Everyone in the investment world right now is down in the doldrums, with perhaps just one or two talking optimistically about it being a great time to find deals out there. But if investors want to find investments that are in some way secure against the emerging recession, they need to find companies that operate in markets which are driven by established consumer demand, where it has been rapidly growing.
It is better if these companies are single play businesses, not likely to be dragged down elsewhere by other operations that will suffer under any recession, and of course they need to be public in order to be available for investment.
So let’s list a number of business areas that appear to have these criteria, first taking in general areas of high growth, then looking at what businesses are reliant on others for spending, and eliminating areas where growth can evaporate quickly. What we are left with should be good investment candidates.
The big problem we find with huge demand, is what happens when it meets oversupply, such as is happening in the Flash memory market. Flash in particular is an exceptionally tough market. SanDisk has a share price in the basement, so much so that in September Samsung entered a hostile battle to gain control of it.
Flash, particularly NAND flash, is so key to the future of so many product lines ‘ handsets, TV sets, DVRs, PCs – these will all eventually use huge amounts of Flash as it finds more and more places to replace rotating disk storage. Disk is cheaper per GB, but Flash is physically lighter, more robust and takes less power. But because of the fundamental importance of this market, all of the majors are chasing it with $ billions, hence the oversupply.
Much the same can be said of large flat TV screens, using LCD or Plasma technology, and the annual price drop is now at the level of 35% plus as oversupply and feature rivalry have taken the value out of the investments in this market. At the same time the gradual creation of replacement technologies, for instance AMOLED screens, which are like flat CRT screens, with far better contrasts and lower power consumption, threaten on the middle horizon to replace LCD screens. That uncertainty makes them even more nervous investments to hold.
So let’s look at content and how you get it to people. Largely there are three ways – you can broadcast it, you can narrowcast it or you can physically take it there, so think broadcast network, VoD or Blu-ray DVD.
Satellite radio or DVB-H or ATSC M/H would be examples of relatively new broadcast networks. Right now the most rapidly growing broadcast network type is DVB-T. So you might make a case that anyone producing equipment for the broadcast process. The trouble here is that there is genuine competition in the CPE for DVB-T, because it is a retail proposition, which means that it always finds its right price between 20 suppliers, and the supply and demand for equipment. Take up rates for consumers are likely to go up, not down here, since pay TV will lose marginal subscribers in a recession (though not many because who can live without premier football in a recession) and outside the US, they will mostly go to digital terrestrial DVB-T.
Centrally, at the broadcast transmitter network end, there are multiple suppliers like Harris, Rohde and Schwarz and even NEC. This business is more than healthy, due to the rise in digital terrestrial networks, and the arrival of digital switchover in varying dates around the world.
The problem for these companies is that for many years this has been a market in the doldrums, as a result most of the companies that address it have been acquired and are now part of major conglomerates. It is these other businesses that they are part of here which the recession is likely to bite. Also broadcasters around the world may slow their spending a little in broadcast network build out, to get completed networks to coincide with the end of the recession, a few years down the track. That’s not a very sensible strategy, but the availability of debt to build those networks is now an issue.
We have seen this whole malaise hit the DVB-H networks around the world. They are still being built out, and they are still new revenues streams to these companies, but they have slowed, and even for a pure play transmitter company or network builder or owner like Arqiva or TDF, this is already in the price and there are few investment opportunities there. The few chip companies that address it, or those providing the software stack, IP encapsulators or encoders for systems, are all private.
But the trend is undeniable ‘ pay TV will feel a squeeze and free to air TV once digital (even in the US), will be the place to turn, resulting in sales of free to air DVRs, set tops and digital TV sets. Working out how to make investment decisions from there is the tough move.
Another replacement for pay TV will be getting the key ingredient, live sport, online, and canceling that part of the pay TV subscription, but there are very few public investment opportunities purely in online sports right now, although there is plenty of activity here.
A piece of consumer research this week from Continental Research confirmed that in the UK, consumers are trading down their pay TV services or replacing them entirely, with as many as 24% looking to reduce their spend and 15% of potential new subscribers changing their minds and opting for a free to air solution instead.
Cable can be thought of as either narrowcasting or broadcasting really and we would expect this sector to suffer the most. Over recent years ARPU has gone up at each household, but the number of customers has remained static. If ARPU heads down, then the cable operators do less well, but their suppliers may not. What cable operators all reach for to make their services better are either HD delivery or offering a free DVR.
That will have an immediate effect on DVR manufacturers, and especially those which can cope with HD (like Pace). There is a report out this week from Informa pointing this out and making the point that DVRs are coming down rapidly in price, stimulating more pay TV operators to offer them bundled in a subscription price. But this will bring in a rise in sales at companies like Motorola, which would be dragged down by its handset division anyway; and at consumer electronic companies, which have other low margin businesses like hi-fi dragging them down. So despite spotting a winning technology, it is very difficult to turn this into an investment opportunity anywhere except at TiVo.
