of Verizon Wireless, Verizon announced on Monday that it would sell fixed and floating-rate debt from six diverse maturities, extending from three to 30 years. To tempt investors, Verizon will now pay higher yields than what its prevailing bonds are already offering. The epic sale may exceed Apple’s $17 billion record-breaking sale in April.

Hyundai Motor and its Labor Union Reach Agreement

South Korea’s largest automaker, Hyundai Motor and its labor union, which had been on partial strikes since August 20, have finally resolved their differences and reached a settlement. The company, which produces about 43% of its global output in South Korea, has lost Won1tn ($921m) in lost production of 50,000 vehicles during this labor disruption. Increased production in the latter half of this year is expected to recover at least a part of this loss.

THE NEXT 24 HOURS

The big news for the next day is Apple’s news conference. The company, which does not have any growth priced in, according to its PE multiples, will have to prove that it can move beyond its founder’s legacy and continue to innovate.

In other news, we have the NFIB Small Business Optimism data coming out tomorrow. We take this indicator seriously as we know that small businesses are the backbone of the labor markets and provide two-thirds of all jobs in the United States. Analysts expect the index to rise to 95, after a 94.1 print last month –the second highest for the year.

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