ST Ericsson – No Life in the Old Cat

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ST Ericsson is being quietly put to sleep after further failures.

  • Ericsson is following Broadcom and Renesas into the void by announcing the closure of the baseband business that it took back from its j.v. with ST Micro in March 2013.
  • The cat has finally run-out of lives after being reincarnated in a joint venture and merged with the wireless assets of both ST Micro and NXP semiconductor. (see here)
  • Multiple strategic shifts and numerous management teams have all been unable to revive its fortunes and now it will be closed down just three months after it was re-launched at Ericsson. (see here)
  • This confirms my view that Ericsson was never prepared to invest in this business and was simply seeing if there was a greater return to be had from the assets that were returned to it.
  • It’s one product, the thin LTE modem M7450, will continue to be delivered to those handset makers that have based handsets on it but there will be no future evolution.
  • I suspect that Ericsson has done the rounds with handset and device makers and found that there is no way that it can compete against the technology of Qualcomm or the price of MediaTek.
  • This will result in the loss 1,000 job positions but I suspect that a number of these will be able to be absorbed into the base-station business.
  • This is due to the high level of cross over between the two businesses when it comes to radio expertise.
  • This is yet another sign that the wireless baseband market is becoming very like the market for mobile base-stations.
  • At one end there is a technology leader (Qualcomm) and at the other a cost leader (MediaTek).
  • Anyone caught in the middle is likely to have an extremely difficult time especially as the biggest handset makers are looking to increasingly insource their chips.
  • This is a minor incremental positive for both Qualcomm and MediaTek but the Ericsson chip business is already so small that I suspect it will vanish with barely a ripple.

Sony – Still in play

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Sony is still in a better position than many.

  • Sony has reduced its FY2015E net profit forecast by JPY180bn ($1.66bn) due to the write down of all of the goodwill associated with the acquisition of Ericsson’s half of Sony Ericsson.
  • Net loss for the year ending March 2015E will now be JPY230bn rather than the JPY50bn forecasted in July.
  • When goodwill is tested, the company looks at the long term outlook, makes a forecast and runs a discounted cash flow valuation to estimate what the business is worth.
  • If the business is worth less than the net assets plus any associated goodwill, then goodwill is written down to the appropriate level.
  • The fact that Sony is writing down all of the goodwill suggests that long term ambitions of 10% margins in mobile are now deemed unrealistic.
  • The fact that no other forecasts have been changed suggests that the unit shipment and margin forecasts for the business in the short term remain pretty much unchanged.
  • This move also heralds a change in the strategy where the mid-range products will be cut back and the fewer resources concentrated on the premium products.
  • This makes sense because at low volumes a handset maker needs high gross margins in order to make a positive return.
  • However, even just concentrating on the premium segment, I think Sony will not be able to make better than 3-4% margins without developing its ecosystem.
  • Sony has managed to capture a real lead in the console based gaming segment over its key rival Microsoft and now is the time to capitalise on that.
  • The first issue is that the user experience on PS4 outside of playing the games themselves is very poor. The XBox One knocks the socks off it in that category (see here).
  • This must be addressed because Sony needs to build its ecosystem on its core strengths of gaming and media consumption.
  • Using these assets it needs to expand into other areas of Digital Life and make its devices work seamlessly together.
  • This is all about software which historically has not been Sony’s strength.
  • Sony’s devices are sleek and differentiated when it comes to hardware but unfortunately users don’t care that much anymore.
  • What is needed is a rich, fun and easy to use user experience that is unique to Sony, seamless on every device it makes and where users want to hang out and explore.
  • Into this it needs to add cool and fun Digital Life services that will create user loyalty and stickiness.
  • If it can achieve this then users will once again clamour for Sony devices meaning that Sony can start putting its prices up and make some proper money.
  • This is the only way I believe that the handset business will ever earn more than 3-4% EBIT margins.
  • This is not impossible and Sony is actually in a much better position than many other contenders that are trying to do the same thing.
  • Its lead in gaming (the most important Digital Life segment), its solid media assets and its full suite of consumer devices give it the assets to succeed.
  • Whether it will or not is very uncertain but it seems that management are no longer taking success for granted.

Microsoft – Glaring Obsolescence

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Microsoft is still missing the opportunity created by laptop obsolescence.

