Apple – Das Auto

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Apple is not about to start making cars.

  • Apple has confirmed that it is interested in the automotive sector but it is an enormous leap of faith to assume that it will start making cars.
  • At the Re/code conference, Apple SVP operations Jeff Williams referred to the car as the ultimate mobile device but that does mean Apple wants to make the whole thing.
  • The car is an obvious addition to the growing list of devices where users live their Digital Lives and so it comes as no surprise that Apple is exploring its options here.
  • However, Digital Life is pretty much limited to the infotainment unit and I think that Apple can easily go no further from here and still reap all of the value available to it from the car.
  • The biggest problem for Apple when it comes to making cars is margins.
  • Apple typically makes around 40% gross margins on the hardware that it sells and to start making cars would probably have a devastating effect on its gross margins.
  • This is because the auto industry is just not that profitable and in many cases car companies make far more money on the financing surrounding a car purchase than from the vehicle itself.
  • Consequently, I think that it will prove impossible for Apple to make 40% gross margins on engines, brake pads and wheels.
  • However, I think it will be quite possible for Apple to make 40% gross margins on the infotainment unit and it is here that I think it will focus.
  • To date these units are almost always designed by the car companies themselves resulting in a universally poor user experience.
  • This is a great place for Apple to make a big impact given its expertise in the user experience but convincing the car companies to let go of this crown jewel will be tricky.
  • Hence, I think it is on the infotainment unit that Apple is focusing which could easily sell for the same price as an iPhone and net Apple very healthy margins.
  • That is a business that would open up a new product segment, play to Apple’s strengths and could drive significant revenues and margins.
  • Messing around with shock absorbers and brake pads would cause a lot of headaches and be bad for margins.
  • I would expect this to be launched in conjunction with one or two major automakers as they would have to be on board to create the socket into which the device would fit.
  • Automobiles have design cycles of four years or more and so it may be a long time before this is launched.
  • Consequently, those relying on this to drive further revenue growth in the short term are likely to be disappointed.
  • I continue to prefer Microsoft and Google as I worry about slowing iPhone shipments as the replacement cycle for iPhone 6 begins to subside.

 

Snapchat – Salad days.

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Snapchat very unlikely to escape the bubble bursting.

  • If Evan Spiegel really thinks that the tech market is currently a bubble then there is hope.
  • It would imply that are plans already in place for when the torrent of easy money dries up which are certain to include monetisation and rapidly becoming self-sustaining in cash terms.
  • However, in the bursting of said bubble, he would have to accept that his company (currently valued at $15bn) is not quite as valuable as he would like.
  • I think that 2015E is a critical year for the Instant Message (IM) chat players as growth in users is rapidly slowing down and it is a very crowded market.
  • Consequently, I see the focus rapidly moving to monetisation as it is revenue generation that will define who succeeds and who fails.
  • With nearly 100m daily active users, of whom 65m send something every day, Snapchat has great engagement but no revenue to speak of.
  • The good news is that Snapchat is already moving to explore how it can monetise its users through targeted and relevant advertising.
  • The bad news is that as engaged as its user base is, it has a fundamental weakness in that Snapchat users have very little money to spend because they are so young.
  • This will make advertisers less willing to spend a lot of money advertising to these users but I can see a case centred on long term brand building.
  • Snapchat also appears to be firmly on the road to an IPO and has ruled out an acquisition.
  • This makes the need for monetisation even more acute as revenue growth is one of the prime requirements to be successful in going public.
  • Revenue is the next big hurdle for Snapchat but I struggle to see even in the best instance how a valuation of $150 per daily active user can be justified.
  • RFM research indicates that Google, which is the master of monetisation via advertising, generates $25.1 per year for each iOS user and $13.2 per year for each Android user.
  • Snapchat’s coverage of the Digital Life pie is only a fraction of Google’s meaning that it can really only hope to generate a fraction of the revenue.
  • Even if Snapchat defies all of RFM’s estimates and generates an average of $15 per user each year it will still take 10 years to generate revenues equal to its valuation.
  • Profits are another matter entirely and are what public market equity investors value most of all.
  • This is why I suspect that even though Evan is planning for the worst, he needs to keep his fingers crossed and hope that the bubble does not burst before he can get his IPO away.

 

Blackberry – Survival instinct

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Blackberry’s hardware days are numbered.

