Samsung – The slow subtle web

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Extending HomeSync is yet another strand of the web.

  • Samsung’s moves are subtle but taken together it is clear that Samsung is intending to build its own ecosystem to the detriment of Google.
  • The latest move is to allow its HomeSync media center to begin working with non-Samsung devices.
  • This could be a ploy to bolster poor sales by making the device appeal to more users but I think that there is a longer term game plan attached here.
  • This plan is to attract more and more users to Samsung services whether or not they use a Samsung device.
  • Samsung currently makes excellent margins on its hardware (especially smartphones) which will not be sustainable unless something changes.
  • Samsung has a brand, scale and hardware design advantage over much of its competition but devices are becoming more and more commoditised.
  • This forces differentiation into software and specifically into the ecosystem,  as the user experience and even applications are now pretty similar across the two main ecosystems.
  • This is why Samsung is spending a fortune on developing its own services such as ChatOn and on recruiting engineers like crazy in Silicon Valley.
  • The end result is likely to involve Samsung taking the Android code off in its own direction just as Amazon has done and as Nokia is rumoured to be contemplating.
  • This will be the opening shot in what I think will be the biggest battle in the technology industry over the next 3-5 years.
  • Forget Apple vs. Samsung. The real fight will be Google vs. Samsung as Samsung must remove Google from its devices if its margins are to stay above 10%.
  • Google is well aware of this and this is the only rational reason for it to hold onto the white elephant that is Motorola Mobility.
  • Motorola will provide a route to market for Google applications should Samsung cut it off.
  • This will be easier said than done as Google applications are currently the 2nd, 3rd, 4th, 5th and 6th most popular apps on US smartphones.
  • Hence, Samsung’s strategy is both slow burning and looks to be a long shot.
  • However, don’t forget how everyone laughed when Samsung said in 2004 that it would become the number 1 smartphone maker in the world.
  • Samsung is nothing if not patient.

2013 App Charts – Top of the Pops

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Twitter and Apple fare badly on smartphone usage.

  • The smartphone app. charts for 2013 are out (for the US anyway) and it makes interesting reading (Nielsen).
  • Smartphones in use are 52% Android and 41% iOS which is not a big surprise.
  • Given Apple’s recent surge with the iPhone 5s, I would expect the balance to move a bit towards iOS in early 2014.
  • On the App. front Facebook and Google rule the roost.
  • Facebook is top with 103m unique users in the US with Google applications taking up the next 5 (!) slots.
  • 7th is Instagram followed by Apple Maps in 8th position.
  • Twitter is a lowly tenth and saw its usage grow in 2013 by less than both Instagram and Apple Maps.
  • This is great news for both Google and Facebook as their businesses are dependent on usage in order to drive advertising revenues.
  • Given these figures, it looks certain that their revenues from mobile will again see healthy growth in 2014.
  • However, I am more concerned about Apple and Twitter.
  • I am not worried about Microsoft yet as it is still in the very early stages of trying to get itself into this space.
  • These figures closely match RFM research that found that Apple’s greatness comes from its ability to deliver third party apps. and services in a fun and easy to access way.
  • The user attachment to Apple’s own applications is far weaker.
  • The problem comes when the ecosystems are more mature and all apps. are available on all ecosystems to an equal level of quality.
  • How then does Apple differentiate itself and earn a high level of profitability?
  • I think that it doesn’t and as a result unless it develops hugely popular services of its own, is margins will begin to slip as its edge erodes.
  • Twitter also concerns me greatly.
  • This company has a market cap of $35.3bn with 2014 EV/Sales of 41.5x and yet only manages to register a lowly 10th when it comes to usage.
  • Facebook with the number 1 and number 7 slot is valued at 12.7x 2014 sales and looks to me to be far better value.
  • Twitter is growing revenues faster (51% over the next 2 years compared to Facebook at 26%) but that does not make it worth over 3x the multiple.
  • Furthermore, it does not have the usage and it is usage that generates advertising revenues.
  • I am comfortable that Twitter can grow revenues to $2bn, but beyond that it must look outside of its core microblogging universe.
  • That alone will keep it growing nicely until 2016 but at this valuation that is already more than priced into the shares.
  • I continue to value the shares at $22.76 and think that there is only one rational option for any investor with a hint of a fundamental bias.

