Possible Disruptors: Tech Investing Special Report, Part II

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This is the second of a three-part special report on tech investing. Click here for the first part on major trends, and check back later today for the finale, a company-level look at the major players.

The Significance of China, India and South America

When you look at the tremendous gains that Apple (NASDAQ:AAPL) stock made in 2012, much of that growth can be attributed to the iPhone — a single product that’s responsible for nearly two-thirds of the company’s profits. The iPhone has seen phenomenal growth since its 2007 debut, but as 2012 progressed, some of the wind went out of the iPhone sales. They were still good and still increasing, but not quite at the rate that Apple investors had been expecting.

Competition was one issue, but arguably the bigger one was the realization that the markets in North America and Europe were in danger of becoming saturated. People don’t always upgrade their iPhones every year, and there are fewer people remaining who don’t already own a smartphone, so investors began to worry that Apple’s iPhone sales momentum would slow, bringing down profits (the iPhones are very high-margin devices).

The problem of market saturation is not exclusively Apple’s — all smartphone manufacturers in this market have had to turn increasingly to upgraders instead of people who don’t yet own a smartphone (a tougher sell and a more cyclical one that’s tied to multiyear wireless contracts) — but the iPhone’s impact on the company’s stock price was a big part in the 39% decline since last September.

The answer to this problem is increasingly China, and to a lesser extent South America and India. All of these markets have the advantages of being massive in comparison to the Western smartphone market, with very low current smartphone adoption rates. China in particular is coveted by Apple, Samsung (PINK:SSNLF) and the other major smartphone makers. It has a population of 1.3 billion, the country has become an economic power and its citizens are increasingly buying up technology such as smartphones as status symbols.

Unfortunately, these emerging markets also come with disadvantages, in particular disposable income.

Apple has no problem unloading $649 iPhones in North America, where per capita income hovers in the $50,000 range. However, China’s sits around the $5,000 level; none of the emerging markets comes close to North American or Western European income levels. Even if the same sort of subsidies that make a new iPhone cost just $199 on a two-year wireless contract were negotiated with Chinese cellular providers, how many of the 1.3 billion people could afford to shell out that kind of money?

That’s why there have been nonstop rumors in recent months about Apple frantically working on developing a low-cost iPhone. The company needs to a make an iPhone with a much lower cost of entry, but it needs to keep margins as high as possible. To a certain extent, Apple could cede margins for high volume (something it has avoided doing to date) — but if its stock is going to recover, it needs both.

Making things even trickier in China, in particular, is the rise of competing local smartphone manufacturers like Lenovo, ZTE and Huawei who are beginning to release premium smartphones that compete directly against the likes of Apple and Samsung.

Potential Disruptors

A number of issues could potentially disrupt segments of the technology marketplace. Any of these on their own, or in combination, could knock a company or a segment of the tech industry for a loop.

Apple television: Rumors that Apple would release an Apple-branded television (as opposed to its Apple TV set-top box) have been going strong for several years; former CEO Steve Jobs was reportedly working on this as his final project. Such a move would be risky — expectations are high and failure to meet them could result in an expensive flop — but the rewards of being able to sell a premium TV (with corresponding premium prices), expand its reach into the living room and spur growth in a new market segment are tempting. One big problem here is that TV makers have had a hard time making money for years … and Apple may turn out to be no different.

Apple watch: So-called smartwatches (a wrist watch with Bluetooth connectivity and the ability to run apps) have been on a roll over the past year. Kickstarter darling Pebble released its smartwatch this year, and the rumor mill has Apple working furiously on an “iWatch” with reports that a team of 100 is assigned to designing the device. There’s also a current fascination with health and exercise monitoring devices like the FitBit activity sensor. An Apple iWatch that combined apps and monitoring could be a breakout product with sales potential to lift its stock out of the doldrums.

