Facebook Q3 – See Saw economics

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There are signs of stability that Wall Street will over interpret.

  • Facebook comfortably beat forecasts but comments around usage and limiting the degree of monetisation caused a 15% reversal in the share price after hours.
  • Q3 revenues / EPS were $2.02bn / $0.25 compared to forecasts of $1.91bn / $0.19.
  • Mobile revenues were very strong at $880m (49% of advertising revs) matching the fact that 48% of users now access the service via a mobile device.
  • Advertising revenues growth was 66% YoY driven by a 16% increase in impressions and a 42% increase in price per ad.
  • This is a strong indication of the improvements that Facebook has made in the quality and relevance of its advertising placements.
  • However, the slower growth in ad impressions themselves and the stabilising user ad usage metrics are signs that growth is likely to moderate from the heady 66% seen this quarter.
  • This will be further exacerbated by the sensible decision not to lace the news feeds with more ads.
  • This is very important for the user experience but it will have the effect of slowing growth further as the inventory for sale will now be stable.
  • This is not new news and indeed the company discussed this issue on its call last quarter.
  • This is what is what will drag down expectations but it is worth remembering that online advertising still has a long way to go.
  • For example, people spend more time consuming digital services than they do watching television but it is still only a fraction of the advertising budget.
  • Hence, I think that there is still plenty of growth to be had from the migration of advertising spend to online media and services.
  • However, it is not going to be anything like the kind of growth we have seen this year.
  • It looks to me that estimates are going to begin coming down for 2014 and that’s where I see the opportunity as the chances are they will come down way too far.
  • Wall Street is very fickle in its loves and loathes and I would wait for all the disappointment to set in before attempting a second bite of the apple.

 

BlackBerry BBM – Last hurrah?

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A big bump up but still a long way to go.

  • BlackBerry has gained 20m BBM subscribers in the last week after making the service available on iOS or Android.
  • This has taken the number of BBM subscribers to 80m which is a nice bump up but still a very long way adrift of the competition.
  • This is all well and good but 80m still remains well adrift of the leaders in this space (see here) and it is unknown how many will now abandon their BlackBerries.
  • (I fear that Blackberry device usage will now plummet).
  • BBM is the only service that BlackBerry offers that still has any degree of user traction of loyalty.
  • E-mail, browsing, gaming, social networking, contacts, calendar etc. are now at least as good and in many cases far better on competing platforms.
  • BBM offers a superb user experience as the clients exist within a VPN meaning fast device to device communication, reliable presence information as well as security.
  • The problem is that these services are offered for free by most vendors and anyone who thinks that they will be able to charge a subscription for basic service has a rude shock coming.
  • Hence, the only way to really monetise IM is through selling media (like LINE’s stickers) or by learning about the user and then monetising that traffic through advertising.
  • Instant Messaging is an important but small part of a consumer’s Digital Life and therefore I believe that the revenue opportunity from advertising as just an instant message vendor is limited.
  • Where this makes more sense is to provide instant messaging as part of a series of services like Google Talk, iMessage or Yahoo! messenger.
  • This is why I see massive consolidation in this space.
  • Unless the IM plays can find ways to earn a decent revenue stream on their own, they are likely to be gobbled up by the larger ecosystem players.
  • The only one that seems to be close to this goal is LINE which reported good revenues earlier this week.
  • Most of this is due to user’s willingness to buy cutsie avatars that they can then send to their friends rather than a silver bullet for monetising IM.
  • This is also why I suspect BlackBerry has been seen meeting with Facebook.
  • The only part of BlackBerry that Facebook could realistically want would be BBM as it would help Facebook to expand beyond simple social networking.
  • Facebook could conceivably want the patent portfolio but given it has no hardware, I think this is a long shot.
  • Either way, BBM remains a minnow in this space and I can’t see this business being worth much more than $200m to a large ecosystem player.
  • I am expecting Fairfax to heavily adjust downwards its offer for BlackBerry following its due diligence.
  • Something around $6.32 looks more realistic.
  • With the share price at $8.3, there is only one rational action to take.

Apple Q4 – New life needed

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Growth from here needs another segment.

