Company yet again flip-flops as it bleeds cash and searches desperately for direction

After losing NT$3.5B ($118.9M USD) before taxes and NT$3.58B after taxes in Q3 2013 -- its first ever loss in corporate history -- HTC Corp. (TPE:2498) is riding on fumes and desperation.  Once the top-selling phone brand in the U.S., today the company is making dire sacrifices, vowing to cut a quarter of its total expenses and dramatically change directions in hopes of turning a small profit in Q4.

I. Down, Down We Go

The latest rocky quarter for the embattled Android OEM saw it jettison its 24.85 percent stake in Beats Audio for $415M USD.  That's not entirely a bad thing as HTC acquired a 51 percent controlling stake in Beats Audio for an estimated $300M back in 2011.  It later traded that for a smaller stake in Beats Electronics, and some cash.  Now it's yet again turning a small profit off the deal, which it says should amount to additional $85M USD in profit when all is said and done.

A stronger sign of desperation can be seen in HTC's decision to sell Saffron digital which it also bought in its 2011 heyday.  It paid $48.5M USD for Saffron at the time, but is making only $47M USD off its just-announced sale, along with the freedom to use Saffron's patented video delivery technology.

Beats by Dr. Dre
HTC sold its stake in Beats for a small profit. [Image Source: Hot New Hiphop]

HTC continues to shed employees and shutter facilities as well.  It expects to reduce operations to NT$10B ($339M USD) in Q4 2013, down from NT$13.1B ($445M USD) in the money-losing Q3.
Layoff notice
The pink slips have been flying at HTC, although it's been proactive and driven off many employees before it came to such unpleasantries.

HTC continues to struggle to find a strategy.  After saying last quarter that it was focused on building high end smartphones for the expanding Chinese market, where it has seen increasing success, HTC's new finance chief has abruptly announced that HTC instead would focus on a "broader" (read: low-to-mid range) lineup, stating, "We're looking at broader products in this quarter...we aim for higher volume into 2014 that will give better profitability."

II. Cutting Off its Arms and Legs to Save the Torso

If HTC indeed sticks to this plan, the HTC One and One Max -- high end, high quality, rather unique flagship Android phones -- may be the last of their kind in a sense, as HTC tries to fill lower spots on the food chain.

It's looking increasingly probable that HTC will adopt this approach out of necessity as it will likely have neither the engineering staff, nor the financial resources to design high-end Android handsets by the end of Q4 2013.

The HTC 8S Windows Phone

Meanwhile HTC's revenue continues to plunge downward.  HTC made NT$60B ($2.04B USD) in Q4 2012 -- not exactly great.  But by contrast, HTC's new forecast has that bitter memory looking a lot rosier as it just predicted revenue would fall by as much as a third to NT$40B ($1.36B USD) to NT$45B ($1.53B USD) for the quarter -- below the previous Thomson Reuters SmartEstimates analyst estimate of NT$47.1B ($1.60B USD) and far below the NT$52.2B ($1.77B USD) estimate that 21 analysts surveyed by Bloomberg expected.  

Net profit is expected to move from NT$1B ($33.9M USD) in Q4 2012 to anywhere between a modest NT$1.41B gain ($47.9M USD) (NT$1.70 earnings per share) -- at best -- to a drop to NT$83M ($2.8M USD) at worst.

Sales of the HTC One Mini were limited by production problems in Q3 2013.
In other words since it began to struggle in late 2011 to early 2012, HTC has or is yet to shed most of its engineering staff and global facilities, in a survival attempt to reposition it as a maker of budget to mid-range phones.  HTC's massive cuts continue in Q4, as its operating budget suggests that it will cut a quarter of its total  expenses (employees, facilities, etc.).  

HTC smartphones

At best these sacrifices will basically keep HTC steady at a small profit in the tens of millions of USD.  At worst the phonemaker will essentially break even, an outcome only marginally better than last quarter's small, but historic loss.

