The business environment today is constantly changing with respect to competition, products, people, unique processes, manufacturing, market segments, customers and intellectual properties.
All of these are the necessities in the daily operations of a company. For a company to beat competitors and increase shareholder value, the company will need to surpass all these environmental elements. Since the founding of HTC in 1997, the company had adapted its capabilities with market needs and is now a well-known brand globally. Within the last couple years, HTC entered an inorganic growth phase by acquiring businesses that can add value to the sustainability of the company. This section aims to understand the reasons for acquiring new
Platform Platform Owner Initial OS Launch Geographic origins Current Status
Android Google 2008 US Leads in smartphone sales
Bada Samsung 2010 Korea Little market share in Korea
BlackBerry OS RIM 2000 (Java) Canada Replaced by new QNX OS
BREW Qualcom 2001 US Weak OS, almost nonexistant
iOS Apple 2007 US Leads in Tablets, and proven
OS
Symbian Nokia 2000 Europe Phasing out
webOS HP 2009 US Acquired by HP, cancelled to
be open source
Windows Mobile Microsoft 2002 US Phasing out to WP7
Windows Phone Microsoft 2010 US Great reviews, unproven OS
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businesses by looking at its financial statements, market share & product mix, organization structure & design strategy, and the road map analysis.
a. Financials
From looking at the annual reports for HTC, it is evident that HTC has been quite successful.
The company was able to position itself as a high end brand and continued to be an important brand in the smartphone industry. By entering the market through its own brand and providing the unique UI “HTC Sense” skin for its phones, consumers have responded well. While HTC had the first mover advantage in the popular android OS, many companies such as Samsung, LG, Sony Ericsson, Motorola, Huawei and ZTE have aggressively entered the market and threatened HTC’s business operations.
Figure 3 – Monthly Sales
‐40.0%
Source: HTC Annual Reports – 10K, 10Q
The chart above looks at the top line growth by month from 2008-2011. According to the chart, HTC’s brand initiative did not blossom until late 2009. However, the sales growth was
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aggressively high with YoY % growth of 3.6% in December 2009 and spiking to 212% YoY % sales growth in January 2011. The average YoY % growth from November 2009 to May 2011 was 99.6%. One thing to notice was that the sales growth started to mature. According to HTC’s statement filed to the Taiwan Stock Exchange, unconsolidated sales in January 2012 fell 53.52%
to NT$16,108,401,000 from NT$34,654,934,000 in January 2011. With sales growing less than expected, while competition remaining fierce, the stock price started to decrease. The company’s month high closing price was NT$1,187 on April 2011 but dropped all the way to NT$477 on November 2011 as seen in the figure below.
Figure 4 – Stock Price & PE Ratios
Source: Macquarie Research, Citi Research
The figure above represents the downward trend of HTC’s stock price with its P/E ratio from the Taiwan Stock Exchange. Despite many quarters of record breaking revenues and EPS, investors always look at future forecasts as a mean to buy a stock. Below is a chart showing the
0.0x
2007/12 2008/03 2008/06 2008/09 2008/12 2009/03 2009/06 2009/09 2009/12 2010/03 2010/06 2010/09 2010/12 2011/03 2011/06 2011/09
Stock Price & P/E Ratio 2008‐2011
LHS ‐ Stock Price RHS ‐ P/E‐TSE calc.
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EPS growth from NT$7.15 in 2007 to the NT$73.32 in 2011. By looking at the EPS, it appeared that the company was doing well. However, stock performance is forward looking and analysts like to be certain the company can outperform. To justify a high stock price, HTC would need to increase its margins, gain market share, and find alternative revenue streams. Given the lack of technological opportunity, lack of innovation & technical personnel and the lack of market opportunities in Taiwan, investor will have a higher pressure for HTC to improve company financial results.
