Amazon – A very good turn

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Amazon has done Sony and Microsoft a big favour by acquiring Twitch.

  • Amazon has reached an agreement to purchase Twitch for $972m in cash.
  • Twitch is a YouTube-like website that allows users to upload their video game experiences and share them with other like-minded users.
  • The site has 55m users with 7m logging on every day.
  • Engagement is extremely strong with each of the 7m users spending an average of 2 hours per day on the website.
  • Twitch will become part of the Amazon group of companies but will continue to operate independently.
  • Apart from Twitch’s owners, by far the biggest winners from this transaction are Sony and Microsoft.
  • Gaming is the single biggest piece of the Digital Life pie.
  • Users spend more time playing games on their smartphones and tablets than they do anything else.
  • The Google ecosystem is the largest and strongest ecosystem in the market and it has a glaring hole in its offering: Gaming.
  • By acquiring Twitch, Google would have been a position to use Twitch’s relationship with 55m gamers to jump in and give Microsoft and Sony a really hard time.
  • This is why when it appeared that Google was going to buy Twitch, I was of the opinion that Microsoft and Sony needed to do something to head Google off at the pass (see here).
  • Amazon has very kindly done both companies a big favour and kept Twitch out of Google’s clutches.
  • I suspect that the reason why Google failed to acquire Twitch is the same reason why Amazon will get very little benefit from this acquisition.
  • I think that Google failed to acquire Twitch because Twitch insisted on remaining independent while Google knows full well that to get any value out of it, it needs to be integrated into its Digital Life offering.
  • Start-up companies like this are such hot property right now that they can insist on, and get whatever terms they like when it comes to acquisition.
  • Facebook has exactly the same problem with WhatsApp (see here) and I think that it will be unable to do anything with it while the current situation persists.
  • Consequently, I think that Amazon is going to really struggle to create a coherent gaming offering around Twitch until it can convince the founders to properly integrate into Amazon.
  • This gives Sony and Microsoft breathing space when it comes to the threat that Google presents to their ecosystems.
  • This is particularly so for Sony, whose ecosystem ambitions are almost entirely dependent on growing its influence beyond gaming and media consumption.
  • PlayStation, PC and Xbox produce almost all of Twitch’s content and these platforms are controlled by the two companies.
  • Consequently, I do not think it would be very difficult for Twitch’s offering to be recreated or even improved if the two could come to some arrangement.
  • In the immediate term this is very unlikely and both companies can be very thankful that Twitch has gone to a far less dangerous competitor in the digital ecosystem world.

Firefox India – Double edged sword.

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Unconformity to the design ensures losses.

  • Mozilla has announced that Intex, the Indian handset maker, has launched a Firefox powered device called Cloud FX Phone that will go on sale for $33.
  • Later this week, a second device manufactured by Spice Mobility will be launched for the price of $38.
  • Both of these devices look like they are based on the $25 smartphone reference design that was launched at MWC this year.
  • My view on this platform remains unchanged (see here) in that I believe that the project needs to ship 10m units of the design with no modifications in order to break even.
  • Unfortunately, I see evidence that the same problem that killed the “3G for all” program in 2007 occurring yet again.
  • In 2007 the winner of that contract (LGE) needed to accumulate more than 6m of orders of its reference SKU in order to ship enough units to break even.
  • Unfortunately, every customer wanted something different meaning that LG would end up spending a fortune customising all the variants and consequently lose money on the overall project.
  • Consequently the project was quietly put to sleep.
  • The same thing appears to be happening again as the Cloud FX phone and the Spice Mobility devices look like they are only loosely based on the standard $25 reference design.
  • The specification of the Cloud FX Phone and its price indicate that Intex has tinkered with the specification to make its own version of the device.
  • While this is not an issue per se, it means that Intex will have incurred further costs to make its desired variations.
  • This is clear in that the device has a 2MP camera while the reference design uses 0.3MP and it has 128MB of RAM while the reference has 1GB of embedded DRAM.
  • The fact that the Spice Mobility device will sell for $38 implies that, it too, has made modifications to the standard design.
  • The beauty of the reference design is that someone else has done the integration and testing already meaning that all the vendor has to do is put it together.
  • This ensures a meaningfully lower development cost and greater economies of scale if parts can all be sourced together.
  • This is critical to enabling a handset maker to be able to break-even at a very low price.
  • In this instance the reference design is controlled by Spreadtrum who was also tasked with buying all the parts in bulk so that everyone could benefit from lower prices.
  • However, it looks like each manufacturer is going it alone which essentially ensures that the $25 price will be missed and everyone will lose money even at the higher price points.
  • Furthermore, The Firefox ecosystem is very short on third party apps.
  • So much so that WhatsApp connectivity has to be provided by a third party app. on these devices.
  • Consequently, these manufacturers are not going to benefit from the scale effect that is so desperately needed to make this project fly.
  • I will be surprised if these two devices ship 1m each leaving the project short of 8m devices in the best instance even if everyone was sticking to the script.
  • Consequently, I see no way for this project to make money and continue to remain extremely cautious concerning the outlook for the Firefox ecosystem.