  • The Surface Pro 3 is far more than a laptop replacement but so far Microsoft has totally failed to market this device to its full potential (see here).
  • I am of the opinion that the laptop form factor is now obsolete as there is a far better alternative.
  • Having the keyboard physically separate from the screen enables a far better user experience in terms of use, comfort and flexibility.
  • The only reason to attach the keyboard to the screen has been to create enough space for the components and battery needed to enable a full power portable computing experience.
  • This also created a form factor that is easy to carry around but it offers a cramped, unpleasant and inferior computing experience.
  • This compromise is no longer required but the device makers and users are so entrenched in their thinking that they have yet to see what is before them.
  • Having the keyboard physically attached to the screen is no longer required and this opens the door to whole new use case which I call “Portable Desktop”.
  • However, the laptop has been universal standard for over 20 years meaning that a huge marketing effort is required to make users realise that the world has changed.
  • With a Surface Pro 3, the ingenious Arc Touch Mouse (see here) and superb Logitech Tablet Keyboard (see here), I effectively have a desktop computer that weighs the same as a laptop and is just as easy to carry around.
  • Not a single person to whom I have demonstrated the “Portable Desktop” has indicated that they would rather stick with the laptop form factor.
  • Microsoft’s R&D team is starting to realise the potential of this form factor as it has just launched a wireless keyboard that can handle everything including an Android phone or tablet, iPhone or iPad and Windows Phone to full Windows devices. (see here).
  • Critically, the stand can be separated from the keyboard which now gives Microsoft the potential to launch the two products together as an alternative to the pretty awful Type Cover.
  • In my travels, I use the type cover as a screen protector when it is in my bag and as a mouse mat when working on a glass surface.
  • However Microsoft’s marketing department seems to be completely oblivious to the potential for this product and in its 1 minute marketing video for the new keyboard it shows the stand separated from the keyboard for a total of 3 seconds.
  • Furthermore, all of the marketing materials for the Surface Pro 3 show the device being used with the Surface Type Cover most of the time.
  • Microsoft does not seem to have considered the potential that this device offers and until it puts its weight behind educating the users that something better is available, volumes are likely to remain low.
  • I think that the substantial usability improvement over the laptop is critical to convincing users that this is a form factor that is worth paying up for because it is not a cheap product.
  • This form factor offers so much more than a MacBook Air can ever do but Microsoft is continues to hide that fact from its users.
  • I am certain that Apple is far from ignorant of this issue.

Google – One Purpose

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Android One’s sole purpose is to push Google’s ecosystem into the lower tiers.

  • Google has announced a new reference design for low cost Android called Android One at an event in India.
  • The launch of this design goes hand in hand with availability of three devices from Micromax, Spice and Karbonn which will sell for around $105.
  • MediaTek is also a central piece of this initiative as the initial designs are all based on the MT6582 which is a big factor in the reasonable specifications being able to hit the $105 price point.
  • This reference design specifies stock Android meaning that it will come with the full suite of Google services as well as Google Play.
  • There is no scope for OEM or operator customisation but Google has allowed their apps to be installed alongside its own.
  • I can be certain that these devices are first and foremost Google devices and its own services will be front and centre.
  • Importantly, it is Google that will control the updating of these devices meaning that Google will have almost total control of these devices.
  • Google is the biggest ecosystem but it really only has a strong presence in developed markets and on higher prices devices.
  • In emerging markets it is a fragmented free for all where the vast majority of devices are forked versions of Android where Google is not present.
  • About these users Google learns virtually nothing and therefore its ability to earn revenues from advertising is non-existent.
  • These users will be of much lower interest to advertisers and the marketing spend per device is going to be just a fraction of what it is in developed markets.
  • However, these markets are so big in terms of the number of users that the revenue opportunity is very substantial even at a tiny spend per device.
  • Furthermore, this is where most of the growth will come from in smartphones making this space a must from Google’s perspective.
  • For example there are 30% more people in India alone than there are activated Android devices in the world today.
  • In order for Google to monetise this opportunity it must push its services into the lower tiers which to date has been dominated by others.
  • This is because it is much cheaper and easier to make a non-Google compliant device and the maker can do whatever it likes in terms of software and services.
  • The main issue as I see it is that in the history of the handset industry, reference designs have never been successful.
  • The logic for using them is undeniable as it makes it much easier and cheaper to make a smartphone but in practice no one has been able to stick to the design.
  • This has had the effect of substantially increasing the cost of the devices making them uncompetitive and undesirable to users.
  • This case may be different as these manufacturers will have all agreed not to deviate from the platform for these devices putting the onus for success on their appeal to users.
  • If these devices prove popular, I can see Google meaningfully expanding its reach into emerging markets (with the exception of China that has its own plans).
  • History is not on its side, but the right elements are in place for it to be different this time around.