Video game console competition: As Sony (NYSE:SNE), Nintendo (PINK:NTDOY) and Microsoft (NASDAQ:MSFT) prepare for their cyclical battle for video game dominance with their next-generation game consoles, they face competition from new directions. Nvidia’s (NASDAQ:NVDA) Project Shield and Valve’s Steam Box gaming PC initiative will compete for hardcore gamers by leveraging impressive technology and a vast library of PC games. A worst-case scenario would involve Apple enabling its $99 AppleTV streaming media box to play iOS games on TVs. Going up against Apple’s library of hundreds of thousands of games (many at 99 cents each) would be a nightmare and could devastate this segment the way casual mobile gaming (on smartphones and tablets) has eaten into Nintendo’s and Sony’s portable video game console sales.

Cloud service disruption: A major hacking event or downtime on a major cloud service like Amazon’s (NASDAQ:AMZN) AWS, Microsoft’s Azure or Apple’s iCloud could sour business and consumers on the cloud concept and could be extremely costly to the target company.

Large-scale hack/virus on a mobile platform: Although experts have been warning us to expect one for years, we’ve yet to experience a large-scale attack on a mobile operating system. If that happens on one platform, competing platforms stand to get a boost. One of the reasons Apple’s iOS is popular is its closed approach that protects users from malicious apps. We store credit card numbers, emails and personal photos on our smartphones, and we’re beginning to use them for things like mobile payment, while increasing numbers of people access confidential work networks using these (BYOD). What happens if Google’s (NASDAQ:GOOG) Android, Windows Phone 8 or iOS is hacked?

Firefox mobile OS: In many ways the real fight over smartphone marketshare will be for third place. Android and iOS will remain Nos. 1 and 2, but third place is important as the option for those who want choice. Wireless carriers and smartphone manufacturers want a strong third place to prevent Android and iOS from completely dominating and dictating terms. Placing fourth or worse risks obscurity. The fight over third place was shaping up to be Blackberry (NASDAQ:BBRY) vs. Windows Phone, but the new Firefox mobile operating system could disrupt things. It’s open source, plays nicely with HTML 5, can run on many Android compatible devices and a number of companies including LG and ZTE have committed to releasing Firefox smartphones in 2013.

Mobile payments: 2012 was a mess when it came to mobile payments. The year had promise for those who dreamed that their smartphone would mean never having to swipe a credit card again, but it quickly descended into competing standards, incompatible devices, hardware workarounds (like Square’s credit card reader), traditional credit card companies protecting their turf and no Apple. Consumer demand is there, many retailers have embraced one or more standards, but there’s no clear winner — and until that time, it will remain a mess. However, Apple bought biometric security company AuthenTec in 2012 and released Passbook — a first pass at mobile payments using gift cards and prepaid tickets — potentially setting the stage for embracing secure mobile payments in 2013. With rumors of fingerprint authentication on the next iPhone, this could be the year the company takes a run at mobile payment with its own version. Such a move could be enough to break the impasse and at least break the logjam so there are only a few standards instead of a dozen, bringing mobile mainstream.

Natural disaster: Companies can’t plan for this except to spread the risk by using multiple suppliers (which tech companies dislike doing because it costs them volume discounts, adds transport costs and introduces quality-control issues), but a natural disaster can wreak havoc on sales and even change the ballgame. For example, the 2011 floods in Thailand took a big chunk of the world’s hard drive production offline and spiked PC prices … and the extended shortage helped boost adoption of SSDs, which had been considered too expensive for mainstream. SSDs are now replacing hard drives as the default storage in many PCs.

Check back later today for a company-specific look at the major players in consumer tech.

At the time of publication, Moon had no positions in the securities mentioned.

Brad Moon has been writing for InvestorPlace.com since 2012. He also writes about stocks for Kiplinger and has been a senior contributor focusing on consumer technology for Forbes since 2015.


Article printed from InvestorPlace Media, https://investorplace.com/2013/05/possible-disruptors-tech-investing-special-report-part-ii/.

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