 

 

Project Ara – The Holy Grail

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A great quest likely to be sunk by the 2 E’s.

  • A modular mobile phone has been a dream of the mobile phone industry for many years and now Google is giving it a go.
  • Project Ara (see here) is a phone design which is a touch screen with a superstructure on the back where modules can plugged into a series of standardised sockets.
  • The idea here is that the consumer can chose exactly which specification he wants and then buy the relevant modules and plug them in.
  • This goes for battery, camera, chipsets, sensors, memory, storage and so on.
  • At Google I/O this year a prototype of this idea was shown but it really struggled to even to boot-up.
  • I believe that the engineering problems behind making this device a reality can be solved but the ergonomic and the economic issues will never work.

Ergonomics

  • A device of this type will always be bigger and clunkier than a regular design with exactly the same specification.
  • This is because it is custom components and system integration that allow such small packages to have top end performance.
  • The nature of this modular design prevents substantial parts of the device from being integrated together removing the usual space saving benefits gained.
  • Furthermore, standard connectors and the need for each component to be in a separate case will mean that there is far more material in this unit than a regular device.
  • Consequently, I think that almost all consumers will have very little interest in buying a device of this nature.

Economics

  • To make this device viable, every module will have be specifically designed to fit into one of the standard sockets.
  • Furthermore, every module will have to be cross-tested with every other module to ensure that they can all work together properly.
  • As more and more modules are produced there will be a combinatorial explosion in terms of the testing required to ensure that each module is fit for market.
  • On top of all of that, plug and play radios will make testing to pass operator and FCC testing much more onerous and expensive.
  • Consequently, the development costs of this device and the time to market will be much higher and much longer than regular devices of the same type.
  • Therefore I believe that this device will only have a chance at the low end where new technology takes much longer to come to market.
  • That means that the device will have sell in massive volumes in order to make back the very high development costs that have been expended to get it to market.

Take home message

  • This is why believe that this will remain nothing more than a science project.
  • Google has plenty of money to spend on finding the Holy Grail but the reality is that this idea is likely to prove as elusive as its namesake.

Android – Fragmentation fix.

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Google and China likely to completely take over their versions.