  • In a week where all of Blackberry’s dirty laundry is laid bare in a new book, Blackberry is also moving to again reduce headcount in its handset business.
  • Blackberry has attempted to play to its strengths by narrowing its hardware focus to financial institutions and governments but this does not seem to be working.
  • In Q1 15A, Blackberry’s smartphone market share fell to just 0.3% (Counterpoint) which I think is very far from enough upon which to base a sustainable business.
  • I think that the problem is that Blackberry has misunderstood why its remaining customers are still using its products.
  • Blackberry is very secure but the others are catching up and critically, I think that iOS, Windows Phone and locked versions of Android are now good enough for every use case.
  • Hence, I think that customers have not switched because they are very slow to implement change rather than Blackberry’s belief that they are choosing Blackberry for its security.
  • Many financial instructions who once would never considered anything other than Blackberry, are now allowing employees to connect using their iOS, Android or Windows Phones.
  • This is why Blackberry’s share is continuing to fall and why I think that its hardware business has no long term future.
  • Blackberry’s response to this is to cut jobs, but it I think that the decline in hardware is structural and that Blackberry is experiencing the classic death by a thousand cuts.
  • By the time the cuts are implemented, share will have fallen further necessitating further cuts and so on.
  • While things are looking very bleak for hardware, I think that Blackberry does have a future with its BES enterprise mobility platform.
  • Blackberry still has far more customers for BES than all of its rivals (except Microsoft) and there is scope for it to leverage this to generate a steady revenue stream.
  • Unfortunately, I think that providing Digital Work services to mobile devices is a commoditising business and bigger rivals like Microsoft and VMWare (AirWatch) could easily give the service away as part of a much larger enterprise software sale.
  • Consequently, I think that Blackberry can eke out a living here but it will be no or low growth and very low margin.
  • It has a good installed base, but it must think of some way to make the BES service valuable again if it really wants to recover rather than just survive.
  • Blackberry continues to be priced on hopes rather than the reality of its outlook and the dwindling value of its assets.
  • Hence, there is plenty of scope for downside and I prefer Microsoft or Google.

 

 

Firefox OS – Soggy matches.

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Ignite initiative has far to go before it catches fire.

  • Mozilla has done a complete about face in ditching its cheap smartphone strategy and deciding instead to focus on an experience that users might actually want.
  • Ex-Mozilla CMO Chris Beard has been running the show since July 2014 and last week saw the launch of a new strategy to tackle the smartphone market.
  • In an e-email sent to staff, Mozilla has launched its new initiative called Ignite that throws away many of the old strategies of Firefox OS and takes the OS in a new direction.
  • The main strategies are:
    • First. Cheap smartphones have not worked for Mozilla and from now on the focus will be on quality rather than cost.
    • Mozilla is aiming to build smartphones that users actually want rather than one that they buy because it’s the cheapest.
    • I think that cheap has failed because none of its partners have ever came close to the mythical $25 price point and by the time devices came to market, Android had already beaten Firefox OS to it.
    • Second. Android app compatibility will be included.
    • Mozilla has not said whether this will be done through emulation (most likely) or through porting, but either method is going to be fraught with problems especially when competing with Android apps on Android devices at the same price point.
    • Mozilla will also have to overcome its lack of an app. store, but given I think that Amazon app store would make a reasonable substitute given its 74% score in RFM app store equivalency tests (see here).
    • Third. The software will always be open source and focused on bringing the web more effectively to the mobile device.
  • Offering the cheapest smartphones and reference designs certainly did not work for Mozilla but I am not sure that this will either.
  • Android is currently shipping over a billion units per year, and against this kind of volume Mozilla is likely to really struggle.
  • This is because at any price point, there is likely to be an Android device available with a better specification thanks to the huge volumes in which the platform ships.
  • This leaves Mozilla with the task of making its user experience so compelling that users won’t mind buying a lower specification of device in order to get access to its user experience.
  • This leads Mozilla straight back to the ecosystem where its 22% score on the Digital Life pie (see here) leaves it with a huge hill to climb.
  • Furthermore, when it has a great Digital Life offering that easy and fun to use, it will then have to convince users to adopt it.
  • This is a very difficult feat and one with which even Microsoft is really struggling despite its $17bn in sales and marketing spending.
  • The new CEO of Mozilla has a marketing background and so I hope that he will have a good idea how to market the proposition but before that he has a huge hill to climb in making the Firefox OS ecosystem appealing.
  • I the best instance, it will be sometime and a lot of investment before Mozilla is close to presenting any kind of threat to the status quo.
  • Hence, Apple and Google will not be losing any sleep over this and the opportunity for Microsoft remains open for now.
  • Microsoft and Google remain my favourite plays in the digital mobile ecosystem.

