Google – Flavour of China.

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Getting back into China will be long, tough haul

  • Google has been effectively absent from the Chinese market since 2010.
  • With the growth of Internet use in China and ever increasing smartphone penetration, it is clear that this is a big revenue stream that is currently passing it by.
  • Looking at the ecosystem opportunity, RFM estimates that the Chinese market could account for 30% of all users by the end of 2016E.
  • With developed market growth slowing, this is an opportunity that Google cannot afford to ignore and this is why I suspect that it is looking to enter this market once again.
  • This time it looks like Google is going to make its Google Play or a version of it available in the Chinese market.
  • This also co-indices with a move to allow developers based in China to make money in 130 countries but with the unfortunate exception of China.
  • How this would work is very unclear but I think it very unlikely that this is the beginning of free availability of Google Play on all Android devices.
  • Google Play is Google’s most precious mobile asset as it is the availability of the apps that users most demand.
  • In most markets, in order to get Google Play a handset maker or and operator needs to sign an agreement with Google.
  • This ensures that all of Google’s Digital Life services are also present on the device and that certain criteria around placement and defaults are met.
  • This is how Google’s ensures that its ecosystem is present on around 40% of all Android devices in the market.
  • RFM estimates that Google’s ecosystem will generate around $6.9bn in mobile advertising revenues on Android devices in 2014E.
  • Consequently, I suspect that a Chinese store will be something very different to Google Play, probably with a totally different name.
  • I also suspect that it will be very Chinese in its nature and mostly feature apps and content that are tailored to the Chinese market.
  • Hence, this is not going to represent a backdoor way to getting Google Play on a device without deploying the rest of the Google Ecosystem.
  • The Chinese ecosystems are at an early stage of development and I am looking for three big ones to emerge owned by Baidu, Tencent, Alibaba and maybe Xiaomi.
  • I think that these players are intent on keeping Google out of their home market and are likely to keep their popular services and apps out of whatever Google launches in China.
  • Consequently, I see no change to the existing status quo and continue to expect Google to see no real increase in traction in China.
  • Despite that, the revenue outlook picture for Google still looks healthy and the stock is more than fairly priced despite the overspending and the shortcomings in corporate governance. 

Yahoo! and Mozilla – Face not wallet

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The loss of Firefox hurts image and more than revenues.

  • Yahoo! and Mozilla have announced that Yahoo! will replace Google as the default search engine within the Firefox Internet browser.
  • This change marks the end of the 10 year deal in which Google was the default search provider for Mozilla.
  • Mozilla and Yahoo! have signed a 5 year deal where no details were disclosed.
  • Through the Firefox browser Mozilla was acquiring traffic on Google’s behalf and its share of those revenues made up the vast majority of Mozilla’s revenues.
  • In 2012A (last available figures) Mozilla had $311 in revenues where I think Google was probably responsible for around 85%.
  • Google typically pays away 20% of its gross search revenues to those that source traffic on its behalf implying that something in the region of $1.3bn of its gross search revenues was coming from traffic sourced from Firefox.
  • In 2012A Google’s gross search revenues were $37.6bn meaning that being the default search provider to Firefox represented only 3.5% of revenues.
  • Consequently, I suspect that this means that the loss of Mozilla is unlikely to have much impact on Google’s ability to earn revenues from search.
  • This is especially the case as since 2012A, Firefox’s desktop browser share has declined from 22.5% to 14.2% while Chrome’s share has risen from 17.6% to 21.1% (see here).
  • Add this to the fact that Yahoo! is desperately trying to gain share in search, and it is not difficult to see how Yahoo! was willing to pay more to be the default search provider than Google was.
  • Furthermore, I suspect that Mozilla was keen to get away from Google given that it is actively trying to lure users away from Firefox to its own Chrome browser.  
  • As a result Yahoo! clearly makes a better match for Firefox than Google does and both parties had an incentive to see a deal done.
  • Hence, Yahoo! is probably paying much less than some commentators may think, but probably more than the 20% gross search revenue share that Google was paying.
  • Whether, this transaction meaningfully lifts Yahoo!’s search revenues has yet to be seen as one must not forget that Google is better at monetising traffic that comes in than Yahoo! is.
  • Net net this is a good deal for Yahoo! and it should have some top line impact but the loss to Google is probably more face than wallet.
  • I would still pick Google over Yahoo! in the short term, given Yahoo!’s inability to execute on the assets it has already acquired.

