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Yo, HTC — you got problems. And Dr. Dre can’t fix them

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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(s nok) smartphones, web-hating Blackberry(s rimm) and Windows Mobile(s msft).

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(s aapl), HTC caught the biggest break of its corporate life — Google(s goog) 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(s mmi), 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(s plt) 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.

29 Responses to “Yo, HTC — you got problems. And Dr. Dre can’t fix them”

  1. trollCall

    This is why they need to not license webOS, but BEG HP to be acquired. To me, HTC makes great hardware, and would benefit from being able to focus on one platform, which I feel is the best platform, and help HP get some notoriety from a an experienced mobile hardware provider like HTC. They got the Palm IP. Combined with the likely turn-key integration with HTC’s hardware exploits, webOS could realize a great deal of growth.

  2. First of all of course, past performance does not predict future performance. Since the launch of Android, HTC’s rise has been quite remarkable, but it was a long time coming as its “Quietly Brilliant” strategy of developing phones and moving up the ecosystem food chain over a decade has helped HTC become I believe Taiwan’s first true global brand (I’d bet more people recognize HTC than Acer…)

    I too am somewhat perplexed about HTC’s purchase of Beats Electronics. Maybe they are trying to differentiate their hardware with an excellent audio experience. I wonder what HP thinks of this acquisition, since HP has lately been promoting Beats in their PC’s and laptops.

    Samsung has been in the cell phone business longer than HTC and its rise in the 21st century has been equally if not more amazing than HTC’s and has become the Sony of Korea – and by most accounts, surpassing Sony at least in appeal and execution in most categories. Their broad consumer electronics portfolio in HDTV’s, cell phones, computers, as well as appliances (refrigerators, etc.) certainly will keep Samsung in the smartphone business for a long time. I don’t see HTC surpassing Samsung ever. But that doesn’t mean Samsung will crush HTC. Samsung could crush a less nimble Motorola, Nokia, Sony Ericsson, etc. first.

    As for China, you of course know that HTC is a Taiwanese company. The China market is currently mostly feature phones and certainly Huawei and ZTE will play a substantial role in their domestic market. But do you really think there is no room for other players. Who do you think will execute better in China? Except for perhaps Samsung due to its brand and broad consumer electronics portfolio, do you really think Nokia, Motorola, LG will out execute HTC in China?

    There are 1 million Taiwanese currently working in China right now, and I think HTC will be able to do just fine in the Greater China market. Peter Chou is considered the “Steve Jobs” of Taiwan and HTC attracts the best and brightest of the Taiwanese. (At a recent BBQ, I met a former Microsoft Windows Phone engineer who worked with HTC and was amazed and wondered how the hell HTC did some of the things they did on Windows Phone). Think about how complicated the Chinese market is and which companies will be able to navigate the complicated business and government environment and relationships there.

    As for royalty payments – I have to agree that unless other evidence is shown, if there is actually money being exchanged from HTC to Microsoft for actual royalties without any marketing dollars kickback or other compensatory benefits, I would be shocked. I wouldn’t be surprised what HTC pays to Microsoft in licensing fees will be cheaper than having to pay for lawyers or for settling for lawsuits. There’s a mutual beneficial arrangement between Microsoft and HTC, and there is a deep level of trust and respect at the executive level between Steve Ballmer and Peter Chou.

    The patent issue for HTC is real. Its acquisition of S3 and the initial favorable ruling by ITC for HTC vs. Apple on this matter is encouraging for HTC, but of course, this whole mobile wireless patent mess is not just specific to HTC. Whether or not HTC can partner with both Google and Microsoft to protect itself will be seen. But just look at this week’s EU injunction of Samsung’s Galaxy Tab in Europe. No one is immune.

    The departure of Howard Luke of course is troubling – any time a key executive leaves a company, that is always a concern. We’ll have to see if his departure indeed signified that things at HTC started to go wrong. But I think that is too early to tell. Buying S3 for its patents is confounding? Your hyperlink to the GigaOM blog post makes it seem it made sense. Is this your professional legal Intellectual Property opinion that this acquisition did not make sense?

    Usually a stock buyback is an indicator that a company is fairly confident that the company is undervalued.

    This blog post seems like something you decided to write just because you didn’t know what exactly to think about the Beat Electronics – which I agree, I’m kind of confused. But I think a lot of your other conclusions are much more speculative, but I guess that is what a blogger is supposed to do – speculate. Thought I’d give my two cents. Maybe my Taiwanese heritage pride is masking any rational thought, but I thought HTC needed to be defended against your post!

  3. ihatefanboys

    so some random blogger on a site ive never heard of thinks HTC is in trouble because they purchased beats ? he’s obviously an iphone fan and a samsuck fan as well, so of course hes beating up on HTC, the only handset maker that has the quality to beat both of them. HTC is just fine, if you really want to show “stock performance” it should be noted that the drop in the stock could be because of bad economics or at the very least the ongoing patent battles. for the record samsung should stick to making TV’s , their mobile devices are continuously bug filled, and boring. i might someday buy a samsung TV(only if SONY stop making awesome ones) but i would never buy a phone made by samsung…speculation and opinion from someone with a clear preference for something else, is biased at best.

  4. jbrandonfndonf

    How can you say that in 2010 HTC had minimal competition in only Motorola then a few sentences later show that Samsung sold even more handsets than HTC in the same year?

    This article sounds like you needed to convince us that HTC is in trouble. Where they need help is building an ecosystem to compete with the likes of Apple, Amazon, and upcoming HP. They’re already making moves on that front too with the developer initiative they’ve taken.

    • Samsung was selling different type of smartphones including Microsoft and Bada phones. Their full assault on Android market started in the second half of 2010.

      As for your part two of your comment, what I am trying to point out is that they have a lot more competition and it is not going to be as easy for them going forward. I do agree they need to help build an ecosystem but can they? That is much tougher than most think.

  5. HTC’s agreement with Microsoft is also patent protection. They get under the MS umbrella, and Patent Troll attempts from Apple, Motorola and Samsung can’t touch them, because those other IP holders need MS patents too.
    HTC is in a good position was a hanger on of Microsoft, I think.

  6. $teve Job$

    HTC is now doing what Apple has been doing for years, but is now capitalizing on… patents. Apple can’t innovate anymore so they are buying patents and have started a patent trolling crusade. It’s no longer about what you create, it’s about how big your patent portfolio is.

    Someone else had it right.. patent trolling is the new monopoly. Apple has found great ways of being a monopoly without being pulled into anti-competitive battles in court. Very smart.. very as$holish though.

  7. HTC is slowly, but quietly doing what many others are doing… building the Mich vaunted “ecosystem” … or… at least they are trying to.

    One of those long tails to Apple profits is things like accessories. While this aqusition may not directly improve their phone sales, it certainly does have the potential to vastly improve profits while building their brand further, and that is the most important thing, right? I mean, that is what I hear in every Apple story (since Android surpassed them in marketshare anyway)… who cares what the marketshare is, they command the most in profits.

    In the end, so what if how HTC is executing their strategy is not clear to everyone else… if they are executing and continuing to increase profits, then are they really failing because they haven’t made their strategy obvious enough?

    They have come from being a “white box” builder to a recognized and valued premium brand in a relatively short time.

  8. 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.

  9. Bad_Attitude

    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.

  10. 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.

  11. Jay Bhattacharya

    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.

  12. 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.

    • Rado Velitchkov

      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…

  13. 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.

  14. 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.

    • PXLated

      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?

      • 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.

      • Storm14k

        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.