Google vs. Operators – Storm in a teacup.

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Rebellion against Google’s dominance likely to fail.

  • Between them Google and Apple have the mobile operators in a tight grip.
  • The operators’ failure to develop any kind of services (other than voice and data packets) that users like has meant that they are fully on track to become commoditised bit pipes.
  • The phones and services that users choose are freely available on every network meaning that all an operator can really compete with is price.
  • This has led to a situation where the real profits in the mobile industry are earned by Apple through premium device pricing and Google through mobile advertising.
  • There is very little that the operators can do about Apple, but there is a move afoot to try and wrest some concessions from Google.
  • Operators in Europe are considering doing this by installing ad blocking software in their networks which would prevent the likes of Google, Yahoo! and AOL from monetising their services through advertising.
  • If all the operators in every territory install this software and all turn it on at the same time, then Google will have a problem, however this is exceedingly unlikely to happen.
  • The problem they face is that users want Google services and I strongly suspect that this gives Google the advantage.
  • If a user is faced with either paying a small subscription for the services or allowing himself to be tracked then I suspect that almost all users will allow themselves to be tracked and advertised to.
  • Consequently, Google could reasonably react to ad blocking by turning off its services on networks where its advertisements are blocked.
  • There is no such thing as free internet.
  • Users either pay for services with cash or with personal data and if a user stops paying then the provider of the service has every right to cut the service.
  • I think that the problem here is that users will not take well to having their services cut and will look to switch networks to get their services back.
  • Operators will do anything to avoid losing subscribers and are consequently very unlikely to present users with a united front when it comes to ad blocking.
  • One of them is very likely to break ranks, and when it does, the entire proposition on ad blocking will come tumbling down.
  • I have seen this happen time and again with operators and suspect that this move to block advertisements on their networks will amount to very little.
  • Hence, I see no change to the status quo and think that Google and Apple will continue to earn most of the industry’s profits for some time to come.
  • This move would be a boon to Microsoft which is well set up to monetise its ecosystem through subscription and can easily play the “advertising-free” marketing card.
  • However, before it does that it must bring its ecosystem to life and fix its marketing message and there remains a long way to go on both of these missions.
  • Microsoft and Google remain my favourite ways to play the digital mobile ecosystem.

Samsung – Back to basics.

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Launch of IoT modules returns Samsung to its roots

  • Samsung has launched a range of modules aimed at Internet of Things (IoT) devices at an event in San Francisco.
  • The new platform is called ARTIK and will initially consist of three modules.
    • First. ARTIK 1, a ladybird sized module with a very low power 250MhZ microprocessor from Ineda with basic motion sensors. This could have battery life of around one month.
    • Second. ARTIK 5, a 29mm x 25mm module with a 1Ghz Samsung processor and memory aimed at home hubs, drones and IP cameras.
    • Third. ARTIK 10, a 29mm square with a 1.3Ghz Samsung processor, 32GB of on board storage aimed at more advanced devices where more processing and data storage is needed.
  • This is just the initial launch and I suspect that the range will be deepened as the IoT market develops and new use cases and requirements emerge.
  • This launch brings Samsung into line with Intel, Broadcom and Freescale who already have products in the market but Samsung has an advantage.
  • Samsung’s position in consumer electronics and white goods ensures that there will be a high volume, tier-1 customer for these modules and Samsung intends to put this in almost everything it makes.
  • This is important because ensuring that there are a lot of devices in the market will mean that developers and other hardware makers will be interested in ensuring that their products work with this platform.
  • Furthermore, as Samsung also makes many of the components that go into these devices, it can ensure optimal component design as well as cost effective volume manufacturing.
  • These modules will be the nerve centre of the devices that use them meaning that they will automatically be part of Samsung’s cross-device strategy.
  • This aims to ensure that all of Samsung’s devices can seamlessly communicate with each other thereby incentivising a user who has one Samsung device to buy another.
  • Following Samsung’s exit from the ecosystem, this is one of the few avenues left open to Samsung to differentiate its hardware and achieve some degree of premium pricing and margin.
  • Allowing others into this group could diminish that effect as they too will also communicate seamlessly but having many more devices as part of this group makes the proposition more appealing for users.
  • I think that this will far outweigh any disadvantage from users being able to choose competing devices as it will vastly increase the number and range of devices available.
  • This is a similar strategy to what Xiaomi is doing to grow its ecosystem beyond phones, phablets and TVs.
  • This is exactly the area where Samsung should be competing as making things smaller, better and cheaper is what it is really good at.
  • However in the short term, I still think that Samsung will struggle with earnings growth and I prefer Microsoft and Google for the ecosystem.

