HTC: Hobbled by Windows Mobile

Taipei - These should be fat times for Taiwanese smartphone maker HTC. As cellular operators across the globe rush to introduce handsets using Google's (GOOG) Android operating system, the company is at the front of the pack of manufacturers hoping to supply them. Last year, HTC launched the world's first Android smartphone. Its latest offering—the $180 HTC Hero for U.S. carrier Sprint (S)—has earned upbeat reviews and even outflanked the new iPhone in being named "Gadget of the Year" by British tech magazine T3. Soon the world's biggest carrier, China Mobile (CHL), will start selling its first HTC-branded smartphones—handsets that can be used for e-mail and the Web—including several Android models.

But the erstwhile highflier is struggling. HTC's shares lag far behind the Taiwan benchmark index, and third-quarter profit was off by 18%, its fifth consecutive quarter of sagging earnings. A big part of the problem: For all its Android ambitions, HTC is weighed down by another operating system, Windows Mobile. HTC built its success on Microsoft's (MSFT) offering, and the two companies have cooperated closely.

Today, HTC has the dubious honor of being the world's No. 1 producer of Windows smartphones. While Microsoft may be winning kudos for its new Windows 7 for PCs, phones that run Windows have a reputation for being clunkier than Apple's (AAPL) iPhone, the BlackBerry, or handsets that use Android. Although Microsoft in October introduced an upgrade, Windows Mobile 6.5, that version has underwhelmed many critics.

HTC executives concede they have a problem. "Windows Mobile excitement is declining. We know that, and Microsoft knows that," says CEO Peter Chou. Owing largely to the drag from Windows Mobile, the company will see a 20% drop in 2009 earnings, to $700 million, on a 5% decline in sales, to $4.5 billion, Credit Suisse (CS) estimates. No wonder HTC is trying to reduce its reliance on Windows. By next year, Deutsche Bank predicts, two-thirds of HTC's smartphones will run Android, up from 8% in 2008.

Still, HTC isn't prepared to admit defeat on Windows and is developing new models. The HD2, for instance, can be easily personalized, with extras such as animated weather updates that adjust automatically based on the user's location. "We feel Microsoft can still deliver products that the customer wants," says HTC Chairwoman Cher Wang. Microsoft says it's not worried and that ever more companies are making Windows phones.

Yet HTC is clearly putting increased emphasis on Android. The company's phone shipments will grow 16% in the fourth quarter, Deutsche Bank (DB) estimates, largely because of a 39% quarter-on-quarter increase in Android phones; Windows sales, meanwhile, will be "flattish." Says Erick Tseng, Google's product manager for Android: "We found a really great partner in HTC. They were very eager to take the risk with us to run with Android."

To speed its shift away from Windows, HTC is launching a marketing campaign to build its own brand, which until now has been overshadowed by the carriers that sell its phones. HTC has TV commercials scheduled for the World Series and other high-profile spots, and it has reserved prominent online real estate such as Yahoo!'s (YHOO) home page and YouTube's (GOOG) banner. "It's going to be difficult not to see HTC," boasts Steve Seto, the executive overseeing the campaign. When it comes to the phones HTC makes, though, Windows Mobile is getting harder to spot.

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