Yahoo! – Wrong prescription

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AOL is not the answer.

  • A recent open letter from activist shareholder Starboard has correctly diagnosed all the issues at Yahoo! but its prescription will not fix the company.
  • There is no doubt that performance of the core business has been extremely disappointing over the last 2 years.
  • Revenues in its display and search based online advertising business have been essentially stagnant despite strong growth at almost all of its peers.
  • Google, Facebook, Twitter and many other who earn revenues from online advertising have all seen strong growth particularly from mobile and video.
  • Hence, it is clear that Yahoo! has chronically underperformed both its peers and the market.
  • The main reason for this is that it predominantly earns its revenues from display based advertising which is the slowest growing and least attractive of all online advertising.
  • Its share price performance has simply been a factor of its stake in Alibaba which has shielded shareholders from the underperformance of the core business.
  • Now that Alibaba is listed, the attention is already turning back to the core business and Marissa Mayer’s grace period has now run out.
  • There is certainly substantial value to be unlocked at Yahoo! as the company is trading at a discount to the value of its Asian assets alone.
  • However, the solution offered by Starboard goes no further than unlocking value that is already there and in my view, substantially increases risks.
  • There is rationale for a merger with AOL but the vast majority of mergers of this type don’t work and could actually end up costing shareholders money.
  • The real solution for Yahoo! is to find a way to return the company to revenue growth.
  • This basically means taking Yahoo! superb position in the fixed line Internet and migrating it into mobile.
  • It is in mobile where the growth is and where advertisers are spending their marketing money.
  • Yahoo! has made the right acquisitions as it position in Digital Life is now excellent but it has badly failed to make anything of them.
  • If Yahoo! can migrate its usage into mobile, revenue would start to grow again, the discount would correct and shareholders would be happy.
  • Furthermore, shareholders would be inclined to hold the stock for the long term rather than getting out as soon as the value is released.
  • This is what the acquisition strategy has tried to achieve but poor execution has prevented Yahoo! from integrating its acquisitions into a coherent ecosystem
  • This is what is desperately needed to turn this company around and this is where shareholders should be pushing management to act.
  • Yahoo! remains attractive but the inability to execute its vision is showing through in the results and shareholder patience is already wearing very thin.
  • I would look at Google or Microsoft for holding positions in the mobile ecosystem and think that the time has come to take Alibaba-related profits on Yahoo!.

 

 

iOS vs Android – Fragmentation bugbear

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Quality will soon become the most important factor.

  • As the smartphone market starts to settle down, quality of experience will become increasingly important.
  • This is because in order to grow different ecosystems will have to start taking subscribers from each other rather than relying on new users.
  • When it comes to quality, iOS comfortably wins out and even Windows Phone scores better than Android.
  • A great example of this is software consistency.
  • Only 3 days after launching its latest software iOS8, 46% of all iOS devices had made the upgrade to iOS8.
  • By contrast, 4 months after being released 24.5% of Google Android devices had been upgraded.
  • If one also includes the non-Google versions, I suspect the number would be meaningfully lower.
  • Part of the reason for this is that the operators have control over managing Android software updates in contrast to iOS where Apple controls it all through iTunes.
  • This is important because having large numbers of devices with different versions of the code makes life very difficult for developers.
  • It means that their apps are more difficult to write and will behave differently when run on different versions of the code.
  • Furthermore, there are also significant variations in the code between the different handset makers making life even more painful.
  • This is the fundamental problem with open source. Most phone makers have their own ideas about how they want their phones to work and will tinker with the code to achieve that end.
  • In the desktop world open source works much better because when the code fragments, only the best code line survives.
  • History has shown that in mobile this does not happen and a chaotic jumble of different versions and implementations always results.
  • This is why developers will always develop for iOS first and why I believe that they see a higher return from iOS when compared to Android.
  • This is a big problem for Google as its ecosystem is built on top of Android and the inconsistency damages its user experience.
  • Open source has done a great job of getting Android to be the default OS for almost any device not made by Apple but the time is coming where its poor quality will be an issue.
  • This is why I believe that Google is taking more and more control of the Android.
  • The GMS (Google Mobile Services) software that it puts on top of Android contains all of its services and this is the main control point for Google.
  • The fact that it also writes almost all of the open source piece, gives it the ability to manipulate the code in any way it sees fit.
  • It is doing this in two ways.
    • First: Google is slowly removing functions from the open source Android piece and moving them into GMS.
    • In effect, Google is slowly changing an open source OS into a proprietary OS that uses an open source kernel.
    • This will give Google much greater control over fragmentation and also make it much harder for anyone else to make Android devices without Google’s help.
    • Second: The requirements that Google is placing on handset makers and operators who implement its software are getting more and more restrictive.
    • Google is increasing the number of applications that the handset makers are obliged to implement on their devices and getting more restrictive in terms of how they are placed on the device and forcing them to make them default.
  • This strengthens my view that Google aims to take complete control of it’s ecosystem and aims to migrate Android from open source to a proprietary OS.
  • If Google can successfully effect this transition then it will have a much better chance at taking the fight to iOS on quality as well as price.
  • This will take time and at the moment there is an opportunity for Windows Phone to take share from Android if it can get its message right.

