Tuesday, February 14, 2017

High Tech "State of the Union", Q1 2017

Source: Pinterest

The year 1927 was the midpoint of a turbulent and frightening period of societal upheaval in German history. The Weimar Republic that rose to power after Germany's crushing defeat in the First World War had fallen into disarray and disrepute. A calamitous hyperinflation had ended two years previously, yet economic stability continued to elude the nation as communist and fascist street gangs terrorized an impoverished and shaken civilian population. The old, well ordered, pre-war German polity was hopelessly and irretrievably shattered, leaving a people who feared what new disasters the future would bring and yearning for a return to some sort of normalcy and stability.

It was in this year of strife, near-anarchy and widespread despair that Fritz Lang produced his most visually striking and memorable work - "Metropolis", a tale set in an unspecified future where Lang imagines a world of technological wonders set in a dense, forbidding urban landscape with a social and economic fabric resembling more than anything else an 'industrialized feudalism' composed of an oppressed, restless working class ruled by a tiny and far removed clique of elites. 

Source: youtube

The film came under a fair amount of criticism upon release, with pundits complaining about its length, storyline and, in particular - indirectly foreshadowing the real horrors to come - over its potential communist sympathies. At least 25% of the original film was considered lost after it was heavily edited, though efforts over the last 90+ years have managed to restore it to 95% or so of its original extent. 

The above link is the best I've found of the restored work and I highly recommend a full viewing. Though it is a silent film, the visual elements and soundtrack make the experience anything but boring. There is also an underlying 1920's art deco motif which imagines a future quite a bit more eye-catching and attractive than the bland, generic glass towers of today's cityscapes.

At this point, some of you may be thinking "Oh, brother, here we go again - stop waxing prosaically and get to the point, will ya, baldie?"

Source: looneytunescaps.blogspot.com

Very well. Let's get to the heart of the matter.

Though Lang's dystopian vision may have missed the mark in assorted technical details (there are no computers, smartphones or jet aircraft in "Metropolis"), the general themes of the film are hauntingly familiar - both for 1920's Germany and today. We are encircled by myriad engineering and scientific marvels in communications, transportation and architecture in a world that is more thoroughly enmeshed every passing day across geographic, cultural and economic divides. Yet amidst the popular talk amongst elite circles in academia, business and media of a growing unity across the globe purported to be steadily eroding national borders, an increasing estrangement and disharmony between economic and social classes across much of the 1st world, along with rising dissonance and feuding between religious, ethnic, cultural and tribal entities on a global scale is starkly evident.

"The Tower of Babel", Pieter Bruegel the Elder, 1563 (source: wikimedia.org)

A comparison to the mythical Tower of Babel (a legend at least 4000 years old originating from early Sumeria in the Fertile Crescent) is apropos and is, in fact, a pivotal symbol in a futuristic manifestation in "Metropolis." While the mightiest, most egomaniacal potentate of Mesopotamia four millennia ago proclaimed the ascendancy of mankind united under his rule by building a tower that reached to the heavens in order to display his own supposed magnificence, tensions between class, culture and tribe simmered among his subjects until they boiled over, scattering humanity in all its peculiar foibles, quirks and differences across the face of the earth.

Then rose the seed of Chaos, and of Night,
To blot out order and extinguish light. - Alexander Pope, "The Dunciad"

Such seem to be the cycles of human history, irregular as they are in magnitude and occurrence. A civilization grows to impose its own social, economic and political order, mastering serial challenges, then losing momentum as it either fails to overcome further difficulties or finds the fabric of its institutions unable to adapt sufficiently to changing circumstances, leading to that society's decay, collapse and replacement with a culture which preserves that which is still useful, discards the rest and develops new paradigms in order to contend successfully with fresh obstacles and trials. With the global struggles of the 20th century now behind us, a previously bipolar world order and its system of rules, obligations and limitations is reverting to a multi-polar disorder, accompanied by a distinctly atonal symphony of disruption, retrenchment, discord and trepidation. We seem to be at a great inflection point whose ultimate outcome remains far from certain.