Samsung – No bottom with this line

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Cutting a few models does not address the problem.

  • Samsung has confirmed that it will cut the number of smartphones that it launches in 2015E by 30% in an attempt to shore up profitability.
  • It will also aim to increase its re-use of parts across its portfolio and thereby gain greater scale advantages from volume purchases.
  • The hope is that these measures plus a good slug of cost control will bring margins back up to 10% on the lower revenue outlook that the company faces.
  • Unfortunately, this is a further sign that Samsung appears to have lost control of its handset business and I fear that these measures will do nothing to halt the margin decline of the last 2 quarters.
  • The graveyard of the mobile handset industry is littered with examples of companies who led the market and then lost their edge.
  • All of them were unable to control the loss of market share which unravelled so fast that substantial losses were incurred as management struggled to bring the businesses back under control.
  • Handsets are a business of scale.
  • A handset maker invests in R&D to develop a handset and then runs a marketing campaign at launch.
  • These are fixed costs meaning that the more devices of each model that ship, the higher the margins that are earned.
  • In recent years Samsung has gone from shipping less than 1m each of over 100 models to shipping tens of millions of single models such as the Galaxy S and Galaxy Note. .
  • I have long suspected that the profitability of these devices is at least as high as Apple’s and have almost single-handedly underpinned Samsung rise to prominence.
  • The problem is that these devices are no longer special and it is in the devices that have been expected to ship huge volumes where most of the weakness has been felt.
  • Simply cutting other devices that ship lower total volumes does nothing to address the fundamental weakness currently being exposed in the heart of its portfolio and I think margins are very likely to continue falling.
  • In Q3 14A Samsung only suffered competition from the iPhone 6 for a few weeks but in Q4 14E it will feel it for the full quarter.
  • Now that Apple is producing large screen devices, the one competitive edge that Samsung had has now been removed.
  • Hence it looks certain to lose further share in the critical high end, high margin devices where it has been making the bulk of its profits to date.  
  • Consequently, simply trimming models that are less popular and that have much lower margins is unlikely to have much of an impact as the critical problem remains the profitability of its flagships.
  • The market seems to have accepted that Q3 14A was the bottom for Samsung and that steady recovery is in the works.
  • I have seen nothing that would lead me to this conclusion.
  • Its erstwhile forbears all suffered huge losses before bringing their business to stability and I cannot see that Samsung is doing anything differently.
  • Hence, I am looking for margins to decline again in Q4 14E which I think will be badly received.
  • There is plenty of downside left in Samsung following its recent rally and I would immediately exit the shares before its inability to escape the fate of its peers becomes obvious.
  • Microsoft, Apple and Google all offer far better and far safer places to take a view on the digital mobile ecosystem. 

Yahoo! and Aol – Heaven and Hell

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A deal with Aol would be great for the stock but bad for the company.