Nokia and Microsoft – Still HERE

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Quality of HERE more important than availability on iOS or Android.

  • There is confusion regarding whether Nokia is about to pull its support for Windows Phone for its’ HERE mapping service.
  • Now that Nokia no longer makes mobile devices, it makes sense for it to spread its application to the widest possible audience.
  • This means making it available for both iOS and Android.
  • In terms of its relationship with Microsoft, it has a four year contract to supply Microsoft with its mapping service and so support will not be dropped any time soon.
  • It is easy to think that HERE becoming available on other platforms is a negative for Microsoft but what will really make the difference is the quality of the implementation and the features that come with it.
  • HERE on Microsoft stands out over Google for two main reasons
    • First. The user is able to download the maps to the device for free and use them in offline mode. This is excellent when network conditions are poor and when the user is overseas.
    • Second. HERE Drive is the companion app. that uses HERE maps and provides turn by turn directions. This app. is reliable and effective and much better than Google Maps. It makes a very good replacement for a separate GPS unit.
  • These two features are differentiators and as of today they are only available on Windows Phone giving users extra reasons to adopt the ecosystem.
  • Hence the question is not whether HERE will still support Microsoft but whether these valuable features will be made available on iOS and Android.
  • If HERE services become available on iOS and Android to an equal level of quality then one of the reasons to buy Windows Phone will have been erased.
  • This is why, I believe that ecosystems must develop their own exclusive Digital Life services in order to maintain their edge.
  • Developers are incentivised to get their apps and services on as many devices as possible meaning that the will not be a long term differentiator for any ecosystem.
  • This is exactly why I am concerned about Apple’s long-term margin outlook.
  • Its own in-house Digital Life services that are exclusive to iOS have not fared particularly well, meaning that Apple’s value is in the easy and fun distribution of third party apps. and services.
  • This is not a long-term competitive edge and raises the spectre of commoditisation once the other ecosystems have caught up.
  • This is why I think that Microsoft will end up buying HERE from Nokia.
  • I suspect that Microsoft wanted to do this when it acquired the handset business but was rebuffed by Nokia.
  • With HERE under its control, Microsoft will be able to ensure that HERE on Windows devices is much better than on other devices thereby maintaining differentiation and a reason to adopt the ecosystem.
  • In the meantime, I think that Nokia will continue to develop HERE such that it will be able to get the best possible price when it comes time to exit.
  • Nokia looks set to do the same with its patent portfolio and these are the two main reasons why there is upside in Nokia but it will take some time before this is realised.

BlackBerry – Bendy noise

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BlackBerry Passport will be a niche product. 

