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Summary:

HTC spent $300 million to buy majority of Beats Electronics, a lifestyle brand that makes headphones. That deal might buy the company coolness but it might not be enough for a company fighting a tough fight with well funded and more motivated rivals like Samsung.

drdre

HTC today announced that it is buying a majority ownership in Beats Electronics, a company well known for making iconic headphones and its links to hip-hop impresario Jimmy Iovine and rap legend Dr. DreIt is paying $300 million for coolness and a brand, though it is not very clear how it allows the company to overcome problems that are much bigger than a few cool adverts can paper over.

I have been following HTC for almost seven years. The first time I got to know this white-label phone maker was back in the day when I worked for Business 2.0 magazine. My then colleague Matt Maier was the one who said that these guys are going to be a force to reckon with, so I started paying attention to the company. Remember, this was the golden era of Palm OS, Symbian-based Nokia smartphones, web-hating Blackberry and Windows Mobile.

HTC at the time used to quietly make Windows Mobile phones for carriers, yet few knew it was HTC that build the handsets. It was an upstart, it had the hustle and it was on the right side of history. And when Windows Mobile stalled and Apple released the iPhone, HTC caught the biggest break of its corporate life — Google came up with Android.

Android co-founder Rich Miner had worked with HTC in 2002 when developing the Windows Mobile based SPV handset for Orange, the French mobile phone company. It was easy for HTC to later cosy up to Google and Android. It went on to develop Sense UI, come up with great marketing and manage to excite the early adopters. So what’s the problem, you must be asking?

Fast Start Doesn’t Mean Strong Finish

Well, a lot!

But let’s step back for a minute. During the early Android days, since it was the only game in town, the company saw its smartphone sales zoom as it got a lot of push from phone companies that were unable to offer the iPhone to their customers; like T-Mobile USA, for example. Smartphone sales for the Taiwanese company jumped — from 11.9 million units in 2009 to 24.7 million units in 2010 to an estimated 50.7 million units in 2011.

For much of 2010, its only real competition was Motorola, a company beset with its own set of problems. And then came Samsung – a big gorilla with some natural advantages: a big brand name, the domestic South Korean market to prop-up its market share and more importantly, a vertically-integrated company. It makes screens, memory, storage, chips, radios and now even has its own software unit. And it has billions to burn in order to compete in a crowded market place, and deep pockets to fight any and all patent related battles.

In 2009, Samsung sold 5.5 million smartphones. In 2010 that number was up to 24.9 million phones and in 2011 they are going to sell 83.9 million phones, according to estimates from UBS Research. In three years they have gone from have 3.1 percent market share to 20.1 percent market share in smartphones. Sure, HTC has seen their market share double from 6.7 percent to 12.1 percent, but Samsung is making rapid strides.

Tomi Ahonen, a long time wireless industry insider writes, “HTC seems to be the perpetual bride’s maid in the smartphone bloodbath, they consistently report good results, but always someone else gets a spectacular result so HTC is always in the next-best category.” I think Tomi is being too kind.

The China Syndrome

Why? As if Samsung wasn’t enough, HTC now has to contend with two major competitors from China who have faint regard for profits – Huawei and ZTE, both with massive domestic market share to use as a springboard. The way I see it, HTC will hit a wall sooner rather than later.

HTC stock performance over past six months

But wait, there is one more thing — patents. HTC as a company will pay out nearly $1.1 billion in royalty payments to others, including $5 per phone it paid to Microsoft. That’s roughly 12 percent of their revenue pr over $40 per handset, according to estimates from Ashok Kumar, analyst with Rodman & Renshaw, a brokerage! And that is before Apple gets its pound of flesh. In a cut-throat business like Android smartphones, the average selling price of a device isn’t likely to go up, and HTC is going to be reduced to what it really is  — an aggregator of other people’s intellectual property with no real edge.

To me the first real sign of trouble was when HTC’s chief innovation officer, Howard Horace Luke — a man who I respect immensely — left. Since then, the company has made some muddling moves, buying companies and patent portfolios that are confounding at best. Over the past year or so the company has spent over a $760 million on stock buybacks, ill-advised patent acquisitions and now buying a headset maker.

From a financial standpoint, I do admit, Beats is not very expensive. Beats is likely to do sales of about $350 million this year, close to what Plantronics is bringing in. But is it enough for HTC to become a lifestyle brand and compete in a market where margins are thin and getting thinner? Not likely, with all due respect to Dr. Dre.

  1. Everybody keeps saying that HTC is paying MS $5 per phone for patents, and there is absolutely no proof of this. Yes, the two companies signed a deal, but no numbers were released. I’m not convinced any money changed hands, as I think HTC agreed to build Windows phones in exchange for not having to pay the license fees. So unless somebody has some corroborated proof that HTC is paying that widely quoted $5 per phone, please stop repeating it.