 

Apple and Microsoft – Silver linings.

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The iPad Plus could help Microsoft more than it hinders it.

  • Apple’s launch of the iPad Plus might just create the user excitement that Microsoft seems unable to create for itself.
  • Apple looks set to launch the iPad plus towards the end of this year or early in 2016E.
  • This will be a 12” device with a very large battery equipped with technology that is capable of sensing the pressure exerted when the screen is touched.
  • This technology is used on the Apple Watch but on a tablet it enables a much more interesting use case to come to life which is the use of a stylus.
  • Including pressure sensitivity allows a tablet to offer a far more realistic pen-based experience and opens the iPad to many use more cases including coming closer to a laptop replacement.
  • The inclusion or support of a stylus on the iPad Plus is looking increasingly likely.
  • The iPad Plus will still be running iOS, but adding all this up leaves the specification of the iPad Plus looking more and more like the Surface 3 and Surface Pro 3.
  • This might be a nightmare for the hardware business inside Microsoft, but I suspect there is a silver lining.
  • I am certain that one of the first developers to ensure its apps. are upgraded to take full advantage of these new features will be Microsoft.
  • With the basic versions of Office 365 being free on iOS and Android there is no reason to use anything else and the iPad Plus will be a better hardware specification on which to use Office.
  • This could have a positive effect on Microsoft’s presence on the iPad and support the growth of Office 365 which RFM calculates is one of Microsoft’s most important profit drivers in the long term.
  • Furthermore, this device may begin to make users understand that a tablet form factor (with a keyboard, mouse and sometimes a stylus) offers a vastly better computing experience than a laptop.
  • Microsoft and Intel have been incapable of creating any real user interest around this form factor and instead have concentrated on selling them as laptops lookalikes.
  • Hence, it is quite possible that Apple’s product will kick-start the much needed laptop replacement cycle as users realise that there is a much better, much healthier option available for portable computing.
  • The risk, of course, is that Apple steals a significant slice of market share from Microsoft but the fact that the iPad Plus is using iOS is likely to keep Microsoft safe.
  • iOS devices are not capable of offering a full laptop experience and the majority of users that don’t need this level of performance have already deserted the laptop in favour of a smartphone or a tablet.
  • Hence I think it unlikely that the iPad Plus will be enough for the remaining users to switch but it may be enough to get them thinking about what else is on offer.
  • This will lead them to the Surface as well as other similar products which I am hopeful will be in the market by the beginning of 2016E.
  • Hence, I don’t see the iPad Plus as a negative for Microsoft.
  • In fact it could well be the catalyst that kick-starts a replacement cycle that benefits Microsoft that it has incapable of doing for itself.
  • Microsoft remains one of my top choices in the ecosystem where I think that the shares are worth around $61 even if it does a poor job on the ecosystem.

Research Publication – Microsoft – Mission Impossible

May 11th 2015:  Radio Free Mobile deepens its flagship research product with the publication of: Microsoft – Mission Impossible – An in depth analysis of the Microsoft ecosystem

Microsoft – Mission Impossible  –  (Click here for details and purchase options). RFM corporate subscribers will receive their copy directly by email. 

Cover

Microsoft’s position is difficult but not impossible. Nadella’s mission, which he has decided to accept, is three fold. 1) Control legacy, 2) Bring the ecosystem to life and 3) Merge Digital Work and Digital Life. Microsoft must reverse its share declines in mobile, make its ecosystems delightful and fix its marketing in order to succeed. Fortunately, the shares of Microsoft are attractive even it blows Missions 2 and 3.