Technology has always been an agent of change - created to solve specific problems, yet generating effects that spread, bifurcate and cascade unpredictably in both magnitude and direction, thus driving further unplanned and unforeseen developments. It's been over a year that we haven't scrutinized together the lay of the land in High Tech, and much has transpired in these last 15 months. Let's start by looking at some of the 'old guard' participants to gauge how changing times are affecting them.

The Big Iron

We now have almost 9 full years of quarterly revenue data on IBM, HP and Cisco, so any trends and/or changes should be clear at this point. The chart below has a deliberately stretched vertical axis to make some of the new data easier to discern.

Cisco - John Chambers resigned as CEO in July 2015. 5 quarters into his tenure, new CEO Chuck Robbins has yet to make any meaningful impact on the company and put it back on the path to growth - this, despite his highly aggressive initiatives in the IoT and the growth of Big Data, Cloud Computing and the Datacenter market. Yet I would not rule Robbins a failure just yet - after all, Chambers failed to produce any substantive growth in his final 3 years at the helm. What the revenue trend suggests is that the worldwide communications market has been more or less stagnant for the last 4-5 years.

HP - one of the Silicon Valley originals, HP broke into personal computing (HP Inc) and business system (HPE) groups in Q1 2016. The primary reason for stretching the above chart was to provide some visibility for the revenue data on these two entities. The results were quite surprising, making the industry pundits once again look stupid, as HPE struggled and HP Inc strengthened - the reverse of expectations. Nonetheless, combined revenues maintained a long term yearly downward trend begun in Q1 2011. 

IBM - Ginni Rometty and her executive staff continue their track record of "success" in gutting and poisoning the greatest technology company ever, having now achieved 5 consecutive years of deep revenue decline. It is not hyperbole to suggest that, if Rometty and her crew were deliberately attempting to destroy IBM, they would have done less damage. I suspect most Soviet-era industrial bureaucracies were run better than this.

In summary, the Big Iron numbers are deeply troubling. These three companies represent the infrastructure segment of High Tech. As systems houses, their clientele encompasses the entirety of the global IT market for both the private and public sector. Aside from grotesque managerial incompetence at IBM, what these revenue numbers tell us is that for the past 6 years, the global economy has been largely stagnant or in mild decline.


Contrary to all my instincts, these two companies continue to impress me. There is nothing about their histories which suggest they should be competitive - 4 decades old and more, quasi-monopolists that are still producing (by and large) the same mix of products that they have steadily evolved over that same timeframe and governed by stifling corporate bureaucracies. Yet Intel and MSFT continue to maintain their position as relative bright spots in my quarterly State of the Union reports. 

MSFT appears to have stumbled with its abortive Nokia cellphone acquisition from April 2014, which it had to divest at considerable loss (over $7B, to be precise) 15 months later, as well as its extended Windows 10 rollout as a free product and the associated revenue hit. On the bright side, there is continuing strength in the Azure cloud offering - a direct challenge to market leader Amazon and a growing threat. In this, MSFT continues to demonstrate that they have absolutely no fear of gigantic competitors (including Google/Alphabet.) An oddity is the acquisition of LinkedIn, which the company purchased for a whopping $26.2B. MSFT's Skype acquisition seems to have been a waste of money, with empirical evidence suggesting that Skype users are now less satisfied with the service than before. What MSFT's plans for LinkedIn are and how they expect it to contribute to the company's strategic direction is not clear at all at this point. All in all, I am still cautiously optimistic about MSFT and hope that the company does not prove my optimism to be misplaced.

Intel completed its Altera buyout at the end of Q4 2015 and revenues from the acquisition are already accretive. The purchase was intended primarily to drive growth in the Datacenter segment, already Intel's healthiest market. Despite the continuing drag on earnings from the extended decline of the PC segment, Intel is starting to look strong and may be breaking out of its 5+ year stagnation. 

The Stone Masons

Qualcomm and Mediatek appear to be marching in lockstep for now. This is unsurpising, as their primary market (smartphones) is forming a plateau and will either stagnate or decline to low single digit growth for the foreseeable future. Paralleling the experience of many other companies, attempts at diversifying the customer base thru efforts in the IoT have proven ineffective. The Internet of Things remains a nascent market and will not advance until one or more killer apps emerge. Qualcomm's fortunes may change in the short and medium term with its recent acquisition of NXP (discussed in greater detail below.) Mediatek, however, will likely remain moribund until it can expand beyond smartphones.