Returning to the NT$10B ($339M USD) operating expenses number, remember that Q4 is a holiday quarter, which usually has much higher expenses (due to advertising, product, launches, etc.) than Q3.  Yet HTC plans to actually cut its expenses, an extraordinary effort that equal parts praiseworthy and insane.

One X Plus
HTC will likely climb down the stack with more budge fodder along the lines of the now-aging HTC One X+ [Image Source: Anandtech]

In Q4 2011, fresh off its dominance of the American smartphone space, HTC spent a whopping $NT63B on operating expenses.  If HTC completes its current cost cutting trajectory it will have one-sixth the budget it had in 2011.  It's hard to design great products, when you've fired most of your engineers and design staff.

III. Befuddled Marketing

HTC is currently spending roughly $1B USD to try to gain marketing ground in brand-sensitive smartphone market.  Marketing Chief Benjamin Ho offered no excuses for his and his company's poor performance, remarking, "Perhaps in the past we have not marketed ourselves that well.  We are in the process of tightening up and revamping a lot of things that we used to do."

Since Mr. Ho officially stepped aboard the leaking HTC ship in January, he's tried to recraft HTC's message of "quietly brilliant" designs into a brasher, more in-your-face marketing message.  

HTC quietly brilliant
HTC is no longer content to be "quiet". [Image Source: Reuters]

Taking to Twitter, he's exulted the HTC One and trashed the flagship devices of rivals Samsung Electronics Comp., Ltd. (KSC:005930) and Apple, Inc. (AAPL).  He also signed actor Robert Downey, Jr. to a multi-million dollar advertisement deal that yielded a set of cryptic, obtuse commercials that may have have drawn some attention that HTC still exists, but largely left customers even more confused as to why they would want to buy and HTC phone.

The generally pro-Android, pro-HTC staff at Android and Me summarized:

While HTC was the leader in the Android space for a few years, most people in the US didn’t know the HTC name. They were buying an EVO, a myTouch or a DROID. The new HTC “Change” ad campaign may be some people’s first introduction to the “Happy Telephone Company.”

It may not be ideal, but HTC would rather have people ask “Did you see that weird HTC commercial? What the heck as that?” than not have anyone talking about the brand at all.'  For now, the only word we can use to describe the full two minute commercial is “odd.” 

But from an investor perspective HTC's behavior seems even odder.  HTC's commercials proclaim "HTC, it's anything you want it to be" -- but customers don't seem too interested in wanting it to be anything.  And yet HTC's leaders still seem a bit at odds with the reality of just how dire the fate their facing is.

IV. HTC's Leaders Channel Their Inner RIM

A purchase by a strong rival OEM could benefit HTC's brand, employees, and investors if executed well.  And yet HTC Chairwoman Cher Wang -- reportedly the richest woman in Taiwan -- has publicly vowed to not sell HTC no matter how bad things look.  As Ms. Wang -- the daughter of billionaire former chairman of Formosa Plastics Corp. (TPE:1301), Wang Yung-ching -- currently owns an estimated 20 percent of HTC, there's little hope of a sale for now.

HTC may eventually sell, but it will be a tale like that of BlackBerry, Ltd. where poor leadership could have traded pounds of cure (and massive shareholder losses) for an ounce of prevention, had they been less prideful and sold sooner.  

Even the company's arguably most valuable leaders has become a detriment of late.  HTC CEO Peter Chou was a leader who exhibited a certain kind of bold brilliance that allowed HTC to rise from obscurity to be a market leader in an era where smartphone releases were more sporadic and less driven by brand.  But in the modern era where OEMs must compete quarterly with new product, at a faster, iterative chain of short spec hops, he's struggled to adjust to this new market reality.

Peter Chou
Once an asset, CEO Peter Chou has ignored his own promises and become just another denialist detriment. [Image Source: Reuters]

It was widely reported/confirmed by HTC staff that at a meeting of HTC senior management last winter, Mr. Chou told staff that the company would see one of two outcomes -- the HTC One would be a sales success, or he would resign.  Such a promise seemed the mark of a brave and thoughtful leader, a general willing to lead his troops personally to victory, or in defeat take the blame on his own back.