  • Opening act: Nadella has already achieved what many thought was impossible in flipping the culture of Microsoft on its head. From boardroom to water cooler, the company is aligned in realising that things have to be very different going forward.
  • Mission 1: Control legacy. RFM calculates that Microsoft has snuffed out the PC revenue time bomb by moving to business subscriptions. There is a long pay-back period but there will be more profit generated in the long run. RFM thinks that Microsoft has succeeded in this mission, moving the focus onto Missions 2 and 3.
  • Mission 2: Ecosystem. Microsoft’s position in Digital Work is very strong and it has a good portfolio of Digital Life services. However, the services need to be properly integrated in order to offer the seamlessness user experience that will win the hearts and minds of users. Microsoft must also reverse its market share losses in mobile as this is having a seriously negative impact upon its credibility in mobile. Progress so far in fiscal 2015E has been disappointing.
  • Mission 3: Digital Life and Work. Merging Digital Life and Digital Work seamlessly in a way that is both easy and fun to use is something that only Microsoft has a real hope of achieving. This will create differentiation allowing the company to monetise and improve profit growth. To succeed here requires Mission 2 to work, service integration at least as good as Google’s, and a turnaround in marketing.
  • Marketing. RFM thinks that Microsoft’s marketing is not nearly as effective as it should be. In the ecosystem, Microsoft is the challenger and hence it must explain to users why they should live their Digital Lives and Work with Microsoft. Simply telling users that it exists may have worked 20 years ago. It no longer does today.
  • Safe to live in hope. The good news is that Microsoft’s valuation is undemanding even if it fails to execute on Missions 2 and 3. RFM has used a combination of comparative valuation and DCF to arrive at a valuation of $61.0 per share. This makes Microsoft is attractive just on the basis of the success Mission 1 where it is already showing excellent progress.

Fitbit – Market timing.

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Perfect timing gives Fitbit its best chance of making it.

  • Wearables maker Fitbit has timed the market perfectly, in announcing that it will raise $100m in an IPO.
  • From its IPO documents it is also pretty clear that Fitbit is pinning its long-term future on building an ecosystem around its devices that will keep users choosing to use a Fitbit device.
  • The good news is that there is money to invest in this strategy as the documents also reveal that the company is more profitable than I had given it credit for.
  • In 2014A revenues / EBIT were $745m / $158m representing over 174% growth in revenues and 21.2% EBIT margins.
  • 9m devices were sold with an ASP of $68 and the company reported that it has 9.5m active users.
  • This is somewhat lower than I would have expected given that the company has cumulatively shipped 17.0m devices in the last few years and the fact that it is by far the stickiest wearable product on the market. (No data yet for Apple Watch).
  • This points to a higher replacement rate than I expected and also raises question marks about the long term strategy.
  • Fitbit needs to create an ecosystem around its devices in order to maintain long term profitability, but the number of users is not nearly enough.
  • Furthermore, this is an ecosystem created around health and fitness which is both a crowded and competitive space where the juggernaut of the sector has just entered.
  • However, Fitbit’s devices are just a fraction of the price of the Apple Watch and so the focus must now be on growing the user base as quickly as it can.
  • With all networks and ecosystems, their value or utility increases by the square of the number of users or devices that are attached to them.
  • Consequently, if Fitbit can grow a large and loyal user base, then it should survive the worst that the market can throw at it.
  • This would even include my bearish prediction (see here) that, like digital cameras, the demand for pedometers will be eaten up by smartphones as their ability to track physical movements continues to improve.
  • This is why outside of the quarterly twists and turns in the fortunes of Fitbit, the most important number to watch will be how many active users the company has.
  • In the grand scheme of things, the numbers are tiny as RFM believes that 100m users are needed to make an ecosystem viable and 300m to make it very successful.
  • However, health and fitness is a focused area this means that less investment is required to offer users a great service.
  • Therefore a lower total number of users is needed to be successful.
  • However, Fitbit will be open to the risk that one of the bigger players makes a realistic play for the segment and uses its scale to push Fitbit out of the market.
  • With positive cash flow, despite heavy capex and working capital requirements, there is $200m in the bank which gives Fitbit the ability to invest and grow its ecosystem.
  • Fitbit has timed its IPO beautifully which is likely to mean strong demand and a successful debut.
  • This combined with the cash reserve gives it a fighting chance but it must focus on delighting users and keeping them within its ecosystem otherwise, it too, will eventually fall by the wayside.