  • The latest report from OpenSignal strongly implies that Android fragmentation is getting worse but I suspect that the reverse is true.
  • The latest study shows that within a sample of 682,000 devices upon which the OpenSignal App. has been installed, there are 18,796 different Android devices.
  • This is a significant increase on last year where 11,868 different devices were found within the same sample size.
  • This does not mean that there were 18,796 different versions of the software but there are that many different handsets in the market.
  • This is both a blessing and a curse.
  • Greater diversity has made it possible for the cost of Android devices to be substantially lower than that of iOS and Windows Phone.
  • This has been a major factor behind Android’s rise to around 80% of smartphones shipped in Q2A.
  • The ability to buy a smartphone for less than $100 has enabled Android to penetrate huge markets such as China, India and Africa where cost is the single biggest concern of the consumer.
  • At the same time, it has meant that handset makers have had to make huge compromises when designing and building the devices.
  • This includes the removal of many hardware components as well as using older versions of the code which are much cheaper to implement.
  • This has also meant that, in many cases, very little is spent on optimising the standard Android code to run on stripped down hardware.
  • This has meant that third party applications either don’t run or behave erratically on different handsets from the same manufacturer.
  • No one is immune from this problem as RFM’s research has found multiple instances from app developers where their app behaves differently on different models made by Samsung.
  • This is why everyone develops for iOS first.
  • By developing for iOS a developer knows that he is targeting a much more consistent group of devices as well as targeting a higher demographic in the market.
  • This problem is endemic to Android and there is very little that is likely to improve unless something changes.
  • However, I see that change is coming.
  • RFM research reveals that both Google and the Chinese ecosystem players are working on addressing this issue.
  • The only way that this issue can be addressed is for those that are writing the code to take more and more control of it.
  • This is exactly what I see Google doing with GMS.
  • GMS is Google’s proprietary, non-open code that sits on top of the open Android software which contains all of the Google services that users are keen to have.
  • I see Google slowly expanding the scope of GMS to include more and more of the device’s functionality until the open piece is nothing more than a kernel.
  • This will mean that Google will have effectively created its own proprietary OS and in doing so it will be able to control the fragmentation that keeps it behind iOS in terms of quality of experience and security.
  • I see the Chinese players doing exactly the same despite the failure of Aliyun which it appears that Google was successful in blocking a couple of years ago.
  • In the long term, this is likely to result in Android becoming nothing more than a kernel upon which ecosystem players run their proprietary systems and experiences.
  • The end result will be less fragmentation within devices within a single ecosystem but much greater fragmentation between the different ecosystems.
  • Currently, there is nothing visible that will prevent Google from succeeding in this strategy and the end result is likely to be more and more user data being captured by Google on its servers.
  • This will be instrumental in maintaining its market share in mobile advertising and it will also help increase the relevance of the adverts that it sells.
  • This combined with strong user demand for its services is why I do not see any other ecosystem challenging its dominance anytime soon.
  • This is likely to mean growth in revenues above 10% for the next few years making the stock still look interesting despite its strong run over the last few years.
  • Google along with Yahoo! and Microsoft are still the most interesting places to look when considering an investment in the mobile ecosystem.

HPQ Q3A – Gentle drift

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HPQ is drifting from one quarter to the next with no direction. 

  • HPQ reported good Q3A revenues as market share was gained but weaknesses in the high margin businesses kept any gains from hitting the bottom line.
  • Revenues / EPS were $27.6bn / $0.89 compared to consensus at $27.0bn / $0.89.
  • The stabilisation in the PC market that helped both Intel and Lenovo was also felt by HPQ but HPQ also managed to gain share in PCs to 18.3% just behind Lenovo on 19.4%.
  • Unfortunately Enterprise Services, Software and HP Financial Services all saw declines in revenue
  • These are the areas where HPQ needs to grow most as it is here where there is value to be added and good margins to be earned.
  • The result of these declines was lower margins which wiped out both benefits from the revenue beat in PCs and benefits delivered from the cost reduction program.
  • Guidance for Q4E was in line with expectations with EPS of $1.03 – $1.07 compared to consensus at $1.05.
  • These results are indicative of the malaise that currently besets HPQ.
  • The company is cruising from one quarter to the next with no real strategic direction which is showing through in the financial results.
  • The improvements delivered through streamlining and cost cutting are being eaten up by weaknesses in business that should be growing and badly need to be set to rights.
  • HPQ needs to decide where it wants to go as a company and make its assets all pull together in the same direction.
  • This is the only way that the company can return to growth because as things stand at the moment, the next time the PC market dips, HPQ’s earnings will go with it.
  • Lenovo, Asustek, Microsoft and Intel remain far better ways to gain exposure to theme of a recovery in the PC market.