  • The Aol and Yahoo! story is heating up again (see here) as Starboard has gone back into Aol and now has a reasonable stake in both companies.
  • There is substantial value to be released in both companies and while putting them together would give a one-time release of value, it would do nothing for the long term outlook for either company.
  • The main issues here are that Yahoo! is trading at a substantial discount to the sum of its assets and that its core business continues to underperform.
  • The activists want Yahoo! to realise the value in its Asian assets, cut costs and return cash to shareholders thereby releasing substantial value for shareholders.
  • Such a release of value would most likely result in a one-time substantial rally in the stock but little else.
  • They are also pushing Aol and Yahoo! to get together in the belief that they can solve each other’s problems.
  • Unfortunately this approach ignores the fact that Yahoo!’s only real chance of seeing real growth again lies in the development of its ecosystem.
  • Over the last 2 years it has accumulated a series of Digital Life assets that together give it over 70% coverage of the Digital Life Pie.
  • While it has been great at accumulating these assets it has done almost nothing with them.
  • These assets need to be integrated and rolled out on mobile in a fun and easy to use way where users can identify with Yahoo!
  • That way users would want to spend time with Yahoo! which Yahoo! can then use to sell valuable, targeted advertising.
  • Unfortunately, none of this has happened which is the main reason why the core business has been a bad underperformer this year.
  • Getting together with Aol does nothing to fix this problem and in every likelihood would make it worse.
  • This is due to the added complexity of adding in Aol’s assets on top of the jumble that is already there at Yahoo!.
  • Furthermore, other than the potential to release value for shareholders, this combination does nothing for Yahoo!’s ecosystem strategy and nothing to get growth going again.
  • This is why I suspect that the management of Yahoo! will resist this deal but the sale of its Asian assets would go a long way to mollifying investors.
  • I continue to be frustrated by Yahoo!’s lack of progress and think that until there an improvement in the company’s ability to execute, its core business will continue to underperform.
  • I am taking Alibaba-related profits on Yahoo! as there is no sign of a turnaround and I do not expect it to sell its Asian assets.
  • I could be looking for a re-entry point in 2015E but I need to see some signs of progress first.  

 

BlackBerry – Commodities trader

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BlackBerry now looks stable but commoditising fast

  • Blackberry held an event in San Francisco where it unveiled the new version of its server product (BES12) and launched a partnership with Samsung for regulated industries.
  • The new version of the server makes a number of meaningful improvements over BES10 that include:
    • First: Seamless support for all platforms.
    • The platform supports iOS, Android, Windows Phone, BlackBerry 10 and BlackBerry OS.
    • The ability to run both versions of Blackberry in the same place is a meaningful improvement as until now the two different versions had to be managed separately.
    • Second: The platform supports all ownership structures including: BYOD (bring your own device), COBO (company owned business only) and COPE (company owned personal enabled).
    • Third: the platform has designed to be saleable with up to 25,000 devices per server and 150,000 devices per domain.
    • Fourth: BlackBerry has placed its development emphasis on user experience, extensibility into Internet of Things (IoT) and total cost of ownership.
    • Fifth: A number of advanced features such as VPN authentication, simple and secure authentication among other features were also launched but only for BlackBerry devices.
  • At the same time, Samsung and BlackBerry have jointly announced that BES12 will support Samsung Knox and that the two companies will work together to address the regulated and government sectors.
  • These are two sectors where security is incredibly important and where Android’s lack of security has hampered its adoption.
  • Samsung Knox is also thought to be not that secure and teaming up with BlackBerry will help Samsung penetrate this industry more deeply.
  • I suspect that this relationship will be along the lines of offering a complete device and service offering for these industries.
  • Here, I think that BlackBerry devices will address the COBO and COPE segments of the user base and Samsung devices the BYOD piece.
  • John Chen is doing the right things to keep BlackBerry solvent but what is emerging is a vendor of MDM services.
  • This is a tough and competitive landscape with Airwatch, MobileIron, Good Technology, Microsoft and a host of others all vying to manage an enterprise’s mobile devices.
  • BlackBerry still has an advantage here as it has around 50m subscribers which is far more than any of its competitors and its solution is still the most comprehensive.
  • However, BlackBerry is having to offer heavy concessions (EZ Pass) to keep customers happy and I fear that this segment is rapidly becoming a commodity.
  • Consequently, I suspect that BlackBerry should now stabilise but the days of high margins, high growth and a high multiple are long gone leaving the shares with a difficult and uncertain future.
  • I would prefer Microsoft as an investment in the Digital Work ecosystem.

Twitter – Hopes and dreams

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Far more changes are required to meet the long term goals.