  • Apple reported good Q4 results but concerns around competition and profitability caused weakness in after-hours trading.
  • Revenues / EPS were $37.47bn / $8.26 which was better than consensus at $36.84bn and $7.93.
  • Q4 shipment numbers / ASPs were:
    • iPhone: 33.8m ahead of consensus at 33.4m but ASPs were soft, falling to $577 with the shift to older and cheaper models.
    • iPad: 14.1m slightly ahead of consensus at 13.9m with ASPs stable at $439. This gives some hope that the mix between the regular iPad and the mini may have stabilised. However this may lurch southwards again with the launch of the iPad mini with the retina display.
    • iMac: 4.57m which was ahead of consensus, pointing to some small back-to-school effect this year.
  • Q1 guidance was mixed with:
    • Revenues $55bn-$58bn compared to consensus at $55.5bn
    • Gross margin 36.5% to 37.5% below consensus at 38.5%.
  • Mid-point of the guidance gives an implied EPS forecast of $13.51 which is below the $13.86 consensus estimate.
  • This is entirely due to the gross margin guidance and this is where the real concerns were to be found.
  • However the gross margin miss was entirely due to a change in the way the company defers revenues on iPhone, iPad and Macs.
  • This is due to the fact that the software updates on these devices are provided free of charge and that the ASPs of the devices implicitly include software.
  • Hence some of the revenues need to be deferred to match the costs incurred in updating the software over the life of the device.
  • If one takes out this change, gross margin guidance would have been around 38.5%, which is in line with consensus.
  • It was this issue that caused the recovery in the share price in after-hours trading after its sudden collapse.
  • The problem that Apple faces is that it needs to address new segments in order see a proper return to growth.
  • I detect some disappointment that this has still not happened meaning that the shares are likely to drift around current levels until that happens.
  • I remain pretty indifferent to Apple as there remains no catalyst and I am worried about its own service offering to consumers.
  • Yahoo! and Microsoft are the places to be when looking for those that might surprise on the upside.

 

 

 

 

 

 

Instant Messaging – The realm of conjecture

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Valuations in this segment are reaching nose bleed territory.

  • Just four months ago Snapchat closed a series B round of $60m with a valuation of $860m (post money).
  • Institutional Venture Partners and its co-investors will be smiling this morning as talks are being held with regard to selling a much larger stake to a strategic industry investor probably from Asia.
  • The valuation being discussed could be as high as $3.6bn which I suspect is being partly driven by Pinterest’s recent raising of $225m at a valuation of $3.8bn.
  • Snapchat is not even close to being the largest player in this field as I estimate its 250m users put it in 3rd or 4th place globally.
  • WeChat currently leads the field with 460m users then WhatsApp at around 400m. Third and fourth is shared between LINE and Snapchat at around 250m each.
  • Then comes Samsung ChatOn, Google Talk and KakaoTalk at around 100m each.
  • Finally there is BlackBerry BBM which has not grown for a year and is languishing at 75m although the usage of the service is very high.
  • A $4bn price tag for a company that has virtually no revenues is a sky high valuation and both Pinterest and Snapchat are guilty of having this problem.
  • This feels an awful like the gold rush of 1999 and 2000 and I do not want to be around when he enthusiasm runs out.
  • To give Snapchat credit, I believe that it is fully aware of this issue and I see it moving very quickly to monetise as well as expand its service into adjacent areas.
  • However, until it can generate some meaningful and growing revenues, the real value of the company is going to remain in the realm of conjecture.
  • There are many instant messaging services, (albeit each being slightly different), that I suspect that there will be a race to the bottom.
  • This means that the realistic price that one can charge for this service will end up being zero meaning that revenue will have to be made by monetising the traffic through advertising.
  • Of all of these services, the one that looks the most robust is LINE which already has a growing revenue stream and has managed to convince users to pay up for its cutsie cartoon stickers.
  • There is certainly a strategic value to be had from owning an instant messaging service but one needs to work out how to earn a decent return on investment before jumping in.

Microsoft and Amazon – 2 for 2

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Microsoft and Amazon both had good nights on Thursday.

  • Amazon posted fantastic sales but lousy profitability while Microsoft was bailed out by enterprise once again.

Amazon

  • Amazon reported Q3 revenues / EPS of $17.1bn / LOSS $0.09 compared to consensus at $16.7bn / LOSS $0.09.
  • Guidance was very wide with revenues of $23.5bn-$26.5bn and EBIT of LOSS $500m to $500m forecasts. Consensus has revenues at $25.89bn.
  • This is a great sign for a good Q4 which much of the technology industry badly needs but profitability continues to drag.
  • The promise of Amazon is that one day costs will stop rising and the company will actually show a profit as sales continue to expand.
  • There was no sign of this is quarter as margins remained pressured by the continued investments in logistics.
  • Amazon Prime saw good growth in subscribers with “millions of new subscribers added” but the company stopped short of mentioning how many it has.
  • Given, the $79 fee, I suspect that the subscribers are probably somewhere around 10m.
  • This is great for user loyalty but the numbers are way too low if the company wants to become a proper ecosystem.
  • Apple and Google have somewhere around 300m each meaning that Amazon will have to change the way Prime works if it wants to be relevant in the ecosystem world. (see here).
  • The essential problem is that picking, packing and shipping is a variable cost meaning that as revenues rise, costs also rise.
  • For the shareholder, this is no good at all as the company badly needs to see some operating leverage to fulfil its promises and justify its valuation.
  • I remain pretty lukewarm on Amazon as I don’t like paying for promises that are yet to be kept.