HTC M8 for Windows – Hearts and wallets

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Microsoft needs to appeal to the user’s heart not just his wallet.

  • HTC has launched an virtual clone of its flagship HTC One M8 with two main differences from the original:
  • First, it is running Windows Phone 8.1 instead of Android / Google Mobile Services (GMS).
  • Second, after the subsidy, it is half the price of the Android / GMS version at $99 with a two year contract instead of $199.
  • The unsubsidised price of the original is $670 and I suspect that this device will be $100 less (i.e. $570) if purchased without a contract. .
  • HTC is in no position to make such a concession and I suspect that Microsoft will be providing HTC with marketing support of $100 per device.
  • Unfortunately, to make this device, as well as its own devices successful, appealing the user’s wallet is only half of the story.
  • Microsoft has only 3.2% share of the smartphone market and majority of these are the Lumia 500 and 600 series which are cheapest phones that the company makes.
  • This clearly indicates that price will only get one so far.
  • These are a great choice for a budget conscious smartphone user as he gets a lot of smartphone bang for the buck in terms of hardware specification and camera capability.
  • The user also gets access to an ecosystem that offers a comprehensive range of services within which he can live his Digital Life but I suspect that almost all of these users are unaware of this fact.
  • This is where Microsoft must step up and educate users about what it has to offer.
  • Windows Phone is a very different experience to both Android and iOS both which are now so prevalent that they sell themselves.
  • Microsoft does not have this luxury and it must show users what the ecosystem is capable of before there will be any meaningful uptake.
  • This means having live devices at the point of sale that are populated with typical user data so that users can really see how it will benefit them.
  • This is still very far from reality and until it starts to happen I think it unlikely that the ecosystem will gain much traction.
  • Appealing to the consumer’s wallet will only get Microsoft so far, it must also win his heart.
  • This is why I suspect that only a handful of these devices will sell despite the $100 discount being offered.
  • This is a minor issue for HTC which continues to struggle with its lack of scale and differentiation leaving it unable to turn a decent profit.
  • I see no real strategy at HTC to change this state of affairs and remain fearful for the long term future of this company. 

 

 

BlackBerry – Bottom bumble

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Stability buys time, but for what?

  • BlackBerry has staved off the immediate threat of collapse but where it goes from here is a mystery.
  • The job cuts and consolidation have created a company with $4bn in revenues, 0.6% market share in smartphones and critically one that is cash flow neutral.
  • This gives it time to consider its options but hopes for its up and coming smartphones are not high.
  • The BlackBerry Passport has very little to entice users other than those who have no choice where the device is handed to them by IT.
  • Even in the enterprise market where BlackBerry now focuses, there is aggressive competition and I don’t think that BlackBerry’s devices are here for the long term.
  • This issue is also highlighted by BlackBerry’s recent re-organisation of its key assets into a single unit called BlackBerry Technology Solutions.
  • This new unit now holds the patent portfolio, QNX embedded software, the Internet of Things project and various other applications and innovations.
  • The idea is to generate new revenue streams along the same lines that Nokia is doing with Nokia Advanced Technologies.
  • However, the patent portfolio is not strong and QNX has a limited number of applications.
  • Consequently, this looks like a division that is not going to produce the much sort after return to growth.
  • This combined with a hardware business that also does not have much future leaves me wondering where BlackBerry intends to go.
  • One potential direction is to use the BES server to offer mobile device management for enterprises along similar lines to Good, MobileIron, AirWatch and Microsoft.
  • BlackBerry has a long history and a longer client list than many of its competitors, but this service is rapidly becoming a commodity.
  • Consequently, there needs to be innovation on top to make it interesting for clients and profitable for the provider.
  • Here, BlackBerry seems to be short of ideas and I am not optimistic that revenues will be able to outpace price erosion.
  • Consequently, I see a period where BlackBerry bumbles along the bottom while it tries to figure out where its future lies.
  • There are much more interesting places to invest in the digital and mobile ecosystem (such as Yahoo!, Microsoft and Google).