Figure 5 – HTC Earnings Per Share
Source: Macquarie Research, Citi Research
HTC’s competitive environment has intensified so much that Qualified Foreign Institutional Investors (QFIIs) have started to take money out of HTC. By looking at the chart below through the Bloomberg terminal, the average HTC QFII % holding from 2005-2011 was 49.95% with high of 65.3% in 2011 (Bloomberg) while average QFII % holding in general (Tech+fcial+
nontech) was around 33%. This showed that HTC’s investors were starting to lose faith, taking
0
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money out of the company and reinvesting it into other companies for growth. In order for foreign institutional investors to start investing again, HTC will need to innovate aggressively to get back to its old QFII holding %.
Illustration 4 – QFII Holding for HTC
Source: Bloomberg Terminal through Macquarie Research
In the next section, the smartphone industry along with company product portfolios will be discussed to strengthen its inorganic growth rational.
b. Market Share & Product Mix
Despite the tremendous growth of the smartphone industry, HTC has been a beneficiary of higher end smartphone devices with higher average selling price since the beginning. According to Macquarie Analyst Daniel Chang, high-end smartphones for HTC should account for 50%+ in 2Q11. With the strong contribution from these high end phones, the average selling price (“ASP”) was likely to come down, affecting the company margins and profitability. Looking at the chart
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below from Gartner, the high-end smartphones which HTC focused on, it was clear that it was low on growth versus the mid and low end. Furthermore, companies such as Samsung, LG, Motorola, Tier 3 brands, Huawei and ZTE have entered aggressively under the android OS platform. Apple continued to dominate in its iOS thus pressuring HTC to launch low-mid end devices at lower prices. Android, iOS, Symbian (Nokia), RIMM, and Windows OS account for 51%, 24%, 12%, 9% and 2% global market share respectively in the 4th quarter of 2011 (Gartner, 2012).
Figure 6 – Smartphone Type Growth 2011
Source: Gartner Research 2011, Macquarie Research
Pressures at HTC were mounting due to slow growth in high end phones and competitive threats from companies with experience in volume cycles. Looking below, we noticed the
average selling price of HTC phones increasing to its high of US$364 and decreasing throughout 2011 as seen from the figure below. The reason for the ASP decrease was due to operators
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shifting away subsidies from the high end smartphones launched by tier one brands to mid or low smartphones. With this unexpected change, HTC had to change its product mix in 2011 in order to compete on pricing. Phone launched that are less than US$300 were HTC ChaCha, HTC Explorer, HTC Salsa and the HTC Wildfire.
Figure 7 – HTC ASP VS Unit Shipment Graph
Source: HTC Annual Report – 10K, 10Q
According to Gartner, the dominate OS is clearly Android with around 47% of the 471 million units smartphone industry in 2011. IOS itself through Apple is in second place with 20%
of the smartphone industry. While Android OS went from 67 million units to 219 million units, Android OS has grown as a consequence of the open source platform and the decreasing popularity of Blackberry OS, Symbian, Windows OS.
24 Figure 8 – Operating System Market Share & Growth
Global Smartphone Market Share (1,000 units) 2010 1Q11 2Q11 3Q11 4Q11 2011 Total
Android 67,220 36,350 46,776 60,490 75,906 219,523
Growth QoQ 29% 29% 25%
Symbian 111,580 27,598 23,853 19,500 17,458 88,410
Growth QoQ ‐14% ‐18% ‐10%
iOS 46,600 16,883 19,629 17,295 35,456 89,263
Growth QoQ 16% ‐12% 105%
Research In Motion 48,000 13,004 12,652 12,701 13,184 51,541
Growth QoQ ‐3% 0% 4%
Bada NA 1,862 2,056 2,479 3,111 9,508
Microsoft 12,380 2,582 1,724 1,702 2,759 8,767
Other NA 1,495 1,051 1,018 1,167 4,730
Grand Total 99,775 107,741 115,185 149,042 471,743
Source: Vision Mobile, 2011
Although RIM and Microsoft have begun investing back into its OS, both companies have had a tough time attracting new users from the likes of Android and iOS. Symbian from Nokia on the other hand was discontinued and started to develop Windows Phone 7 OS phones.