    HTC makes good phones, and as long as they continue to do that, they will be competitive with Samsung and Motorola. But I agree, that Beats wont’ do much for them.

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    1. So, why do you want proof from others on their theory that HTC is paying Microsoft $$s and yet you’re “convinced” they’re not without any proof?

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      1. Neither MS nor HTC has said how much HTC is paying, or what the terms of the licensing deal are, but after it was announced, one report said HTC “could” be paying $5 per phone. That possibility has been repeated as fact by every website reporting on the android patent issues. I don’t believe it. I don’t think HTC would give up so easily, when the patents in question are not that strong. MS needs hardware vendors to sell WP devices, and I think they got HTC to agree to build X number of WP models, possibly with a good license fee to MS. But I don’t see them so readily agreeing to pay the licensing fee to MS without a battle.

        I want proof because I don’t believe it’s true.

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      2. So because some blogger states that he “speculates” that HTC is paying MS and it gets repeated so much that people drop the “speculation” and take it as fact we are to believe it?

        From my understanding HTC had to sign an NDA just like everyone else entering these deals with MS so no one knows how much they are paying if anything at all. Its been “speculated” as well that no money changes hands in these deals and the whole point of the NDA is to spread the idea that Android/Linux are infringing on IP when they aren’t. The deals may likely go something like “sign this NDA and play along or watch the licensing costs on your MS products go up along with audits”. Much easier to sign the deal then isn’t it? But that speculation doesn’t get repeated because it undermines the whole protection scheme.

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    2. maybe htc pays msft for using android, but there is also the possibility that msft pays htc for producing windows phones.

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  2. Eh I hate sense anyway for all I care they can disappear

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    1. And how does less choice benefit you and every other consumer out there?

      They also produce stock phones.

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  3. What will fix the problems?

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  4. HTC makes great phones and their Sense UI is far better than Samsung. I think they should create a market for their product accessories rather than using beats brand (over rated headphone in my opinion).

    Samsung is also in trouble with Apple blocking their new Galaxy Tab products all over the world starting in Europe.

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  5. If the aim is to simply be more present in smartphones, then yes, I’d think that this acquisition in light of their other moves, is a bit of a problem. However, I think – and I’m being generous here – I think that HTC sees what Apple knows, what MS realized, and what Nokia built but couldn’t execute on – smarpthones are a step towards the type of lifestyle computing where quality of the experience matters not as a device, but as the brand(s) have something worth holding onto. Right now HTC doesn’t have anything except “Sense” as something to hold onto. And that’s not even a card they care for (at least given their perspective on boot loaders).

    What seems to be the case with this move is that HTC wants to move itself closer to the other “senses” of the mobile experience – probably even making a branding transition into some kind of “Beats-themed” makeover (not just a lineup as was said in the announcement). At such a move, HTC could become a bit more of a consumer-noticeable brand that doesn’t carry the “geek” cachet to it and actually evokes a feeling besides “comes with carrier approval.”

    I think that’s their aim. I hope… because otherwise it is like you say Om, their in trouble and it won’t be a slow fall.

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    1. Rado Velitchkov Friday, August 12, 2011

      I just got the HTC sensation and the *sole* reason to choose it over Galaxy II S was Sense! I agree that the next frontier is not hardware but UI…

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  6. HTC should bundle Dre’s long-delayed Detox with select phones before the CD/MP3s go on sale. That would make for a killer quarter. Other than that, this seems like a bad marketing deal.

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    1. Funny ….I do agree dre’ s next album is going to be hot.

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  7. Jay Bhattacharya Thursday, August 11, 2011

    If they can get kids to pay as much for a Beats Smartphone as they do for those Beats Headphones, there’s a revenue bump that pays for the deal. Doesn’t solve their long term problem, but certainly re-energizes marketing.

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  8. HTC bought Beats for HTC Listen, HTC’s answer to Itunes and is expected to be released next month. HTC already have HTC Watch, and now they are going to have HTC Listen and HTC Read. Obviously, HTC Watch for movies, HTC Listen for musics, and HTC Read for books.

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  9. Well said! Too often now what starts out as speculation or opinion ends up being turned around and reported as fact. But wait, if we read it on the big world wide web “It’s got to be true”. HTC-got problems? Absolutely! Second quarter revenue up 63% over last year. Second quarter “profit” US$ 268 million after taxes. I have a hard time believing that HTC will not be a major player in the smartphone busines for quite some time.

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  10. I’ve been watching Huawei, and the kind of phones they’ve been releasing lately. They seem to be higher and higher quality, and they remind me of how HTC has risen from just an OEM for others, to becoming a very successful brand themselves. I think Huawei will follow a similar path.

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