Xiaomi MIUI 6 – Mission impossible?

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Xiaomi is like Apple except for its margins.

  • Xiaomi has released the next version of its user experience which will be rolled out onto its phones, tablets and other Android powered devices.
  • Google is nowhere to be seen on this device meaning that this software is proprietary to Xiaomi and replaces the functions and services that would normally be provided by Google Mobile Services (GMS).
  • The look and feel of the UI is very similar to iOS 7, and it is clear that the aim continues to be to deliver an iPhone like experience at a fraction of the price.
  • MIUI 6 has replicated many of the functions of iOS 7 like the app. store, cloud based storage and the media and video experience.
  • MIUI 6 includes some Digital Life services such as cloud based storage, media consumption, search and reference but it is still very far short of a full suite.
  • Xiaomi is known for the high quality of its devices and its low prices which is both a blessing and a curse.
  • It has really helped the company gain market share but it makes it very difficult to actually make any money.
  • This combined with the fact that it will now be up against the big Chinese ecosystem contenders Baidu, Tencent and Alibaba, means that there is still a huge mountain to climb.
  • The usage statistics and market share are all going in the right direction but I am far from convinced that the company’s financials paint such a rosy picture.
  • Most of the other players (Lenovo, Huawei and Sony Mobile) who ship similar volumes to Xiaomi, have higher ASPs and still fail to make anything more than wafer thin EBIT margins.
  • Hence, I suspect that even at this new level of volume, Xiaomi is still loss making.
  • In order to get margins to improve, Xiaomi will have to differentiate itself further.
  • A differentiated offering through its ecosystem will enable it to shed its low pricing as it will have user preferring its devices.
  • This is what I believe must happen for Xiaomi to start making a proper return.
  • To do this, it will have to broaden its Digital Life offering and that will require further investment.
  • Xiaomi has the right strategy and is a force in the Chinese smartphone market but it must now invest in the ecosystem in order to remain there.

 

Facebook & friends – Internal affairs

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Facebook’s messaging mess highlights a problem for everyone.

