HTC – Thousand cuts.

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HTC has all the hallmarks of death by a thousand cuts.

• HTC has warned on Q2 15E sales and profits as it is clear that the M9 has not fared nearly as well as the company had hoped.
• Q2 15E revenues / gross margins will now be NT$33bn-NT$36bn (NT$34.5bn) / 19.0%-19.5% compared to guidance given on April 28^th 2015 of NT$46bn – NT$51bn (NT$48.5bn)/ 23.0% – 23.5%.
• Using the midpoints, Q2 15E gross profits are now expected to be NT$6.6bn compared to previous guidance of NT$11.3bn.
• This represents a 29% downgrade in revenues and a 42% downgrade to gross profits.
• HTC has blamed the weaker revenue performance on slower demand for high end Android devices and weakness in China.
• Weak gross margins were blamed on poor product mix and lower scale.
• At the same time, HTC has launched yet another cost reduction program to right size its business and has written off NT$2.9bn in assets that are no longer likely to be productive.
• The source of this warning is almost certainly the poor reception of the M9 which was hoped to be the engine of revenue and profit generation this year.
• The M9 underlines a problem which is endemic to almost all Android vendors.
• Their products are commodities where user preference is driven by other factors such as the ecosystem.
• The M9 has two big problems.
  • First. It is first and foremost a Google ecosystem device.
  • The Google ecosystem is freely available on any Android device which complies with Google’s standards giving the user no reason to choose HTC.
  • Second. The M9 is very similar to the M8 and I suspect that most users (myself included) can’t tell the difference.
  • Consequently, I suspect that Samsung’s 2014A problem where the Galaxy s4 (much cheaper) out sold the Galaxy s5 in has been repeated here.
• The end result is that HTC can only differentiate itself on form factor and on price.
• With nothing to differentiate its products from anyone else’s, HTC’s devices are commodities that will earn 2-4% operating margins in the best instance.
• HTC is also now in the difficult position of having to cut into the muscle of its business meaning that more cuts are likely to mean further revenue falls necessitating further cuts and so on.
• This is the vicious circle that Ericsson, Motorola, Nokia, BlackBerry and Palm all failed to break and HTC is showing every sign of following the same trajectory.
• Hence, this is very unlikely to the last profit warning that HTC issues and I think that there is further downside to come.
• Until HTC can find something that differentiates itself from the brutal competition, the only beneficiary from its excellent devices will be Google.
• This is why Google is the only company I would go near when considering investing in an ecosystem built on Android.