  • The uproar over bent iPhones has completely drowned out any real splash that BlackBerry was hoping to make with the launch of its new device: The BlackBerry Passport.
  • At events in Toronto, London and Dubai, BlackBerry launched its new attack on the professional smartphone user.
  • The BlackBerry Passport is radical as it incorporates a 4.5inch screen that is square rather than rectangular.
  • This obviates the need to turn the device into the landscape mode but it also makes it significantly wider than any other device on the market.
  • At 3.56 inches wide it even beats the gigantic Lumia 1520 which comes in at 3.36 inches wide but sports a massive 6 inch screen.
  • However, BlackBerry have done an excellent job with the keyboard.
  • The keys are significantly wider making it easier to type and the 4th row of the keyboard has been replaced with context sensitive touch keys that appear at the bottom of the screen.
  • This row adapts to the task being performed and also learns the user’s preferences as time passes.
  • It is also possible to scroll up and down in true BlackBerry fashion by swiping on the keys in the middle of the keyboard.
  • BlackBerry have also tweaked the functionality of BlackBerry 10.3 offering a digital assistant, improvements to integrated messaging and a better browser.
  • This form factor makes significant improvements to the use case for writing email and editing documents but comes at the expense of one handed usage.
  • The Lumia 1520 is already very difficult to operate one handed and this device will be even worse.
  • However, BlackBerry is counting on professional users spending more time using data than actually talking on the phone and therefore being willing to accept the compromise.
  • The inclusion of the Amazon App. store will go some way to addressing the fact that the BlackBerry App store is woefully inadequate compared to Google Play or the Apple app store but there is a problem.
  • The Amazon App. store sells apps that are written for Android which means that there has to be a software emulator on the device that tricks the apps into thinking they are running on Android.
  • This trickery comes with a big disadvantage: performance.
  • The instructions from the apps have to be translated into BlackBerry code, executed and then translated back into Android in order to run the apps.
  • In every implementation I have ever seen this has always meant slow and buggy performance by the apps rendering them almost useless.
  • BlackBerry has implemented its own software to execute this task but unless huge improvements have been made, this is going to be a disappointing experience for users.
  • However, for the professional market, this does not matter nearly as much as it does for the consumer.
  • Hence, BlackBerry might just get away with this as professionals really only care about productivity apps on BlackBerry devices.
  • At $599 it is not cheap and the days of companies block buying large numbers of devices for employees are almost over.
  • I think that this device will find some traction in the financial industry and in government which are still strong BlackBerry segments.
  • I doubt that this will be enough to rescue the hardware business but if it can stem the cash haemorrhage it will give John Chen more time to figure out what the real future of the company is.
  • I continue to believe that the long-term future of BlackBerry is in mobile device management where it has a much larger installed base than any of its competitors. (see here)
  • However, it is a rapidly commoditising business and companies like VM Ware and Microsoft have the resources to give the service away in return for business elsewhere.
  • I still see downside in the shares.

 

Apple – Happy days

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iPhone 6 just as profitable as the 5s despite bigger screen. 

  • The screen of a mobile device is by far the biggest single cost element of any mobile device.
  • Hence, when Apple launched the iPhone 6 and 6+, my immediate reaction was that the BOM (Bill of Materials) would rise pressuring gross margins.
  • However, I also expected that higher volumes of phones would also offset any weakness in gross margin through operating leverage. (see here)
  • However, it appears that Apple has gone one better by managing to offset the higher cost of a larger screen through lower component costs elsewhere in the device.
  • The first tear downs have been released and the BOM’s are not massively different (excluding storage) from the iPhone 5s at $200-$247. The iPhone 6+ comes in at $216-$263 with Apple paying around $0.47 per GB of storage. (IHS).
  • By comparison the BOM of the iPhone 5s was $199 to $218 at the time of launch.
  • This gives gross margins of 69% or70% depending on the model purchased which is roughly in line with the iPhone 5s.
  • The screens are being sourced from LG Display and Japan Display and are estimated to cost $45 for the 6 and $52.50 for the 6+. (IHS).
  • This is meaningfully higher than the $41 that the iPhone 5s screen costs and I suspect that Apple has used a combination of Moore’s Law and its huge purchasing power to put pressure on suppliers of its other components.
  • With gross margins essentially flat compared to previous generations, operating leverage generated by higher shipments from market share gains will now flow directly to the bottom line.
  • This is good news for Apple but not so good for its suppliers.
  • Apple’s resurgence over the last few quarters will have increased its desirability as a customer giving it more scope to procure components at lower prices.
  • While this is great news for Apple and its shareholders in the short-term, suppliers that have had to fight hard to get into the device are likely to be feeling the pinch.
  • I am pretty optimistic on the outlook for Apple in the short-term but I still have concerns regarding the long term profitability given its weak position in Digital Life.

 

Apple Pay – Kickstarter

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Apple Pay might just kick start the opportunity for everyone. 