  • The number of attempts Facebook is making to crack the millennial messaging market is growing fast and with it the bill for shareholders.
  • Facebook’s travails also highlight a very significant problem faced by all of the ecosystem contenders when it comes to developing their Digital Life offerings.
  • Many contenders are using M&A to grow their way around the Digital Life pie but unfortunately the reality is much more complicated.
  • Facebook seems to be desperately trying to win back the younger part of its user base by trying to address the success of Snapchat.
  • Following its failure to create a clone, it then tried to buy the original and when that failed, it returned to trying to copy it.
  • Its first attempt called Poke failed after a couple of months, Slingshot has suffered a similar fate and now Facebook is trying again with Bolt.
  • Bolt is a standalone app. that is derived from Instagram that effectively replicates the functionality of Snapchat.
  • So far the signs are quite good but it has only been launched in New Zealand, Singapore and South Africa.
  • These efforts also go hand in hand with the Facebook chat app. and the WhatsApp acquisition to make a very confusing messaging strategy.
  • It looks like Facebook is trying to hang onto the younger generation of users many of whom have been put off the main service by the arrival of their parents onto the system.
  • Facebook now has at least three separate messaging strategies for a single service that are all separate and distinct from one another.
  • The value to Facebook of messaging would be many times greater if all of these services were able to interact with each other.
  • Unfortunately, the agreements made at acquisition seem to ensure that the acquired entities remain separate and continue to operate independently.
  • If this remains the case then Facebook will never be able to take WhatsApp into gaming or integrate it with its other services.
  • In my mind this is the only way in which Facebook can have a hope of earning any return on the $19.6bn of shareholder’s money that it invested in acquiring this company.
  • This is the most striking example of a major problem that besets all of the digital ecosystem contenders.
  • To generate value to its full potential, a Digital Life offering needs to have all the services integrated and aware of one another.
  • This way the services work better and the owner of the services can gain a much deeper profile of the user.
  • This is critical to selling value added advertising as well as providing a deeper and richer service to the user.
  • So far only Google has come close to this ideal and this is a major reason why I believe it is by far the most successful at monetising the mobile internet opportunity.
  • Yahoo!, Microsoft, Apple, Amazon, Twitter, Facebook, Sony, Tencent, Baidu, Alibaba and so on must all get on top this issue if they are to really succeed.
  • Almost all the deals struck to date state that the acquired service or app. will continue to operate independently of the acquiring company.
  • I believe independence is the only way in which acquiring companies can entice hot new services and apps to allow themselves to be purchased.
  • Many acquirers believe that once the acquisition is closed, the problems are over but I suspect that the reverse is true.
  • The acquirer has a fiduciary duty to its owners to earn a decent return on the money it invests and without integration, this is very unlikely to happen.
  • Only a very few of the ecosystem players understand this problem and Facebook is not among them.
  • Consequently I see Facebook’s attempts at expanding outside of social networking remaining stillborn and continue to believe that it will run out of growth as soon as the social networking piece is properly monetised on mobile devices.

 

 

 

Lenovo Q1A – Breathing space

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Improvements give Lenovo more space to invest and execute.

  • Lenovo reported good Q1 results as its handset business and PC business both grew share.
  • This gives the company more breathing room when it comes to turning around the loss making Motorola Mobility that it is about to acquire from Google.
  • Q1 revenues and net income were $10.4bn / $213m compared to consensus forecasts of $9.9bn / $201m.
  • Lenovo saw a 15% increase in PC shipments despite a stagnant market and also registered a 16% increase QoQ in smartphone shipments against a market that grew by just 4.6% QoQ.
  • Market share in PCs has hit an all-time high of 19.4%, nearly 1% clear of HP while smartphone share has reached 5.1%.
  • Including Motorola, smartphone share is now at 7.6% making it comfortably number 3, although it now has Xiaomi snapping at its heels.
  • EBIT margin has inched up to 2.7% from 2.5% in Q4 but the revenue increase has driven Q1A operating profit to $283m.
  • This combined with the fact that EBIT Losses at Motorola almost halved in Q2 to $99m (Google Q1 10Q) gives Lenovo much more room to effect its strategy.
  • Additionally, the IBM server business is more profitable than the Lenovo group which should also help keep the company in the black when the two transactions have closed.
  • Lenovo has $5.5bn in the bank much of which will be spent on the transactions to come.
  • However, this combined with the improving fundamentals gives Lenovo enough space to give its strategy to become a major player a proper chance.
  • That being said, this will not be easy. I have long believed that at least 10% market share is needed before any scale related benefits start to kick in leaving Lenovo 2.4% adrift.
  • This means that heavy investments are going to have to be made which could easily push Lenovo into loss making territory.
  • Furthermore, sooner or later Lenovo is going to have to contend with the fact that all the value in its industry is migrating to the ecosystem for which it has no answer.
  • It claims to have a stake in the digital ecosystem with its SHAREit application but this is merely a tool for transferring content between different Lenovo devices and is not a Digital Life service in its own right.
  • Hence Lenovo continues to get a 0% score on the RFM Digital Life Pie analysis but I can see it starting to think about being a contender.
  • Historically, I have been concerned regarding Lenovo’s strategic depth but I have to admit that in the last three months it has surprised me.
  • Lenovo remains one to watch but I still think that the new strategy will make a dent in earnings and the valuation before it can hope to come good.