HTC fought perhaps its final battle for the high-end smartphone market and it basically loss.  Dennis Chan, an analyst at Yuanta Financial Holding Comp. in Taipei, Taiwan elaborates to Bloomberg:

Their profit driver for the quarter is HTC One Max, which is not a very competitive product.  HTC One was a good phone but faced supply chain problems, now HTC One max has no supply troubles yet it’s not a strong product.

The verdict is basically in for the One -- it was a great phone, but a sales flop.  And yet Mr. Chou seems to be going back on his word, lingering around and further eroding morale.  The one thing worse than a strong, trusted leader at a struggling company is a leader viewed as weak and untrustworthy in charge of a company that's also struggling for survival.

Peter Chou
HTC CEO Peter Chou was dealing up brutal honesty in a new interview.
[Image Source: Android and Me]

HTC has produced brilliant devices, but it's failed to execute when it comes to the supply chain. 

The best insight we've seen so far regarding HTC?  A top comment on its YouTube channel remarks that HTC should offer a new acronym retitling in a future commercial -- "HTC: Help This Company."

V. Icarus Dreams  

HTC's sales pinnacle was when it made the same kind of produt that today South Korean and Chinese Android OEMs are flourishing on -- entry level luxury devices that pack a lot of speed, but questionable design/durability.

As HTC was deplaced it tried to evolve.  And for those who continued to buy its devices like the one, it's attempt to ascend from plastic-laden smartphones like the HTC EVO 4G into the HTC One.
HTC BlinkFeed
The HTC One

In the end HTC's position made this an impossible dream, but boy did it try.  And that is what will taunt its remaining fans for years to come.  

The quality witnessed in its recent product could be leveraged, if only HTC had the patience granted by financial security to commit to radical changes without worrying about losing money.  Companies with deep cash piles have options.  They have the ability to radically reinvent themselves.  HTC's short stack leaves is one crucial reason why its bid to fly higher in terms of design proved an Icarus dream.

There is certainly a place for low volume, quiet brilliance as Android's Sony Corp. (TYO:6758), Windows Phone's Nokia Oyj. (HEX:NOK1V), Microsoft Corp. (MSFT), and iOS maker Apple have all shown. Apple's own sales are contracting offering yet another sign that the demand for high end devices is shrinking to lower volumes.  

VI. Market Gravitates Towards Cheaper Entry-Level Luxury Models

The mass market among consumers who can afford something better than budget/mid-range is gravitating towards cheaper entry-level devices where competition is reduced to a ubiquitous path of iterative hardware updates and flimsier, utilitarian designs packaged in low-cost plastics.  Apple's recent iPhone 5C suggests that Apple may leverage its market share to slowly transition to a wider line of cheaper product (design-wise) that still packs industry-leading high-end internals.

In today's market virtually all phones are made in China, thus it is not surprising that many of the new elite in unit sales come from this region, including The Lenovo Group, Ltd. (HKG:0992), ZTE Corp. (SHE:000063), and Huawei Technologies Comp. (SHE:002502).  

These companies all produce relatively similar flagship entry-level luxury products.  While there's slight tweaks to the size, color, or plastics used, if you chipped off the brand logo it'd be hard to tell a ZTE from a Huawei or a Samsung -- or vice versa.  This isn't just coincidence -- it belies the fact that there's certain materials and designs that are simply cheaper to produce, even if they don't meet the tastes of luxury buyers.
Nexus 5
But HTC's problems aren't merely that the market for such products are crowded.  It may seem equally close to the source of components (China, mostly), but recent supply struggles suggest that for some reason its relationship with components companies in China is failing.  It's unclear whether this is due to HTC own dysfuntionality (very posssble), underlying hostilities between China and Taiwan (most of the parts that HTC have been "snubbed" on were China source sensors), some source combination of both, or simply bad luck.  