Apple – Favourable Omens

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Signs point to scale making up for any gross margin weakness.

  • Apple has entered a new product category and is attempting to kick-start wireless payments but in the short term, financial performance will be governed by the iPhone.
  • All the signs are pointing to a very strong calendar Q4 for iPhone shipments as pre-orders look to have been the strongest for 2 years.
  • Furthermore wait-time on some versions of the device are now up to 4 weeks and both Apple and the biggest operators are reporting higher than expected demand.
  • This does not come as a huge surprise to me as both the iPhone 6 and 6+ address the long term problem of small screen size.
  • Screen sizes of 4.7” and 5.5” bring it into contention in the phablet space which Samsung created and has dominated to date.
  • This combined with the thinness and sleekness of the new models make them worthy competitors to Samsung on hardware alone for the first time for some time.
  • When I then also consider the superior quality of the iOS ecosystem compared to the others like Google, China etc., I can see why users may be tempted to switch.
  • I suspect that the vast majority of the iPhone 6’s that are sold will be to existing iPhone users, but I am also expecting that there will be some market share gain over the next few months.
  • Against this, I expect that the larger screen sizes are going to result in somewhat higher BOM costs than the market has become accustomed to.
  • As the pricing of the device looks largely unchanged, I can see slight gross margin weakness from this device compared to older versions.
  • While this may cause concern, I think that scale will more than compensate for any weakness.
  • Market share gains should lead to greater volumes meaning that the fixed costs of R&D and Sales and Marketing will be better covered.
  • Hence, I am not concerned that operating margins, net margins or cash flow will be negatively impacted.
  • To the contrary, I expect a strong calendar Q4 where operating leverage more than makes up for any shortcoming at the gross margin level.
  • Apple’s challenge is now to develop the exclusive Digital Life services that it needs to keep users paying over the odds for an iOS device.
  • This is the key to its long-term profitability but at the moment is lagging behind Google, Microsoft and even Yahoo!

Google – Method in the madness

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iOS still makes more money for Google than Android does.

  • Android may dominate the statistics when it comes to unit shipments and number of users, but iOS remains critical to Google’s revenues from mobile.
  • This is why it will continue to ensure that the user experience of its apps on iOS is as good as it can make it.
  • The latest is the announcement by Google of iOS sync which is part of its efforts to provide companies who use Google to run their companies, with an enterprise grade service.
  • This obviously flies right in the face of Android for work which is Google’s strategy to reform Android into an enterprise class platform for companies but there is method in the madness.
  • iOS sync allows companies to control the Google apps on iOS and to make document storage on Google drive seamless and secure.
  • This is all part of Google’s strategy to ensure that its ecosystem works just as well on iOS as it does on Android.
  • Of the 58 apps that currently make up the Google ecosystem, at least 17 are available for iOS and these are the main apps that make up its Digital Life offering.
  • Google has a love / hate relationship with iOS.
  • On the one hand it derives 52% (2014E) of its mobile advertising revenues from iOS devices but on the other it knows that Apple will wipe it from its devices as soon as it can afford to do so.
  • This is the biggest threat to Google’s current growth in my view as losing revenues from iOS would bring medium-term revenue growth to well below 10%.
  • All it can do is to ensure that Apple can never afford to remove it from its devices for fear of annoying its users and seeing them defect.
  • This is why Google will continue to develop its Digital Life service for iOS to the best of its ability.
  • If Apple can develop its own services to a point where users are happy to switch over, then it will be in a position to remove Google from its ecosystem but not before.
  • This is a very long way from happening but importantly Google is not resting on its laurels and continues developing to stay ahead.
  • Consequently, Google offers one of the securest growth stories among the ecosystem players and with Yahoo! and Microsoft, it remains top of my list.

 

Micromax – Bollywood beckons

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The home market is ripe for taking if Micromax is quick.