Microsoft

  • Microsoft reported Q1 revenues / EPS of $18.53bn / $0.62 that beat forecasts of $17.79bn / $0.54.
  • Commercial products and services was the real driver of revenues and more than made up for the weakness in consumer products where sales fell by 7.4%.
  • Surface also fared better than expected generating revenues of around $400m.
  • I would estimate that this equates to around 1m units and is double what the company shipped last quarter.
  • This was a result if the very heavy price cuts that Microsoft has put through to try and shift the unwanted inventory.
  • With the new product launched, prices have gone back up again and the older product is now obsolete.
  • Hence, I would expect that this quarter will show another disappointment.
  • There was no real guidance but Microsoft indicated that Q2 revenues would probably be greater than the $21.1bn consensus estimate.
  • Things are looking better for the next quarter and beyond as PC declines are slowing meaning that continued strength from the corporate sector should start to affect the figures to a greater degree.
  • Microsoft remains good value for the investor and offers the only real alternative ecosystem to Google or Apple.
  • Yahoo! and Microsoft remain the only stocks to look at when investing in ecosystems.

 

Vertical industry – Monkey business

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Qualcomm and MediaTek have at least one hurrah left.

  • In the latest twist, Samsung and Corning have tidied up the shareholding around the j.v. Samsung Corning Precision Materials with Corning buying Samsung’s 43% stake.
  • In return Samsung becomes a 7.4% shareholder in Corning which comes with a long term supply agreement lasting until 2023.
  • This agreement is almost all about the supply of Gorilla glass which used in most high end smartphones and tablets made by Samsung’s competitors.
  • This will cause the eyebrows of those competitors to rise who will of course be wondering about whether Corning will be treating them fairly now that Samsung owns a stake in the company.
  • I have no such fear. Samsung owns a small stake and is the result of Corning taking full control of the joint venture.
  • However, this further underlines a recent trend in the technology industry that we have not seen for nearly 20 years.
  • This is the virtualisation of technology companies.
  • When PCs and handsets first appeared, the manufacturers made the components, the devices and wrote the software.
  • As technology became more and more expensive to develop and the market became more competitive it made sense to outsource that development.
  • This meant that technology only had to be developed once lowering the costs for all and the barriers to entry.
  • Intel, Microsoft, Qualcomm, ARM and MediaTek are all great examples of companies that benefitted from technology outsourcing.
  • The recent success of Apple has changed all of that.
  • Apple has always been vertically integrated and now everyone is following suit.
  • These days software is by far the most critical piece and control of that software is a key to long term success.
  • Vertical integration allows hardware and software to be optimised such that they work perfectly together and hence deliver a better user experience.
  • This is great but it is much more expensive to develop.
  • As long as one has high market share, high volume and high margins this will work.
  • The smartphone market is a good example of this as it has become exceedingly concentrated with Apple and Samsung earning more than 100% of industry profits.
  • I suspect that this is not going to last.
  • The market is slowing which means that competition will increase.
  • Handsets will need to become more differentiated from each other and the number of models to adequately address the market is also likely to rise.
  • This will leave the industry searching for more efficient ways of developing technology to mitigate rising costs.
  • This leads straight back to the horizontal model.
  • In the short term, the vertical trend is likely to continue meaning that the addressable market for Qualcomm and MediaTek may start to shrink as insourcing of chips gathers pace.
  • However, I doubt that it will last and when horizontalisation returns, these two will outgrow a slowing market.
  • That’s when they become exciting once again but for now there may be bumps along the road as they suffer from insourcing.

 

 

 

Apple – Home protection

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Apple’s launches will keep share, nothing more.