Broadcom has exploded upward and is poised to become a Titan of the industry, perhaps second only to Intel. As outlined in exhaustive detail in my 5/29/15 blog post, Avago's three year M&A binge gobbled up LSI, the original Broadcom and nearly a half dozen other smaller firms to create an enterprise offering HW and SW IP that begins at the smartphone RF block and extends thru the wireless and wireline chain all the way to the datacenter. By demonstrating genuine strategic sagacity, Broadcom/Avago's executive team is achieving spectacular growth in an otherwise moribund semiconductor market. I confess that I am in awe of this company and will be following their strategic moves closely.

Nvidia has finally embarked on an exciting growth streak. How they have achieved this, though, is a far less impressive story. A good 75% of its sales are still in the PC market with its graphics products, as other departments have provided only token revenue contributions - this despite a massive R&D effort in recent years. My longer term outlook is thus negative. It is doubtful the graphics business will continue growing at such a pace (especially as AMD seems poised to re-energize its competitive stance in graphics) and Nvidia currently has nothing else 'in the pipe' from its other initiatives which appears poised to break out. Perhaps the company's datacenter efforts will bear greater fruit in the coming quarters, though the segment has already become crowded with competitors. We shall have to wait and see.

As for the final company on the chart, I have included Xilinx here for two reasons: 1. Lattice and Altera have both been acquired, leaving Xilinx as the only large independent programmable logic company. I have thus scrapped the "Vanara" chart and transferred Xilinx to the Stone Masons.
2. There is some value in continuing to track Xilinx. Programmable Logic is a leading indicator of design activity.  Any upswing in the systems houses will be presaged by 9 months in the programmable logic market. 
Currently, though, Xilinx's long record of desultory performance establishes an unhappy trend, foretelling continuing stagnation in the Big Iron. If the company has any ambition to grow and is not simply content to wait for a buyer to come along, it will need to expand its technology horizons beyond programmable fabrics and learn to compete head to head against the other Stone Masons in the wired and wireless communications segments.

Area 51

Apple broke a three quarter streak of y-y declining revenue with its latest earnings report. Unfortunately, I suspect time will prove this to be an outlier. The medium and long term prospects for the company are negative because of the developing (and likely permanent) plateau in the smartphone market. The excellent revenue number predominantly represents gains in market share at the expense of competitors - notably Samsung, with its new phones having hit the market "with a bang" - as well as announced gains in China. Without breakthrough new products, however, Apple is more than likely to reverse course in terms of revenue and decline to the levels of 2012-2013 over the next 2-4 years. Price pressures on smartphone HW and service providers will only continue to worsen and, with the end of Moore's Law, the ability of vendors to add value to their mobile computing products will be severely constrained. Perhaps there are highly creative developers within the bowels of Apple who are working on VR products with compelling SW content or IoT devices that will be genuine game changers. Only time will tell if the spirit of Steve Jobs still haunts the hallways of Apple's Cupertino HQ. 

Alphabet continues to grow but, despite its massive technology R&D and new product efforts, still depends almost completely on Google and, to a lesser extent, Youtube advertising revenue for its earnings. Changes in the organization and executive management of the company have not helped to diversify the company's offerings to any real extent and it remains a one trick pony. I have friends in the company who are quite happy and truly love working there, which says lots of good things about Alphabet's general management principles. Nonetheless, knowing how fickle the advertising business can be, if I were a stockholder I would be feeling increasingly irritated and unsettled.