  • Micromax is the latest of the new generation of handset makers from Asia that are starting to make an impact on the global stage.
  • Top of this list is Xiaomi which is now the No.1 smartphone vendor in China and whose phones are used more than the iPhone. (see here)
  • Hot on its heels is Micromax which earlier this year beat Samsung into the No 2. Slot in its home market, India. (Counterpoint).
  • As of Q1 14A, Micromax is the global No.4 feature phone manufacturer with 6.2m units shipped (Counterpoint) and is now arguably the most important smartphone manufacturer in India.
  • India is like China in that it is a big enough market to support a local handset manufacturing industry on its own.
  • When it comes to smartphones, penetration is going to end up being much lower than US, Europe or even China but because the market itself is so large this is less of an issue.
  • RFM estimates that the middle class, which could afford a smartphone in India, is at least 300m which is not far off the population of Western Europe.
  • Consequently, there is a very large addressable market for Micromax even it chooses just to remain at home.
  • Micromax is not resting on its laurels and has commenced operations in the Russian market earlier this year.
  • Micromax is like Xiaomi in that it is very good at offering devices that have a pretty good specification at very low cost.
  • For example its recent Canvas Nitro A310 device offers an octa-core 1.7Ghz processor, 13MP camera, a 5inch 720p screen, 8GB storage and 2GB of RAM for $214.
  • The device runs Android 4.4 KitKat but has little other than hardware and great pricing to differentiate it from its competitors such as the Moto G and Xiaomi Mi3.
  • This is where Micromax needs to focus. Xiaomi (see here) has done a great job at capturing the use of smartphones with consumer content and I believe the same opportunity is available in India.
  • India has a massive film industry which also drives its music industry.
  • This content is very specific to India and I think that the market for delivering this to users is fragmented and not very well developed.
  • If Micromax can have some impact here, it will have the beginnings of an ecosystem from which it can branch out into the other important Digital Life services.
  • Without an ecosystem, Micromax will only be able to compete on price meaning that its margins will remain in low single digits in the best instance.
  • The Indian Digital ecosystem market is almost non-existent today and there are no obvious large contenders like Baidu, Alibaba and Tencent like there are in China.
  • This gives Micromax a good opportunity but it will have to move relatively quickly before everyone else cottons onto this opportunity.

Apple – Dazzling Banalities

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Great eye candy hides the missing spark of genius needed.

  • Apple launched its first product in the wearables space along with new iPhones that were exactly in line with expectations.
  • Apple also launched a payments solution incorporating both BLE and NFC but while this remains an Apple-only solution, it is likely to remain limited in its market traction.
  • The new product category is called Apple Watch, will be available early in 2015 and will start at $349.
  • The launch of this product took me by surprise as Apple typically does not launch devices until they are imminently about to ship meaning that they have already gone into mass production.
  • The Apple Watch will not hit the shelves for four months explaining why there was no chatter regarding the mass production of a device.
  • This is usually the key signal that a device will be launched rather than remain a prototype.
  • The device itself comes with a whole array of glitzy innovations and functions but critically, it lacks the spark of genius that will allow it to define a new product category for the technology industry.

The Good

  • First: Apple has done as much as it can with the user experience with the Digital Crown, App. Cloud UI, movement triggered screen and the glances function.
  • This optimises the device to be as useful as possible when it is on the wrist.
  • A number of Apps have been ported to the device and optimised for the use case and here Apple has done well in terms of thinking of fun to use, albeit pointless functions.
  • Second: Pressure sensitive screen, haptic feedback, heart rate monitoring all enhance the functions of the device such that the user experience is more interesting.
  • I am assuming that Apple has cracked the heart rate monitoring problem that has made continuous heart rate monitoring unreliable and inconvenient for the user.
  • If this proves to be a problem, I can see very high return rates for this device.
  • Third: Apple has done as much as it can to address the fashion element of the wrist watch industry,
  • The Apple Watch comes in two sizes, three different case options and a dizzying array of innovative and easy to swap options for the strap.
  • This makes the Apple Watch far more customisable than its peers and this will be appealing to potential buyers.