In the android platform, vendors have the ability to create its own phones with the OS and differentiate itself. For example, Samsung has been successful because of its conglomerate manufacturing, bargaining power, and Amoled screens. HTC has been successful with its unique design and HTC Sense UI. Huawei and ZTE from China have been successful because of its low cost manufacturing and low price phones. The graphs below show HTC’s market share in
android, decreasing from 50%+ in 2009 to 18% in 3Q11. Although market share is only a partial story, the graphs shows the losing competitive edge of HTC to companies such as Samsung and Huawei. At the end of the day, profitability is a better measurement of performance.
25 Figure 9 – Android Market Share Breakdown
Source: Gartner Research, Macquarie Research
c. Organization Structure & Design
It is quite often that companies do not have a clear competitive strategy. Whether the
company believes in a differentiated strategy or a cost leadership strategy, many companies may be conflicted because of the hybrid attempt. For HTC, a differentiated strategy will allow it to be
Global % breakdown by Android Vendor 1Q11 2Q11 3Q11
HTC 22% 22% 18% ↓
LG 11% 10% 7% ↓
Motorola 11% 9% 7% ↓
Samsung 28% 31% 35% ↑
Sony Ericsson 9% 8% 9% −
ZTE 2% 4% 5% ↑
Huawei 7% 6% 7% −
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more sustainable in the long term because of non-conflicting mentality on high price phones with low price threats. While the company knows it needs to be differentiated, it has performed with mixed reviews. According to HTC UK’s CEO Phil Robertson, he said: "We have to get back to focusing on what made us great – amazing hardware and a great customer experience. We ended 2011 with far more products than we started out with. We tried to do too much. So 2012 is about giving our customers something special. We need to make sure we do not go so far down the line that we segment our products by launching lots of different SKUs" (Millett, 2012). Mr.
Robertson discussed how HTC wants to refocus on hardware and its software experience. With a congruent experience from fewer HTC devices, this experience will provide customers a truly valuable smartphone.
Historically speaking, it has been tough for Taiwanese companies to get out of the cost leadership mindset. For example, some of Taiwan’s biggest industries include LED, computers, LCD, components, and electronic manufacturing – all of which focused on being low cost. In these industries, market share generally suggested the success of the company. Acer, now a global provider of notebook PCs, has since gained an enormous amount of market share worldwide through its outsourcing strategy. Acer retreated from its ODM “low cost strategy”
business in 2000 and focused on branding. By outsourcing its manufacturing downstream into a competitive environment, Acer can manufacture at low prices while charging higher prices. It can been seen in Acer’s financial statements that after the divestiture of Wistron, the company’s EBIT margins improved from 1.6% in 2001 to 2% in 2002. Additionally, the company increased its revenues from 30bn NT$ in 2001 to 629bn NT$ with a 2.8% EBIT margin in 2010. Despite the market share gains and increased revenues by 21x since 2001, the company’s design structure
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failed to implement a sustainable differentiated strategy as margins went downwards since the end of 2010 (Acer Group, 2011).