Once thing big US cable is doing is changing the nature of its network delivery in order to re-harvest bandwidth. This new bandwidth it uses to offer faster broadband services and more VoD streams. To do this cable operators can either install 5th generation switched digital QAM, which dynamically allocates TV channels across the entire spectrum on the cable so that those TV channels which are not being watched at all, are not transported. The spare spectrum can be offered in bonded channels which is needed for DOCSIS 3.0, which makes the cable operators resistant to broadband erosion by telcos. If cable operators don’t do this they can also just install more traditional QAM and split their networks into smaller and smaller loops.
So they cannot stop spending on switched digital QAM and DOCSIS 3.0 terminations, or on DVRs, or on HD, or they risk losing their customer base.
The cable companies themselves have said as much and been pilloried by investors for the amount of capex in their plans for the coming year, but it’s there and that’s good news for the suppliers.
Companies like Arris and BigBand offer fairly pure plays in this market, while Motorola and Cisco’s Scientific Atlanta make it a higher competitive market, which helps keep prices to the floor, but with still some margin in them. European cable will follow on from this spending in the two to three years ahead, lagging the US market.
So when consumers drop or threaten to drop expensive services it leads to capex spending in order to keep customers and where it is spent should point to strong investments.
Indirect beneficiaries of this include the chip makers which are making chips for DOCSIS, ADSL2+, VDSL2, QAM, and things like HSDPA broadband chips, which brings us neatly to Broadcom and Qualcomm.
The Broadcom mix is MADE for a recession. It waits until chip markets are about to go into real volume and then bids to bring the prices down further with SoC designs. It has done this in wi-fi, where spending remains high due to continued broadband build out and telcos supplying wi-fi routers. It has done this in ADSL, which is growing for the same reasons. Broadcom is now doing this in DOCSIS 3.0 and other associated cable architectures, and it has done this in Blu-ray, a market that HAS to be pushed by the studios and CE companies because it is the only way to alleviate their margin pressure. Broadcom loves commodity chips.
And just as HSDPA chips go into real volume the leader in that market is Qualcomm. Broadband dongles are skyrocketing across Europe, and only Chinese competition (Huawei) is getting in the way of US and European chip leaders mopping up.
We could go on listing technologies. There’s Near Field Communications as the basis for mobile payments; the rise of mobile advertising; DVD online rental, as it shifts to Blu-ray, and acts as a replacement for pay TV film services; multimedia infrastructure for mobile markets such as IMS elements and multimedia mobile gateways from companies like Starent, which support the rise of multimedia on cellular networks.
In every case operators are forced to spend because what they are spending on is what’s stopping them from going into recession. Handset vendors are still shipping more handsets, falling to perhaps single digit growth rates, but the components inside them, both software and hardware, are being tilted towards broadband, video and music along with the services that need to protect them, such as DRM, or enable them such as music and video finger print databases and charge couple devices (or cameras) and accelerometers (for movement sensitivity).
Quite simply where consumers are pulling a particular use out of a network, that use will grow and the operator’s spend will shift in the direction.
Another example is internet advertising, which actually shrank last quarter in the US. Within that, video advertising grew by 224%, due to the amount of video that is being watched and now monetized by using video advertising.
Billing is another area that will not have a spending slow down, because bringing out new services and launching bundles which will halt churn, relies on converging billing systems. The average major cellco has around 10 billing system, and these are always in a constant state of being merged in order to offer triple and quad plays ‘ and that will create customer loyalty. Not many operators will halt spending on billing projects that are going to halt a big increase in churn.
Similarly for IPTV networks. The biggest contributor to churn is poor video quality, so these operators cannot afford to stop spending on quality of experience software and hardware tools, such as those supplied by IneoQuest. The problem is that these are small spend levels and it’s tough finding a pure play video quality player that is not pulled down by other revenues streams or not still private.
This week Digital Fountain put out a paper (see elsewhere this issue) talking about how its forward error correction techniques could be used to make DVB-T networks receivable on a handset, not just in Germany, but across Europe, Asia Pacific and South America. To anyone that says they cannot see how a large public company can be formed around error correction, we would just point them towards Qualcomm, which did this very same thing.
There should be a final word here for placeshifting and Sling Media, now part of EchoStar. This phenomena is here to stay and it will be the next method by which cable, satellite and IPTV suppliers all attack one another. At the same time mobile operators are starting to have the devices and broadband capacity to embrace placeshifting across their networks, and one or two already have. This leaves Sling in a very strong position, fairly recession proof if it wasn’t tied to Dish Network (which technically it no longer is).
Following the simple rules which ask ‘What are this network’s problems?’ and following this by asking ‘What can it buy to fix those problems,’ leads more or less directly to those companies that will not be wringing their hands come their fourth quarter results, and who’s share prices will be holding up the financial markets.