  • Twitter made some bold promises at its analyst day giving investors some confidence and sending the shares up 7%.
  • Firstly, a series of product announcements aimed at increasing engagement for logged-on users and casual visitors that include:
    • Instant timeline. Gives new users and casual visitors an idea of what is going on without having to follow anybody right away.
    • “What you missed”. Curates a list of tweets that were posted since the user logged in.
    • Homepage. A new design to make the homepage more engaging for both logged in and casual visitors.
    • New apps. New apps for mobile beyond Twitter and Vine will be released although what function they will serve is unclear.
    • Localised and event content. Content will be location aware and also curated by events that occurring around the user.
  • Secondly: Twitter provided some numbers that gave some context around the size of its audience and its long term targets:
    • Audience: Twitter estimates that its total audience is roughly twice the size of its user base at around 500m.
    • Long term audience: Twitter thinks that by 2020 it will have a reach of 2bn people, 4x where it is today.
    • Long term revenues: Twitter thinks that it can reach around $14bn in revenues within around 10 years, up from about $1.4bn in 2014E.
  • Thirdly: The company tried to play down the recent executive turmoil and turnover but in reality it explained very little.
  • Twitter is rapidly approaching saturation with its existing business and there has obviously been large differences in opinion in terms of where the company should go from here.
  • The fact that the head of product role has changed numerous times recently is a bad sign which only adds to the issues created by the departure of the head of analytics and VP of engineering at the end of October.
  • The medium term path has now been laid out and I hope that Costolo now has his ship under control and that turnover will now cease.
  • It will be a very bad sign if departures continue.
  • From the long-term goals it is clear that Twitter has no chance of meeting them unless there are fundamental changes.
  • I estimate that in its current form Twitter revenues will normalise at around $2bn.
  • This is because users only spend a very small portion of their Digital Lives engaging in microblogging.
  • Consequently, the information that Twitter receives about its users is more limited and the opportunity it has to advertise to them is also much shorter than for other activities like social networking.
  • Furthermore, Twitter knows nothing about at least half of the users that are viewing the tweets making targeting more difficult.
  • Some targeting will be possible based on the nature of the tweets being viewed, but the quality of these adverts and the revenues earned will be much lower.
  • In order to get to $14bn in revenues Twitter needs to address far more of the Digital Life pie and it must do so effectively.
  • Assuming it is a good instant messaging platform, Twitter currently addresses 9% of the Digital Life pie (see here).
  • If it can increase its reach to 2bn viewers on a monthly basis, I would estimate that Twitter needs to cover at least one third of the Digital Life pie to reach $14bn in revenues.
  • This means it will have to have a stab at competing in social networking, gaming or media consumption.
  • Of this, there is no sign and until there is I think it very unlikely that Twitter will ever come close to this target.
  • If it increases its reach to 2bn viewers with no changes to its current activity, revenues might just make $4bn in 2020E.
  • Either way it is clear that Twitter is not the next Facebook (see here) and while investors continue to pin their hopes on this dream, they are in for disappointments.
  • Twitter is a great company but I think the stock will remain bad for now.

Apple vs. MCX part II – Crash course

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MCX is likely to fail unless something changes.

