Monday, May 21, 2012
The "gadget boom" is still on... But there are signs of trouble for some high-flying stocks.
Last week, tech research firm Gartner released the latest numbers on the mobile phone boom. During the first three months of this year, smartphone sales rocketed to over 144 million units. That's a whopping 45% increase versus the same period last year.
Huge growth in smartphones has led to huge growth in the "boom and bust" semiconductor sector, which provides the chips that go into smartphones. That may be changing...
Giant "carriers" like AT&T and Verizon are starting to cut back on the subsidies they provide on fancy, expensive mobile phones.
Until recently, these carriers have been happy to pony up hundreds of dollars to reduce the price of smartphones for their customers. Apple makes about $500 when it sells an iPhone... But consumers only pay $100 or $200. The difference comes out of the phone company's pocket. AT&T and Verizon don't mind because they make a lot more off the long-term contract the customer has to sign.
That's been the story for years...
But over the past few months, U.S. carriers have quietly started to cut back on these generous subsidies. In February, AT&T raised the fee it charges when a customer upgrades his phone to $36 from $18. A month later, Verizon introduced its own $30 upgrade fee.
Meanwhile, both companies have eliminated their "early upgrade" programs. In other words, they're making existing customers wait longer before being able to qualify for a subsidized new phone.
These changes seem small until you consider the potential for a major slowdown in smartphone sales.
Less than two weeks ago, analysts at Credit Suisse adjusted their estimates on North American smartphone sales. The analysts now expect 119 million smartphone units to be sold in 2012... down from their previous estimate of 142 million units. That's a massive cut. Credit Suisse now expects just 11% sales growth this year... down from 32%.
Of course, the analysts tried to put a positive spin on the situation. They noted that a 10% longer lifespan for phones would have a minimal impact on earnings for the semiconductor companies that supply parts for mobile phones. They also included a chart showing how stronger international sales would easily make up for lower smartphone sales in the U.S.
I'm not convinced.
AT&T and Verizon have spent years building their massive customer bases. They've spent billions building their networks and competing for customers. They're just starting to cut back on subsidizing phones. It's impossible to tell how far they might go... or how much the cuts could affect phone sales.
Meanwhile, investors are worried about the slowing economies of China, India, and Europe. It's wishful thinking to assume international customers will "save the day." I'm more worried that foreign telecom companies will take a cue from their U.S. counterparts and start cutting their subsidies as well.
That could spell big trouble for the small semiconductor companies that build the chips that go into smartphones. These companies are all expecting 40% growth in worldwide smartphone unit sales this year. If that number turns out to be too high, they could be stuck with lots of inventory.
For example, giant chipmaker Qualcomm (QCOM) made 60% of its sales last year off device sales. The company shipped 483 million of the chips needed to go into wireless devices. Mobile phones make up the vast majority of that number.
The market is expecting big growth from Qualcomm this year. Revenue is expected to grow by 29%, to over $19 billion. Earnings are expected to grow by 18%. This massive growth is a key reason why investors are willing to buy shares for more than 15 times earnings.
If Qualcomm's growth slows due to lower smartphone sales, the market's expectations will turn out to be way too high. While Qualcomm will survive a lower sales number, investors won't fare as well. The slower growth could push down that "premium" valuation of 15 times earnings. (Slower-growing semiconductor giant Intel trades at only 10 times earnings.)
Skyworks (SWKS) is a perfect example of a company that gets almost all its revenue making semiconductors that go into mobile handsets. The company boasts that a smartphone can contain up to $12 worth of Skyworks' components.
Shares of this name surged more than 33% within a couple months after I mentioned it in January. If you were in that trade, you might want to take profits. The market is expecting Skyworks to deliver 10% sales growth in 2012. That number could easily end up in negative territory if my concerns prove correct.
The latest developments in the mobile market create a major cloud over the "boom and bust" semiconductor sector. For now, there are much safer places in the market.
In February 2011, behind record demand for Apple's iPhone, Larsen called Verizon a low-risk, high-income play on the gadget boom. Since then, shares are up 22%... while the overall market is down 2.5%.
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