  • Apple stayed within the boundaries of the rumour machine yesterday in refreshing its line-up but not venturing anywhere off the beaten track.
  • Top of the bill were the two new iPads.
  • The iPad Air which is much lighter than its predecessor at 450g and takes the device realistically into the one-hand category.
  • This really improves its appeal for reading, watching or any activity where you would hold the device in one hand for an extended period.
  • The iPad Mini received the upgrade that has been long needed and added the retina screen.
  • Both devices carry the new A7 64 bit chip which will help with both raw power and also with battery life.
  • Apple is using these upgrades to keep its pricing high which the market appears willing to bear given the improvements that have been made.
  • This is a good sign for gross margins in an increasingly competitive market.
  • MacBook Pro 13 and 15 inch versions were also upgraded with Haswell processors which should have a profound effect on battery life.
  • The biggest surprise was the new version of OS X, Mavericks, which is being made available as a free upgrade.
  • The Microsoft bears will see this as a move to collapse the value being attributed to the OS in the computing world but I suspect the real answer is much simpler.
  • Making people pay even a small amount, for an upgrade slows the adoption of a new OS.
  • This means that one has a larger number of devices hanging around running old software which needs to be supported by Apple and by developers.
  • Making the software free will mean that users update much more quickly and that older versions of the OS disappear.
  • This will make life for developers easier and cheaper and Apple can remove support for older versions more quickly.
  • This is what I suspect lies behind this move rather than any Machiavellian plot to put Microsoft out of business.
  • Apple’s market share in computers (iPads are NOT computers) has been flat for some time giving it no real ability to have a real impact here.
  • The end result was a product update that should help keep market share and gross margins steady.
  • This will provide some support to the share price but is not what is needed to spur a real recovery in the shares.

 

BlackBerry – Counting beans

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Going private at $4.7bn is the absolute best case.

  • The bean counters are out in force, and with Fairfax’s deadline approaching everyone is trying to work out what BlackBerry is actually worth.
  • The assets for consideration are:
    • The device business
    • The service business
    • BlackBerry Messenger
    • The patent portfolio
    • $2.6bn in cash.
  • It is consensus that the device business is worth zero but I think it could actually be worth less than that.
  • BlackBerry 10 has been an unmitigated disaster and the BB7 devices are now so dated as not to be fit for purpose.
  • I am assuming that this business is closed down or at best given away with a chunk of cash to give anyone, brave enough to take it on, time to turn it around.
  • Either way, to a BlackBerry shareholder this part of the business is worth negative $1bn.
  • The service business is in similar trouble as it is based on BlackBerry subscribers.
    • Firstly, there are many competitors and the price for this kind of service is rapidly approaching zero.
    • Secondly, if the device business is dead then the service business is probably, also dead.
  • If I assume that in three years revenues hit zero then this business is worth $500m best case if it is managed for cash.
  • BlackBerry messenger is a crown jewel but it is rapidly being overhauled by Line, WhatsApp, WeChat and so on.
  • Their subscriber growth is extremely high whereas BBM has been static for over a year.
  • On that basis I am only going to pay a fraction of the valuation for BBM if I buy it as a stand-alone business.
  • Hence I would value BBM at around $200m.
  • The patent portfolio is not nearly as valuable as anyone thinks.
  • This is because:
    • The timing is wrong. The perfect storm of 2011 created a bubble for patent valuation that is unlikely to ever be seen again.
    • BlackBerry’s patents are not very fundamental to the applicable technologies.
    • It has some essential patents but these came from second line creators of technology and are already heavily encumbered.
    • BlackBerry is a distressed seller which will have a fundamental and negative impact on the price paid.
  • Consensus is using historic deals to make its assumptions of up to $3bn which for the above reasons, I believe is fundamentally flawed.
  • Hence, I am valuing the patent portfolio at $1bn.
  • When I add this lot up I arrive at a valuation for BlackBerry of $3.3bn in the best instance.
  • My gut says that the real value could be well below this as I may have been overly generous on both BBM and the service business.
  • This is equivalent to $6.32 per share.
  • With the share price at $8.25, there is only one option for anyone unlucky enough to be still holding the stock.

 

Nokia World – Good News. Bad News

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I expect a good launch event, with one glaring exception.