The Carolingians

Holland-based NXP continues to be the most impressive member of this group, continuing the growth trend that commenced in Q1 2012 with an explosive breakout beginning in Q1 2016 (the spike being driven primarily by the absorption of Freescale, bought for nearly $12B in 2015 and consolidated at the end of Q4 that same year.) Like its counterparts, NXP has distanced itself from low margin consumer segments to focus on building defensible niches in the Industrial sector. Automotive is a particular strength of the company, and it has even managed to build a solid business in a market where almost everyone else has failed - the IoT. With a strong position in MCU and divestiture of low end logic and discrete products thru the Nexperia spinoff, NXP has become the dominant player in Europe. This position will soon change, however, as Qualcomm has acquired NXP for $47B in a deal that will likely close in Q4 of this year. This will bring together two of the absolutely best executive management teams in the semiconductor sector and create a multinational company with a solid foundation of cash cow businesses (smartphone applications and baseband processors, automotive and security) along with a leading position in IoT. As it stands today, the next ten years in the semiconductor industry are shaping up to be primarily a struggle for dominance between Broadcom/Avago and Qualcomm/NXP.

As for the other two members of the group, a stunning flip-flop has occurred - STMicro has recovered from its 5 year tailspin and Infineon has stumbled. I would not have predicted such an event to be even remotely possible, to be frank. Unless one of them makes some sort of major strategic move (most likely thru an intelligent acquisition), the struggle between these two companies will boil down to the relative success of each in the automotive and industrial markets.

A Time of Troubles

Ajax the Lesser Drags Cassandra From the Temple of Athena During the Sack
of Troy (detail from pottery, 360-370 B.C.; Source: www.mlahanas.de)

History is replete with tales of peoples, rulers and governments failing to face cold, hard reality when confronted with existential crises. The Trojan War is the earliest example of this in Western civilization. Cursed by the Olympian Gods with a gift for prophecy that would never be believed, Cassandra repeatedly warned her countrymen of Troy about the perils they faced in their decade-long struggle with the Achaean Greeks. Yet it was to no avail, as they derisively laughed at her and scorned her, called her a madwoman and blissfully ignored her dire visions.

Today's deep dissatisfaction, disillusion and distrust of cultural, political and economic institutions underlies our currently tumultuous public discourse. It is not just an American phenomenon, but is evident worldwide, and most especially in the advanced economies of 1st world nations. A manifest symptom of this is the rise of violent social and political movements from the political fringes that have taken on the semblance of cults. Again mirroring our own times, the second to last manuscript for Fritz Lang's "Metropolis" contained extensive references to occultism and mysticism, both of which are very evidently attracting followers today.  

In deeply unsettled times, we search for the causes of disquieting events, attempt to discern meaning from the circumstances that disturb our tranquility and hope from our contemplation to see a way forward towards a fresh start. Under great and prolonged anxiety, we also tend to seek supernatural insight, as if there was an underlying natural order to things beyond our ability to grasp which could help make sense of our current distress and confusion, providing some sort of guiding light for us to follow.

And so, dear readers, we once again take the mountain trails to the slopes of Mount Parnassus in order to consult with the Oracle of Delphi. We may not have a Cassandra for a seer, so the Pythia will have to suffice. What can she reveal to us after we place our offerings in the temple of Apollo and she sits in her place of honor above the sulfurous vent at her feet?

There is a history in all men's lives,
Figuring the nature of the times deceas'd,
The which observed, a man may prophesy
With a near aim, of the main chance of things
As yet not come to life, which in their seeds
And weak beginnings lie intreasured. - Shakespeare, Henry IV Part II

In our analysis of the High Tech sector, we've seen that there are a couple of companies that are finding ways to grow (mainly thru M&A, though there is some organic growth, notably for Broadcom) and a few others that are shrinking (with a diseased IBM standing out from the rest.) The overall picture, though, is one of listlessness and sluggishness. Without a primary growth driver such as PCs, networking or mobile computing & communications, and with no fundamental breakthroughs in semiconductor technology that could revive Moore's Law, the High Tech market has stalled.

What can we say about the economy in general? The news gives us a very confusing and incomplete picture: the NYSE has achieved new highs and official government statistics suggest unemployment is so low as to be nearly inconsequential; yet home ownership, labor force participation, disposable income and wage growth are all at 30, 40 or 50 year lows. Clearly something is not right

Per my previous quarterly reports, I've used different measures as barometers of economic health - in particular, the BDI (Baltic Dry Index), which measures freight rates at ports around the world, and the two major commodity indexes - the BLS CRB and the Thomson Reuters-Jefferies CRB, which differ only modestly in their choices of commodities to be measured.