Figure 10 - Operating Margins by Comparable Companies
Nam e Ticker Market Cap
P/E FY1
Price/
Book Value EBIT Mgn %
GOOGLE INC. GOOG-US 199,715 14.5x 3.6x 46.8%
MICROSOFT CORPORATION MSFT-O 266,826 11.8x 3.4x 38.3%
APPLE INC. AAPL-US 497,102 12.5x 4.2x 27.9%
Research In Motion Limited RIM-T 8,639 4.2x 0.8x 15.3%
HTC Corporation 2498-TW 17,921 11.3x 4.1x 12.8%
DELL INC. DELL-O 30,738 8.0x 3.6x 7.1%
HEWLETT-PACKARD COMPANY HPQ-N 49,428 6.2x 1.4x 6.7%
ASUSTEK COMPUTER INC. 2357-TW 7,050 12.8x 1.6x 5.1%
HON HAI PRECISION IND. CO., LTD. 2317-TW 35,808 14.9x 1.4x 2.2%
ACER INCORPORATED 2353-TW 4,069 19.0x 1.3x 1.4%
Nokia Oyj NOK1V-HE 18,911 29.5x 1.2x NA
Mean 13.2x 2.4x 16.4%
Median 12.5x 1.6x 9.9%
High 29.5x 4.2x 46.8%
Low 4.2x 0.8x 1.4%
*As of March 6, 2012
Source: Annual 10K and 10Q from each company
While HTC has been successful in attracting customers, the competitive landscape from conglomerate Samsung, powerhouse Apple and various smaller players have threatened the business model of HTC. Should HTC change its cost structure? Focus on design? Focus on software, or focus on capacity? Answering these questions will serve HTC’s future corporate strategy and prevent itself from the likes of notebook manufacturers – Acer, Asus, Dell, HP, all focused on hardware specs and low costs. In short, if HTC’s smartphone does not grow its software / platforms through inorganic growth, the company may end up losing its competitive edge in hardware industry.
28 d. Acquisition Analysis & Roadmap
HTC’s investments into the various companies can be explained with the diversification theory and the synergy theory. By acquiring value added software enhancement companies such as Abraxia and Dashwire, HTC can enhance the experiences of its users by adding new technologies to the UI. With an increase in the overall friendliness of the customized Android OS and Windows OS, HTC’s brand name is becoming more valuable. Along with software
acquisitions, HTC also invested in various businesses such as Saffron, KKBOX, Onlive and Beats that aims to pave the path for HTC’s future.
1. Saffron Digital - Since the US$48 million acquisition, the company has integrated the technology to HTC phones and tablets under “HTC Watch”. With the HTC Watch application, users are able to stream movies and TV shows through any internet connection. This application would act as the digital video content for HTC. This particular acquisition will be analyzed in depth in the next section.
2. KKBOX – In 2011, HTC acquired an 11% stake in KKBOX for US$10 million. KKBOX is an online subscription based music service provider. The service has been launched in Taiwan, Hong Kong and Japan.
3. Onlive – The US$40 million dollar investment in Onlive aims to make HTC the ultimate gaming machine. The idea here is the ability to play games on mobile devices without the need for a separate console.
4. Beats – To watch movies, listen to music and play videos games all require headphones or music software. It’s an even better incentive that the headphones are stylish and durable. HTC acquired a 51% stake of Beats by Dre for US$300 million which is a JV involving Dr. Dre and Interscope record Chairman Jimmy Iovine.
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By investing, acquiring and partnering with these various companies, HTC has not only diversified its risks in being strictly a hardware company but added intangible value for the HTC phones. Looking at the roadmap below, the strategic rational can be seen similar to Apple’s model. While the company is not an exact comparable, HTC’s forward strategy is looking to be more sustainable when compared to hardware companies.
30 Illustration 5 - Roadmap of Industry VS HTC
Source: Personal Analysis, Public Knowledge
31 V. Saffron Digital / Digital Content Analysis
HTC’s US$48 million acquisition of Saffron Digital, now HTC Watch for HTC, was a rational decision. Below is an analysis of the acquisition conducted with industry trends & M&A activities and its business environment. Although the acquisition is still at its infant stage, the proof below will allow the reader to understand why the acquisition was rational and that HTC made a good choice in Saffron Digital.
In brief, Saffron Digital is a London-based company that specializes in the mobile content delivery services focusing around video. According to Saffron’ s then Chief executive Shashi Fernando, the company will continue to be an independent company and serve its clients such as Sony Ericsson, Nokia, Microsoft Vodaphone, T-Mobile, UK Broadcaster Sky and Paramount Digital Entertainment. He also said “The idea is that our technology allows you to get closer to the iTunes ecosystem in the delivery of a connected home and on the move.” Thus suggested that this technology is essential to combat the forces of Apple’s iTune media software (Bradshaw, 2011). The company is listed in the Deloitte Technology Fast 50 2010, has been named one of UK’s top 100 technology and media companies in the Tech Media Invest Top 100 for 2009/2010 and was named Best Video Service Provider in the Mobile Entertainment 2010 awards.