  • The size and brand power of Apple has enabled all of the participants in the complex payments chain to line up together.
  • With all participants signing-up to support the system, there is a good chance that the user experience will be as easy and as seamless as promised.
  • To date, mobile based payments has been a dream that has been hobbled by participants in the chain focusing on self-interest rather than the user experience.
  • As a result, the user experience has been poor, hobbled by security concerns with limited support by the banks and retailers.
  • Apple Pay is a proprietary system based on NFC that joins the links of the payment chain and quietly takes care of the security concerns.
  • The fingerprint reader on the iPhone 6 is the main authentication tool but also a secure element inside the iPhone 6 and 6+ takes it one stage further.
  • It is the combination of these two elements plus the support of the entire chain that might just make this work this time around.
  • Apple’s business model is centred on making its devices as desirable as possible which is the major driver of its industry leading handset margins.
  • Consequently, Apple Pay is not a technology that it is going to be licenced out to others, meaning that the market for this system will be limited to owners of iPhone 6 and beyond.
  • If a user wants to use Apple Pay, he will have to pay up for an iPhone.
  • RFM forecasts that in 2016E, iPhones will make up 13% of all the smartphones across the world.
  • Keeping Apple Pay to itself will allow Apple to maintain the exclusivity it needs for its profitability but it will be leaving 87% of the opportunity on the table for everyone else.
  • Many see the advent of Apple Pay as the harbinger of death for many companies that are trying to make it in mobile based payments but I think the opposite is true.
  • The cream of the market may well be skimmed off by Apple but its take-off will create a renewed impetus for the players that address the rump of the market to get their act together.
  • This is also a big endorsement of NFC which has struggled for traction due to fragmentation and a bad user experience.
  • NFC is now very likely to be a key enabler of mobile based payments which is good news for NXP Semiconductor which is the main manufacturer of chips and is the supplier to the iPhone 6 and 6+.
  • Apple Pay may just be the catalyst that finally allows users to leave their wallets at home but the endemic fragmentation that has crippled this segment must be addressed.
  • Apple’s market power has allowed it to address this issue in iOS but for everyone else there is a huge hill to climb.

Microsoft – Building blocks

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Microsoft is buying users and opportunity not electronic Lego.  

  • Microsoft has agreed to purchase Mojang, the games developer behind Minecraft for $2.5bn.
  • Minecraft is a unique video game that emphasises building and exploring rather than any particular mission or story line.
  • The game is best described as electronic Lego and is available on almost every platform under the sun except Windows Phone (ironically).
  • It is as open-ended as a video game can get and despite graphics that make the Wii look advanced, it has been a colossal success with over 100m registered users.
  • Users can either play for free through a web browser or purchase the software to play natively on almost any platform.
  • So far conversion of free players to paid players is somewhere around 15%.
  • Although, Microsoft has said the acquisition will be break-even in FY15E (ending June), I think that it will quickly make access to all versions of Minecraft free for everyone.
  • This is because I believe that this acquisition has everything to do with ecosystem and users and nothing to do with Lego.
  • Minecraft is a world, not unlike Second Life, where users can interact with each other and this is what I suspect attracted Microsoft.
  • The graphics of Second Life a far superior to Minecraft but critically, it has less than half the number of users.
  •  I suspect Second Life would have cost Microsoft more and have refused to be integrated into Microsoft.
  • Furthermore 86% of Minecraft’s users are below 30 years and 65% are below 21 years of age.
  • One of Facebook’s biggest problems has been the loss of younger users as their parents have come onto the system which was part of the reason for the acquisition of WhatsApp.
  • When I look at Microsoft’s Digital Life offering, the glaring hole that it has is in social networking which makes up 24% of all user time spent on smartphones and tablets.
  • I have long been of the opinion that Microsoft could migrate XBox Live to fill this space but with the acquisition of Minecraft, I think that Minecraft will end up fulfilling that role.
  • Its’ completely open ended environment could be developed to also offer a new graphical form of social networking thereby filling the last major hole in Microsoft’s Digital Life offering.
  • Minecraft’s huge user base would also give this critical mass from launch and I suspect that Microsoft will do everything it can to keep the existing users happy.
  • This is why I believe that Microsoft has purchased Minecraft and comparing it to the $40 per user that Facebook paid for WhatsApp, $25 per user does not look so expensive.
  • This acquisition is also critical because it is first definite sign that Satya Nadella is taking Microsoft down the ecosystem route rather than the Enterprise software route.
  • If he was not on board with this strategy, there is no way that he would have allowed this acquisition to go ahead.
  • To me this is a positive sign as ecosystem is the only route to long-term growth and reinforces my view that Microsoft is still one of the best places to look when investing in the digital ecosystem.

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.