  • The combined power of Apple and the major credit card companies is likely to exert so much pressure on MCX that something will have to change.
  • Retailers have problems with credit cards. The credit card companies charge them a fee every time a card is used which eats into their wafer thin operating margins.
  • As a result the Merchant Customer Exchange (MCX) was created by a consortium of US retailers to try and create an alternative payment system where the fees would no longer be charged.
  • This involves the use of store cards or direct debit on the customer’s bank account.
  • To date the payment experience has been the same for everybody with the customer presenting a card and signing a slip of paper or entering a PIN.
  • This has meant that MCX was offering a payment experience that was equivalent to everyone else giving a level playing field.
  • However, Apple has thrown a huge spanner in the works by creating a payment system that is much easier for users and that can be used any NFC enabled point of sale device.
  • This is a huge problem for MCX because it threatens to completely undermine all its efforts to move transactions in its members’ stores onto its systems.
  • MCX is developing its own mobile-based payment system called CurrentC but this has two huge disadvantages compared to Apple Pay.
    • First. It is a cumbersome QR Code based system that is more effort than making the payment with a piece of plastic.
    • Second. The merchant has to pay a higher fee to use CurrentC than either Apple Pay or a normal credit card.
    • This is because payment via CurrentC is classified as a “card not present” transaction which attracts a higher fee due to the increased risk of fraud.
    • With the creation of its very secure system, Apple was able to have Apple Pay transactions classified as “card present” transactions which are cheaper.
    • All other forms of in-App purchase also attract the higher fee giving merchants a strong incentive to adopt Apple Pay.
  • These two disadvantages alone are almost guaranteed to ensure that CurrentC fails.
  • The biggest problem with MCX’s strategy is that it is focused on the welfare of the merchants and does not seem to care about the customer experience.
  • This is exactly the kind of thinking that has hobbled the take-off of mobile based payments for the last 10 years.
  • This is where the huge risk lies. If customers start going to stores that accept Apple Pay instead of MCX member stores then there is a huge problem.
  • In the meantime, something has to change as MCX’s current course is almost certain to lead to failure.
  • If MCX is smart, it will quickly move its payment processing infrastructure to support Apple Pay because then it can achieve its own aims while keeping the consumers happy.
  • This would have the benefit of circumventing the fees charged by the credit companies as well as giving consumers and excellent user experience.
  • The consumer is king and there will always be alternatives where he can use whatever payment system he desires.
  • The sooner MCX realises that the financial well-being of its members depends on happy consumers, the better its chance of breaking Visa and MasterCard’s stranglehold on payments processing.

 

Amazon Echo – No Eureka.

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Amazon Echo does nothing to address the big issues.

  • As long as Echo is a great Bluetooth speaker it is unlikely to be nearly as big a disaster as the Fire phone.
  • Amazon has initiated its latest experiment with the consumer with the launch of the Amazon Echo which is basically a Bluetooth speaker with a brain.
  • This is a large (9.3” x 3.3”) cylindrical Bluetooth enabled speaker that has a digital personal assistant built in.
  • The voice controlled device can be used to answer questions, set alarms, check the news and play music.
  • The device is priced at $199 which puts it in line with other Bluetooth speakers such as the UE Boom, Jawbone Jambox and Bose Soundlink Mini.
  • However, all three of these companies have invested large amounts of money to work out how to make small units make a large amount of high quality sound.
  • The Echo is far larger than any of them meaning that it will have to deliver better sound at a higher volume to get reviewers excited.
  • Furthermore, the device has no battery as it is designed for in-home use which is likely to count against it when the reviews come in.
  • The idea here is to give consumers easy access to various aspects of their digital lives (media consumption, search and reference) via Amazon web services.
  • Like Google, the Echo does all of its thinking in the cloud making it almost infinitely upgradeable in terms of functionality over time.
  • However this is where the problems will start to occur.
  • The personal assistant functionality of Echo will only be as good as the systems that sit behind it and here Google is far better than anyone else’s.
  • Recent tests of Google, Siri and Cortana showed that Google was far better at interpreting the questions and coming up with useful answers than either Siri or Cortana.
  • I suspect that Echo will lag both Siri and Cortana as this kind of artificial intelligence takes a lot of money and a long time to develop.
  • Consequently, I think that the Amazon Echo will live or die by how well it fares when compared to other Bluetooth speakers in its price range.
  • The fact that it has no battery will count against it but if it has top notch quality sound, it might just see some volume.
  • Finally, it is totally unclear how this product links in with the rest of Amazon’s ecosystem and how it will make spending time with Amazon more fun and engaging.
  • I continue to think that Amazon continues to put the cart before the horse when it comes to its ecosystem strategy.
  • The ecosystem has to be fun and easy to use before one starts making hardware to run on it.
  • Furthermore, the hardware pieces must all work together seamlessly and add depth and functionality to the Digital Life offering.
  • Amazon’s hardware does none of this.
  • It looks like a random series of experiments where no real thought has gone into what the products are actually trying to achieve.
  • Until Amazon gets behind a cohesive and all-encompassing ecosystem strategy, hardware will continue to hamper an already incredibly fragile bottom line. 