The Bad

  • First: While it is new and funky, the Apple Watch adds very little to the overall smartphone experience.
  • The key spark of genius that transformed the smartphone industry is completely missing meaning that only the Apple fan club are going to buy this product.
  • Second: It is square and fat. 85% of wristwatches sold in the market are round and in pure looks, I think the Moto 360 and the LG G Watch R are much better.
  • Third: It requires an iPhone to function making it very clear that this is an accessory rather than a new product category in its own right.
  • Fourth: There was no mention of battery life which combined with the array of functions and sensors, implies that it will be short.
  • Charging is effected with a magnetic cable that adheres to the back of the watch and charges via induction.
  • This means the user will have to take off the device for 1/3 of his life as well as carry an extra cable around with him.
  • This will make it impossible for health functions that analyse any type of sleep monitoring as well as being a pain for the user.
  • Fifth: at $349 it is significantly more expensive than its better looking competitors (Moto360 $249, LG G Watch R $230).
  • It certainly has more functions than its competitors, is much more customisable and comes with a much more powerful brand but price is likely to be a limiting factor when it comes to volume.

The Bottom Line

  • The limitations of this device are likely to keep its appeal limited to the die-hard Apple fan base.
  • Consequently, I am sure it will outsell all of its competitors by miles but critically, I think it will fall short of bullish expectations.
  • This will prevent the Apple Watch from moving the needle meaningfully when it comes to revenue and profit generation
  • The recent rally in Apple’s share price is much more predicated on the new iPhones which look very capable of taking the fight to Samsung which has utterly dominated the large screen smartphone segment for some years.
  • In this vein, I can see some market share gain by Apple with the iPhone 6 and 6+ and continue to think that the short term outlook remains reasonably healthy.
  • This does little to address the issues that Apple faces with its Digital Life services where the offering continues to look very weak when compared against Google and even Microsoft and Yahoo!.
  • This is why in the long term I remain pretty sanguine regarding the outlook for Apple.

Amazon – Fire damage.

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The damage to the Fire phone has already been done.

  • Amazon has cut a massive $200 off the price of its Fire phone with the 32GB version at AT&T (2 year contract) going from $199 to 99c and the 64GB version going from $299 to $99.
  • The device still comes with 1 year Amazon Prime for free making it an excellent deal for heavy shoppers.
  • All of the indications are that shipments to date have been dire (see here) and the Guardian has calculated that just 35,000 have been shipped since launch. (see here).
  • Having looked at its calculations, I can see no fault with its logic and in fact, 35,000 could even be on the high side.
  • Initial expectations were for 2-3m to ship within the first year of launch and I suspect that Amazon has made commitments for something like 1m units.
  • Assuming that all of the 1m units are shipped, then Amazon’s losses on this project have just jumped by another $200m.
  • If they are not, then losses could be greater as unsold inventory will have to written down.
  • Consequently, I think that next quarter will be marred by a write down of Fire phone inventory not unlike (but smaller than) Microsoft’s write down of the Surface.
  • This project and Amazon’s entire ecosystem strategy suffers from two major problems.
  • First: Image.
    • The incredibly poor start for this device has been widely reported in the media.
    • This means that consumers are aware of the issue and this is likely to have a large and deleterious effect on the purchase decision even if the deal is “too good to be true”.
    • This is the nature of the handset industry in that bad press can have a serious effect on market share.
    • Consumers have tended to steer clear of the devices from companies that they see faring badly regardless of how good the offer is.
    • Nokia, BlackBerry, Motorola, HTC and many others have all struggled with this problem and so far have failed to recover from it.
    • Consequently, I think that shipments of the Fire phone are likely to remain dismal despite the price cut.
    • I see a heavy write down in next quarter’s figures.
  • Second: Ecosystem
    • Amazon’s approach to the ecosystem continues to be inconsistent with very little to pull it all together.
    • Amazon’s ecosystem is tiny as RFM forecasts that it had 21.1m registered users at the end of calendar Q2 14A.
    • This is miles short of the 100m which RFM believes is needed for critical mass and hopelessly adrift of the magic 300m needed to make some real money.
    • Having a credit card relationship with Amazon does not make the user part of its ecosystem but it does give Amazon an opportunity.
    • Amazon needs to maximise that opportunity by making its ecosystem compelling and then release a handset not the other way round.
    • The acquisition of Twitch (see here) and the pricing strategy behind Amazon Prime (see here) both need to change before Amazon has any real hope of being anything other than a minnow in this market.
  • The net result is that Amazon’s ecosystem strategy continues to look like a haphazard series of expensive experiments and acquisitions.
  • Until there is some cohesion, loses are likely to continue.
  • Investor patience is already wearing thin. Mine is non-existent.