(Business Wire, 2011)
a. Cloud Computing Trends
Driven by trends like cloud computing, software as a service, social networking, and mobile communication, HTC needs to bolster its information technology, particularly to cloud computing if it wants to create sustainable value for its current and prospective customers. The acquisition of Saffron followed the economic transformation of the global technology
environment to operate in the “cloud.” For example, music use to be purchased and listened
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physically, however the business model has changed to “cloud” music. In this method, music is selected through the use of the internet and is automatically downloaded to the music player or device. Similarly, internet delivery services such as video conferencing and streaming video content are also cloud computing innovations. As internet usage becomes standard as seen in the chart below, with penetration rate as high as 70% in the UK, and with smartphone and tablet usage rising, it is safe to say that cloud computing innovations will be part of the future.
Figure 11 – Penetration Rate
According to Accenture’s Video Over Internet Consumer Usage Survey, a survey of more than 6,500 consumers around the major markets, the video viewing habits have changed
dramatically and new business models have emerged. While the survey suggested that
“consumers are still watching traditional TV, but they’re also viewing content over an amazing range of other devices and interacting with content and people during the viewing experience”
(Accenture, 2011). In fact, 85% of people age 18-24 are internet video consumers and even
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consumers over the age of 65, 2/3rd of the survey responders were joining the internet video movement. One key finding in the survey was that consumers liked special features such as the ability to watch videos in multiple devices, which was possible from the Saffron acquisition. The point from these survey results suggested that the traditional video business model (big box retailer and TVs) were no longer the dominant form of video content delivery. Consumers wanted compelling functions such as video storage, customization of content, and ease of use in multiple platforms such as Laptops/Desktops, mobile devices and tablets such as the iPad.
To further demonstrate the correlation of HTC’s Saffron acquisition with market demands, M&A has been growing. In the first quarter of 2011, Global IT M&A have gone up 26%, 794 reported acquisitions, with total value up 124%, at a value of US$27 billion. According to Joe Steger, a Global Technology Transaction Services Leader at E&Y, stated that “These trends speak to the rapid pace of change driven by the cloud, social networking, smartphone mobility, and the way in which technology is becoming an increasing part of everyday life – not just something we do at work. On the business side, the trends reflect that information is becoming a larger component of the value of all products and services” (Steger, 2011). The use of mobile and internet began to soar in 2010 for entertainment, business conferencing and personal video calling purposes. Thus many multinational companies were responding by acquiring strategic companies. Since HTC acquired 100% of Saffron for cloud computing digital media, Taiwan based Acer acquired iGware, a cloud computing company with the infrastructure tools for portable devices for US$395 million (Ben Boissevain, 2011).
In terms of HTC’s 100% acquisition of Saffron, it was very difficult to determine if the valuations was fair given the limited information on Saffron. However, given the market’s demand for these types of companies, precedent transactions had revenue multiples at around
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4.1x and EBITDA multiples of around 20.3x which were much higher than 2011-2012 tech valuations of 2.0x revenue multiples and 8.1x EBITDA multiple. As an established company like HTC continue to acquire small cloud companies, the universe of good acquisitions targets will shrink with valuations ultimately falling back to the norm. Although Saffron may be an
4.1x and EBITDA multiples of around 20.3x which were much higher than 2011-2012 tech valuations of 2.0x revenue multiples and 8.1x EBITDA multiple. As an established company like HTC continue to acquire small cloud companies, the universe of good acquisitions targets will shrink with valuations ultimately falling back to the norm. Although Saffron may be an