Microsoft – Digital work land grab

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Microsoft moves to cement Office’s dominance.

  • Microsoft is moving to tighten its grip on the Digital Work ecosystem before anyone else can really get a decent foothold.
  • Digital Work is the professional equivalent of Digital Life and describes the digital activities undertaken by users in the workplace and is measured by the amount of time each user spends engaged in activity.
  • One of the pillars of the Microsoft ecosystem is the marriage of Digital Life and Digital Work in a seamless way.
  • Given its dominance of Digital Work, this is a proposition that only Microsoft can make and in my opinion is a key differentiator.
  • However, Microsoft must remain dominant in this space and this is what all of the recent moves have been about.
  • These moves include:
    • Microsoft has now made it possible to create and edit Office documents on iOS and Android even without an Office 365 subscription. Some advanced features are only available for paid Office 365 users but these are unlikely to be required by the majority looking to do basic editing.
    • Updating its Office offering such that Word, Excel and PowerPoint work much better on iPhone, iPad and Android and committing to further regular updates.
    • Offering Office 365 subscribers unlimited OneDrive cloud storage.
    • Doing a deal with Dropbox to tightly integrate its online storage service into Office.
  • I think that there is one motivation behind all of these moves.
  • I believe that Microsoft wants to make Office so accessible, easy to use and useful that no one can be bothered to use anything else.
  • I also think that at the end of the day, the vast majority of creation and editing of office documents is going to remain on a device equipped with a keyboard and a mouse.
  • Touch based editing is fine for small refinements and proof reading but it is very clumsy and painful for detailed editing and for long typing sessions.
  • Consequently, I think it unlikely that Microsoft is going to lose meaningful Office revenues due to these changes.
  • On the contrary, it might actually gain as users are introduced for free and when they need to do more in depth work, they are more likely to become paying users.
  • This also creates a disincentive to use the inferior Google Docs or Apple iWork.
  • Microsoft is breaking with traditions of its past an adopting the models that are currently working with success in the Internet which is an extremely good sign.
  • This reinforces my hopes that Nadella’s vision of Microsoft as an ecosystem company if filtering down to the rank and file and that execution will be quick.
  • There is still a lot to do but all the signs are there that something new is emerging in Redmond.
  • Microsoft remains one of favourite places to invest (alongside Google and Apple) in the digital ecosystem.

Apple – The price of success

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Apple joins long-suffering Microsoft as a target for viruses.

  • Apple has a difficult time ahead of it as I suspect that it is not best prepared to deal with the increasing number of attacks being aimed at its systems.
  • For years, Apple has been virus-free for no other reason than the hackers could not be bothered to write viruses to target such a small number of devices.
  • This has all changed with hundreds of millions of iOS devices in the hands of users and Apple’s dominance of the users that are worth hacking.
  • Hence it is of no surprise that a new virus targeted at iPhones and iPads has emerged.
  • The aim of the virus is still unclear but it is capable of stealing personal data and as well as causing other mischief.
  • The good news is that if the user sticks only to the tightly controlled Apple ecosystem and Apple’s own App. Store then iOS devices should be safe from infection.
  • It is only through using a source other than the App Store on a Mac that the virus can make its way onto iOS devices.
  • This is good news for Apple as it ensures that it has time to act while the hackers are trying to figure out a way of breaking into devices that remain only within the Apple ecosystem.
  • This is a much more difficult task as everything that is available on the App store has to be approved by Apple and checked for malware.
  • However, as Apple’s ecosystem continues to grow in size, it will become increasingly attractive for hackers.
  • Eventually, they will find the weaknesses in the system which has the potential to cause much greater embarrassment for Apple.
  • Currently, this is not a massive problem as only devices that stray outside of the tightly controlled ecosystem are going to be affected but Apple needs to act now.
  • The server based part of its ecosystem has already been shown to be vulnerable and I am certain that there are many other vulnerabilities.
  • This is a constant game of cat and mouse but for Apple to maintain its image as the safest place to be, it needs to act now and prevent intrusions that could do it some real damage.