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Huang Xuehua, 24, from Guangdong province works inside a Foxconn factory in the township of Longhua in the southern Guangdong province May 26, 2010. (BOBBY YIP/Bobby Yip/Reuters)
Huang Xuehua, 24, from Guangdong province works inside a Foxconn factory in the township of Longhua in the southern Guangdong province May 26, 2010. (BOBBY YIP/Bobby Yip/Reuters)

Smartphone boom stutters as demand exceeds key part supplies Add to ...

In the race to take control of its supply chain and fortify relationships with its suppliers in the case of Apple, and further strengthen vertical integration, in the case of Samsung, both companies expect to keep capital expenditures about as high as last year’s.

The iPhone and iPad maker anticipates using about $10-billion in capital expenditures in 2013, including roughly $9.15-billion for product tooling and manufacturing process equipment, and corporate facilities and infrastructure. In 2011, the company’s capital expenditures were $4.6-billion, including about $4-billion for other capital expenditures such as product tooling and manufacturing process equipment, and other corporate facilities and infrastructure.

Samsung expects overall spending this year to be similar to the prior year’s as well, at about 22.8 trillion won ($20.6-million). The company expects its proportion of spending on CAPEX, compared with that of last year, to be larger in the second half of 2013.

Samsung’s first quarter CAPEX totalled about 3.9 trillion won, with the semiconductor and Display Panel segments each accountable for 1.5 trillion won. Samsung said it’s poised to increase CAPEX investment beginning from the second half of the fiscal year to preempt rising demand for various products and to continue to sharpen its competitiveness in the high-tech industry. In 2011, Samsung consumed a total of 23 trillion won in CAPEX investments, including 13 trillion won for the Semiconductor Business and 6.4 trillion won for the Display Panel segment. CAPEX for the fourth quarter was around 5.9 trillion won.

Given the enormity of the global smartphone manufacturing industry and the increasing challenging designs of the components within the phone, which observers have said “stretches the laws of physics,” “the sky’s the limit for spending on complex items like the smartphone,” said Brian Frank, portfolio manager at New York-based Frank Capital, which oversees about $50-million in assets.

IBISWorld’s Yang said that as supply constraints rise, firms will likely also have to invest in marketing that better manages consumer expectations through appropriate device announcements and release dates. Public relations will also play a more important role if supply shortages do occur.

Frank said he wouldn’t be surprised to see increase volatility in smartphone stocks as uncertainties about their sales and earnings outlook rise amid increased headlines about smartphone supply bottlenecks.

“People watch these numbers so closely. Even if the phone is hot but they’re not able to deliver – people may not want to wait for the phone and they’ll buy something else – you can see stocks bouncing back and forth on that,” said Frank. In the short-term, he would keep an eye on deliveries and revenue.

In the long-term, he will continue to keep his focus on CAPEX to calculate free cash flow production by subtracting CAPEX from operating cash flow.

“In the long-term, cash is king,” he pointed out. “As an investor, you don’t want CAPEX to get too high because that’s money out of your pocket. Overtime, dividends, special dividends, stock buybacks ... they can only be done with cash.”

Yang said he’s not expecting much changes to how the smartphone companies go about their revenue forecasting amid the supply constraints. However, he said, it will be important to analyze the production capacity of component suppliers, component input costs for plastics, metals and silicon for instance, and other factors such as transportation management, energy costs and consumer demand.

Frank Capital’s Frank said that ultimately, Apple and Samsung will be the ones to persevere with the greatest success amid all the supply chain stress, by using their sheer size to nail down supply.

Meanwhile, he said, there will be less room for niche players to play in the smartphone oligopoly. Smaller competitors to the giant include Motorola, Nokia, Microsoft, BlackBerry, HTC and Kyocera.

Yang said that Apple, who has an established working relationship with suppliers can minimize supply volatility while highly integrated companies like Samsung can also benefit from a more stable supply chain.

Between Apple and Samsung, Frank as a value investor prefers Apple.

“A big portion of that is the cash that they have and that they continue to generate cash even though their capital expenditures are increasing. They also have a high market share.”

His fund just took a position in Apple because it got hurt so much from assumptions that margins will go down either through supply constraints, about the risks attached to launching a lower-end cellphone and concerns about a loss of market share to Samsung. But Frank said Apple’s advantage over Samsung is that it owns an entire “ecosystem” as the only manufacturer for the iOS phone, whereas the Android operating system for wireless devices used in Samsung’s smartphone is pervasive across the manufacturers and owned by Google.

Based on recent data from Strategy Analytics and Gartner, Samsung remains the market share leader in the global smartphone market.

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