  • Nokia is holding its annual Nokia World event in Abu Dhabi this week.
  • This is the event where Nokia gets together with the developers to keep them informed and enthusiastic about developing software for its products.
  • Tomorrow is expected to see the launch of a range of devices, among them a Windows RT tablet.
  • First the good stuff I am expecting to be launched:
  • Nokia Lumia 1520.
    • I expect this to have a 6-inch 1080p screen, 2.2Ghz Snapdragon processor and a 20MP pure-view camera.
    • This is an answer to the phablet segment that Samsung has created and done very well from, partly due to Apple’s disinclination to participate.
    • For me, this will be a welcome addition to the line-up and if Nokia can get users excited about the prospect of Windows Phone, then it could do very well.
  • Nokia Lumia 1320.  
    • This looks like it will be a successor of the Lumia 625 which has not done too well due to its relatively high price compared to its hardware specification.
    • This version will offer roughly the same specification but critically at a much lower price.
  • Nokia Lumia 525
    • This looks to be an update of the 520 which has driven a very large proportion of Nokia’s shipments and revenues in smartphones over the last two quarters.
    • I suspect that the specification will not have changed too much although I expect that the software has been enhanced and extra services added.
    • Hence, I suspect that this will be very aggressively priced in order to help drive adoption of the platform.
  • Nokia Asha 500, 502 and 503.
    • These updates to the Nokia Asha range will all be full-faced touch devices with different combinations of dual SIM and 3G.
    • This will give a spread of price points and address as many users as possible.
    • This is a tough place at the moment with the market flooded with super cheap, but poor quality Android products.
    • However, none of these companies seem to be making any money and at some point I would expect the market to become more rational.
    • With its understanding of product platforms and logistics, Nokia is well positioned to be a long term player in this market.
  • Now the bad.
  • Nokia Lumia 2520
    • This is a 10.1 inch tablet with a full HD 1080p display and a Qualcomm Snapdragon 800 chipset.
    • It will also feature 4G connectivity and standard resolution front and rear facing cameras.
    • The hardware looks fine but the device will be running Windows 8.1 RT
    • This single feature alone is likely to ensure that no-one buys this device. (see here)
    • Windows RT has already cost Microsoft billions of dollars in wasted development expenses and massive inventory write offs.
    • There is every sign that history will again repeat itself with its awful Windows Surface 2.
    • The market has spoken on Windows RT and it does not want it.
    • The message is so clear that all of the OEMs have stopped supporting the platform.
    • Why will a Nokia tablet be any different?
    • The answer is that it won’t and I can only hope that this device is merely lip service being paid to its new owner.
    • If the device is just for show, then commitments will be tiny and the losses racked up on its behalf, thankfully small.
    • I am pretty sure that this is the case as the management of the device business are pretty pragmatic and sensible in my experience.
    • Hence, while it looks bad on the surface, the reality is that the financial hit will be small and it will keep its new owner happy.
  • Net net, I am expecting a good reception to these devices as they update and expand the offering in a sensible and market relevant manner.
  • The stock is unlikely to move meaningfully in any direction now that the biggest unknown has been quantified.

 

 

Google Q3 – Strength to strength

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Good results mask corporate governance shortcomings.

  • Google reported good Q3 results as market share inched up and its new ways of attracting advertisers gained traction.
  • Q3 Revenues (ex-TAC) / EPS were $11.92bn / $10.74 beating estimates of $11.64bn and $10.36.
  • Growth was particularly strong on Google properties which saw 22% YoY growth to $9.4bn.
  • This was offset by flat advertising revenue from third party websites as the emphasis remains very much on driving traffic to its own sites.
  • In addition, a great user experience is becoming critical for Google as it is only on its own sites and with its own experiences that Google really learns about its users.
  • Long-term this is where the value really lies as that knowledge is very valuable to advertisers keen to target users with valuable information rather than be a pest.
  • Other revenue was up 85% YoY and 18% QoQ to $1.2bn driven mostly by sales of apps and content from Google Play.
  • Motorola recorded yet another thumping loss of around $200m on revenues of $1.2bn further underlining the fact that Moto X hardly seems to be flying off the shelves.
  • To me, Motorola is nothing more than a very expensive insurance policy.
  • When Samsung cuts off Google’s route for its apps to the mobile user, Google will still have Motorola with which to reach the market.
  • This is essential for Google to keep its ecosystem going but at a purchase price of $6.3bn (assuming patents are worth $6bn) and $200m a quarter it is expensive insurance.
  • Combine this with Google’s frivolous attitude to shareholder’s money and one has a governance nightmare.
  • Unfortunately, shareholders have no say in the running of the company as control remains firmly in the hands of the founders despite the economic risk being largely taken by others.
  • However, at the moment they do not seem to care as the core business is going very well and the shares are performing nicely.
  • This was underlined by a mighty cash flow performance with $5.1bn coming in from operations and $2.8bn in free cash flow.
  • The advertising business is now so large that Google needs to look to other areas in order to keep its momentum going.
  • Here it is targeting hardware such as tablets and Chromebooks, content (Google Play) and enterprise.
  • These are all moves in the right direction but at the moment, they remain very small in terms of their ability to have an impact on group revenues.
  • Google remains an excellent company, leading in its field and not nearly as expensive as some of its racer, social networking oriented peers.
  • That being said when I have deducted slower pace of growth and awful corporate governance I end up remaining pretty indifferent to owning the stock.