AI could give consumers new reason to upgrade their mobile phones. What it means for investors. By Adam Clark
The smartphone market needs a lift. Consumers are holding on to their phones for longer, with each new device looking much like the next, even as prices for the latest flagship phones continue to rise.
Global smartphone shipments declined 3.2% to 1.17 billion units in 2023, according to research firm International Data Corporation. Part of that decline was due to a particularly sluggish Chinese market, but there's a sense of a greater malaise.
"You could almost argue that the smartphone is becoming a little bit closer to a washing machine than the cutting-edge, rapidly changing device category that it used to be," says Ben Wood, chief analyst at CCS Insight, a technology research firm.
Samsung Electronics and Alphabet's Google, which have spent years partnering on mobile phones -- and the Android software that powers them -- see a silver bullet in the form of artificial intelligence.
"This new era of AI is a profound opportunity to make smartphones truly smart," Sameer Samat, Google's vice president of product management for Android, said during the Google I/O developers conference on Tuesday.
During its event, Google showed off AI assistants that use the phone's camera to interpret the world and log scenes that can later be recalled by the user. Chatbots on phones, meanwhile, continue to promise additional tasks, from solving complex math problems to telling bedtime stories on the fly.
"Our phones have come a long way in a short time, but if you think about it, it's been years since the user experience has fundamentally transformed. This is a once in a generation moment to reinvent what phones can do."
Samsung advertises its new Galaxy S24 Ultra flagship phone with the tagline "Welcome to the era of mobile AI," with features such as "Circle to Search," real-time translation, and AI-assisted note-taking. Google's Pixel 8 is sold as "AI in your hands."
There are some signs the pitch is working. Samsung's Galaxy S24 series -- which has AI capabilities partially reliant on Google's models -- outsold its predecessor by 8% in its first three weeks of availability, according to Counterpoint Research. Growth in the U.S. was in the midteens percentages.
"Considering we're still really at the beginning stages of the coming GenAI smartphone boom, there is plenty of runway for more growth," wrote Jeff Fieldhack, Counterpoint's research director for North America.
Drew Blackard, vice president of mobile product management at Samsung Electronics America, told Barron's that Samsung is aiming for double-digit percentage growth for its S24 series from the S23, year over year, and said the company is pleased with its progress so far. Samsung is aiming to bring its Galaxy AI software to more than 100 million users by the end of this year, according to Blackard.
In the short term, the loser could be Apple, which has been tight-lipped about its own AI plans. Apple's iPhone shipments dropped almost 10% in the first quarter, according to IDC, while Samsung took the top spot among all manufacturers, with its own shipments down less than 1% from 2023 levels.
During its keynote event this week, Google repeatedly noted that its Android software would be the best, and sometimes only, way to experience Google's Gemini AI features.
"We've embarked on a multiyear journey to reimagine Android, with AI at the core," Google's Samat said.
Chip Stocks Set to Benefit
The exact definition of an AI smartphone is still a work in progress. But the key is likely the ability to run a large AI model on the device itself. That means hosting an AI model that has been trained on a sufficiently large database that it can generate humanlike responses, even without an internet connection. It will need powerful chips.
Research firm IDC defines "next gen" AI smartphones as those where the chips contain a neural processing unit that can perform at least 30 trillion operations per second, a measure of AI chip performance. IDC's preliminary forecast suggests 170 million next-gen AI smartphones will be shipped in 2024, representing almost 15% of total smartphone shipments.
Qualcomm has staked out an early position in the market by providing a chip -- the Snapdragon 8 Gen 3 -- which powers Samsung's top-of-the-line S24 Ultra, as well as a range of premium handsets from Chinese manufacturers. The company is working with the developers of AI models to optimize large language models for its chips, recently saying that Meta Platforms' latest-generation Llama 3 would be accessible on devices powered by coming Qualcomm Snapdragon platforms.
Qualcomm's second-quarter revenue from handsets grew 1.2% from the year-earlier period to $6.18 billion. The company says its latest Snapdragon chips will help its handset business grow at a high-single-digit to low-double-digit percentage rate in 2024. That would outpace the 3% global smartphone growth that Counterpoint estimates.