Let's start with the latest BLS CRB:

As reported previously, the index went into free-fall begining in 2014 all the way thru most of 2016. It has recently recovered a bit, but is still at levels not seen for a decade.

Now the Thomson Reuters/Jefferies index, bracketed to a 10 year range:

We can see the mid-2008 peak, a violent collapse to mid-2009, and then only a partial recovery. Paralleling the BLS CRB, the index turned down again in 2014 and staged another partial recovery at a lower level halfway thru 2016.

Finally, the BDI, again with a 10 year timeline:

For some points of comparison: the BDI opened at 1000 in January 1985. It's record high was 11793 in May 2008, with a record low of 290 on February 10, 2016. According to the above chart, it is at 688 as of February 14, 2017.

The conclusion is inescapable - the global economy never recovered fully from the 2008 banking crisis and is currently sputtering along at a near-comatose level of activity. As best as I can tell, the culprit is the debt situation with sovereign governments and multinational/TBTF banks and other financial institutions. Their combined leveraging is such that, despite global debt financing with interest rates at or near zero, there is precious little capital available for driving actual business investment and growth. 

Sadly, this situation is not without precedent. Japan is in its third decade of economic stagnation. After the late 80's RE bust, Tokyo coddled its banking sector instead of letting the poisoned commercial debt load clear thru bankruptcy courts. Japan's central government also initiated a cycle of chronic deficit spending. The result has been not only economic lifelessness, but net shrinkage of the economy by 40% when discounted for inflation. Sovereign debt is now 2.3x greater than GDP and is effectively non-serviceable. America is now closing in on a full decade of similar economic staleness, for the same reasons as Japan's. 

Invention, it must be humbly admitted, does not consist in creating out of void, but out of chaos. - Mary Shelly, in the introduction to "Frankenstein"

According to the Generational Cycle theory of history developed by the famous demographers Strauss & Howe, we are in a crisis period that comes around roughly once every century. Their theory suggests that the current turbulence in the fabric of society will resolve itself sometime around the middle of the next decade. However, the theory cannot hope to predict what form that solution will take.

As far as the High Tech industry is concerned, though, the way forward is clear. Technology has traditionally progressed thru the introduction of disruptive inventions which occur spontaneously from the sudden, even random confluence of a multiplicity of incremental advancements and innovations. The current doldrums becalming the seas of High Tech are not a new or singular phenomenon.

What form such a disruptive event would take is anybody's guess. Quite predictably, the IoT froth has substantially receded as 'smart watches' did not turn out to be the new smartphone-like driver. Work on further IoT applications proceeds regardless, so a disruptive technology flowering in the sector some time over the next 10 years would not be surprising. VR and digital eyewear such as Google Glass have also failed to materialize into the 'next big thing', but development and experimentation continues. Trial and error is part of the process of creation and is, per Nassim Taleb, vital to the 'optionality' nature of invention, making the process anti-fragile over the long term. Perhaps something that superficially seems very mundane will trigger the next wave of High Tech expansion. For instance: what if someone discovered a technique or methodology that made chip development at, say, the 10nm node cost 1/10th as much as it does now?

In the meantime, we must keep our eyes peeled to the far horizon as we maintain our lighthouse vigil. Perhaps the clouds and winds will forewarn us of what is about to come; perhaps a rogue wave will suddenly sweep ashore.

We shall have to wait and see. :-)

"Shipping off the Eddystone Lighthouse", Vilhelm Melbye, est. mid to late 1800's (source: Wikimedia)

Dear readers,
This is my first regular post in over a year. I have quite a few things on my plate at the moment, including efforts to spec out a software product for the industrial market which would serve as the basis for soliciting angel funding to develop, contract writing work and a sequel to my first novel, "Initial Conditions" (which, btw, is available at the link on the right upper sidebar; just click on it to go to the Amazon page - hint hint, nudge nudge ;-) .) Thus, posting on a weekly or bimonthly basis will be impossible. I will, however, endeavor to provide new content once every 4 weeks. With that in mind: what are some of the current issues in High Tech that you would like to see explored? So far I've received suggestions on 5G and MEMs, but would be happy to receive further inputs.