Either way, the market for "entry-level luxury" -- devices with a high spec, but forgetable plastic designs -- is dominated by players with close ties to the Chinese supply chain.  So HTC either has to try to go up, become an even higher-end, lower-volume luxury product seller, or go even lower, dropping into budget and mid-range niches.

VII. High End Success Stories Required Assets HTC Lacks

In the end HTC's options are even more limited than that.

Some high-end product makers like Sony are succeeding in the face of the new market realities on the merits that there goal from day one wasn't to be top in unit sales, but to produce high quality product at a premium.  Others like Nokia have the market legacy (and again financial security, thanks to Microsoft) to reinvent themselves from higher volumes to a lower volume vendor that produces impeccable product.

When looking at recent U.S. market leader Apple, who fell to second in the U.S. in Q3 and has seen sales drop, you might be tempted to draw parallels to HTC.  But the late Steve Jobs' gift to Apple was that his company not only had a popular smartphone line, but also popular high-end computer, tablet, and music player product.  HTC just has phones, and that makes all the difference in the world as Apple made far more at its sales peak that HTC did.

Apple has far more resources than HTC, thanks to its diverse product line.

And Apple had a far stronger grip on the China-heavy component and device assembly chain that HTC; relationships that not only further accentuated its profitability at its sales peak, but which also offer it the option to become more like Samsung, Huawei, et al. should it want to be (as mentioned above).  Or like Sony, it could allow volumes to naturally contract, while sticking to its guns regarding high-end design -- an approach made possible by its other strong product lines (again, an almost identical story to Sony).

Apple's a lot closer to Sony in terms of trajectory than HTC.  And HTC's trajectory is a lot more like BlackBerry/RIM.

VIII. "As I Lay Here Dying" -- Why HTC, Like BB Can Run, But Reality Will Eventually Catch Up

HTC is rather unique in its position and struggles, and it has very little leverage to remain in the profitable luxury space -- either on the high-end or entry-level luxury end.  

Reality has compelled HTC to exit its brief stay in the superphone market, thus expect a weaker HTC to hang on as a player in the budget to mid-range field, with maybe even the occasional phone with a cheaper design but high-end spec.  But it's doubtful that HTC can even hang on there, as the entry-level luxury players like Huawei and Samsung funnel their aging product downwards into that space, while having much stronger brands to tempt budget buyers.

Circling the drain
Like RIM, HTC has been circling the drain for some time now. [Image Source: Business Dev.]

The strongest likelihood, I believe is that HTC will go the way of BlackBerry, not merely because of its bold, but flamboyant dreams or failing leadership, but because it's hard for company without large financial backing to radically evolve.

Thus expect HTC, much like RIM/BB to continue to struggle in a lazy downard spiral as its management and owners refuse to renounce leadership, refuse to sell, and overall simply refuse to acknowledge the unpleasant, but urgent face of reality.  This will almost inevitably continue on until the day when things get so dire that they look at their shell of a company and their long-scorned former friend reality delivers them a stiff right cross to the face.
BlackBerry and HTC are looking a lot alike these days.

When this dose of reality hits I expect HTC will reverse course yet again and agree to be begrudgingly bought up (or like BB receive a controlling "investment" from a third party -- still more or less a purchase).  

Bury head in the sand
You can only deny reality so long...  [Image Source: Reading Remy]

A sale of some sort would allow the HTC brand to live on as entry-level luxury product for a company like Huawei or ZTE (who might opt for this approach as a route to placate U.S. customers and federal regulators who are hostile to Chinese OEMs), or as some sort of hedge fund owners' dream to own an OEM.  In the former case HTC may still be a market name for years to come, while in the latter scenario, it will likely churn to a final death (as Palm did).

Either way, know this -- HTC's days of producing beautiful product like One are coming to a close.

Sources: HTC [PDF], Bloomberg Businessweek, Reuters

"This is about the Internet.  Everything on the Internet is encrypted. This is not a BlackBerry-only issue. If they can't deal with the Internet, they should shut it off." -- RIM co-CEO Michael Lazaridis

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