Qualcomm is battling alongside rival chip makers including Taiwan's MediaTek, as well as in-house chips from the likes of Google and Apple. But Qualcomm chips dominate the higher end of the market outside of iPhones, and are expected to be used in more than half of all generative AI--equipped smartphones shipped in 2024 and 2025, according to Benchmark Research. It recently initiated coverage on Qualcomm stock with a Buy rating and a $200 target price, roughly 7% above its current level.
"Qualcomm probably has the best road map," says Ted Mortonson, a technology sector strategist for investment house Baird. "[It's] very hard to displace just because of their engineering prowess and their leadership on licenses."
Beyond the chip manufacturers, there is one company that could get an even more pronounced boost from the rise of AI-enabled smartphones: chip designer Arm Holdings.
Arm makes money by licensing its chip designs to semiconductor companies and hardware makers. Its stock surged earlier this year when it said that its latest advanced chip technology, called Armv9, generates double the royalty rates of its previous generation.
Arm CEO Rene Haas recently told Barron's that new premium Android smartphones are "mostly all" based on Armv9 chips. Qualcomm's Snapdragon 8 Gen 3 chip incorporates Arm's v9 technology, as does Google's Tensor G3, which powers the Pixel 8.
In its latest fiscal quarter, Arm's royalty revenue grew 37% from the prior year to $514 million, which the company said reflected increasing sales of Armv9 chips. Analysts at Mizuho Securities estimate the company's mobile revenue could grow at an annual rate of more than 30% over the next few years.
The Risks
To be sure, AI expectations for mobile devices could fail to live up to expectations. Users may not notice or care whether all the AI capabilities of the phone are being carried out on the device or in the cloud. If consumers are happy connecting to a ChatGPT-style bot or an image generator via an app, they might not see an immediate need to upgrade their phones. That could kill hopes of a new upgrade cycle to premium AI-enabled phones.
However, consumers might be drawn to phones that are able to process as much AI as possible on the device itself because of enhanced privacy and speed. "Offering on-device AI is important for many consumers and critical for most enterprises," says Samsung's Blackard, noting security concerns.
Meanwhile, manufacturers are incentivized to provide on-device AI due to energy and cost savings compared with processing in the cloud.
"With the implementation of generative AI, the power and the energy component cannot be a second thought," says Lucas Keh, semiconductor analyst at global research firm Third Bridge. "This is something that needs to be put at the forefront of the design, which is why companies like Arm and Qualcomm -- with strengths in lower-power design -- are being recognized."
The Mobile Phone Disruptors
The other worry for the mobile phone industry is that AI ushers in the end of the smartphone era. New AI-equipped devices -- including smart glasses, championed by Facebook parent Meta Platforms; virtual-reality headsets, and wearable brooches -- are seeking to displace the smartphone, although chip makers would be largely insulated since the devices still need processors.
Breaking the addiction to smartphones might sound unlikely but there's serious money trying to make it happen. Humane, a San Francisco--based start-up, has raised $241 million, according to PitchBook. It recently launched its first wearable computer, the $700 Ai Pin.
For now, the smartphone's dominance looks safe. The Ai Pin, which is capable of answering questions, taking photos, and sending texts, has received lukewarm reviews. Marques Brownlee, an influential technology product reviewer with more than 18.5 million followers on YouTube, called it the "the worst product I've ever reviewed," criticizing its battery life, price point, and occasionally misleading answers.
"The jury is very much out on these AI companion products," says CCS Insight's Wood. "The most logical place, you could argue, isn't a pin on your lapel; it's the Apple Watch on your wrist, or another smartwatch."
A Gradual Revolution
Adoption of AI smartphones will take time. Getting consumers to drop more than $1,000 for a new handset is a far bigger challenge than getting them to download an app like ChatGPT.
However, with the biggest smartphone manufacturers throwing much of their resources at developing AI into the next must-have feature, with some producing their own chips, advances could be significant enough to justify upgrades. The cycle of improvements is only set to accelerate, with Apple expected to reveal details of its own AI strategy for the iPhone next month at its annual developers conference.
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May 18, 2024 06:27 ET (10:27 GMT)
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