Amazon – Prime target

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Amazon needs to restructure Amazon Prime.

  • Amazon has announced that its sales of Kindle products this year were the best ever but given last year’s shipments, that is not saying very much.
  • Amazon’s latest move to drive adoption of the Amazon Kindle Fire series is to allow payment by instalments.
  • Users pay 25% up front and the rest over a 90 day period interest free.
  • If users don’t pay, Amazon can semi-brick the tablet and render it almost useless as far as Amazon services are concerned.
  • I would assume that there is nothing to stop the device being re-flashed with standard Android but that would remove all of the functionality that makes the tablet interesting.
  • Amazon is clearly hoping that this will drive adoption but I think that Amazon is attacking the wrong problem.
  • Shipments of tablets are stronger than ever and Amazon is already at the cheap end of the spectrum. Price is not the problem.
  • The real problem as I see it is the way that Amazon Prime is structured.
  • The Amazon Prime service includes free shipping on all your shopping as well as access to a wide range of music, movies and TV shows via streaming.
  • This service costs $79 a year which for many users is quite a hefty price tag.
  • The only thing that sets the Amazon Kindle Fire series apart from the competition is the Amazon Prime services.
  • Hence, an Amazon Kindle Fire is really only a must have for an Amazon Prime customer.
  • I think that this is incredibly limiting as Amazon Prime only makes sense to the Amazon hard-core shoppers thanks to the free shipping that’s included in the package.
  • My latest estimate is that Amazon has around 17m Prime subscribers which is up about 70% YoY.
  • This is good growth, but in the ecosystem scheme of thing it is nothing.
  • Google is closing on 400m, Apple on 300m and even Microsoft is somewhere around 60m.
  • If Amazon wants to become a proper ecosystem, it needs to have a minimum of 100m subscribers and at this rate it will never get there before the race is done.
  • The problem as I see it is the tying together of free shipping and video streaming.
  • The free shipping forces Amazon to charge a high price and this is what keeps the user number low.
  • If it were to split the services into two separate packs (with maybe a small discount if one takes both), then the service that makes the Kindle Fire worth having could become much cheaper.
  • This I believe would be a much bigger driver for adoption than an instalment plan of payments.
  • Shipment volumes from the other players have shown that price is not the problem.
  • If Amazon were to offer a cheap media streaming service (without the free shipping) then I suspect that the shipments of the device would be much greater.
  • Until this happens, Amazon Kindle Fire is likely to continue disappointing, leaving the architects of Amazon’s strategy scratching their heads.
  • I like Amazon as an up comer in the ecosystem space but its valuation is already asking for way too much in terms of profitability that seems never to materialise.
  • I prefer Yahoo! or Microsoft.

 

Microsoft – Lose lose

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Making Windows Phone and RT free is pointless.

  • The latest notion to come from the re-organisation of Microsoft is the idea that reducing Windows Phone and Windows RT royalties to zero will somehow boost support for the platform.
  • I am sure that this idea has occurred to Microsoft but I think it very unlikely to ever see the light of day.
  • This is because it will not benefit the company or the platform and only increase the risk of pricing pressure on its core products.
  • I have two reasons for this view.
    • First. Windows Phone and Windows RT have no meaningful volume outside of Microsoft and Nokia.
    • Hence, if Windows Phone and Windows RT were to become free, it would benefit no one.
    • Second. No-one outside of Microsoft / Nokia wants to make Windows Phone or Windows RT devices.
    • Furthermore, this lack of OEM support for Windows Phone and Windows RT has nothing to do with price.
    • In the case of Windows Phone, no one supports it because supporting Windows Phone now means that one would become dependent on a competitor for one’s technology.
    • The long saga of Symbian clearly shows that a set up where a handset maker licenses its software to its competitors will fail no matter what precautions are taken to maintain independence.
    • In the case of Windows RT, no one supports it because consumers have universally shunned the platform and making devices based on it has only lead to massive losses. (see here)
    • This is why I suspect that the Nokia 2520 and Windows Surface 2 will be showcase products only and no real volumes will be manufactured. (see here).
    • These issues have nothing to do with price and therefore reducing the royalties to zero would in no way resolve them.
  • There is also added risk of reducing prices on software that is closely related to Windows 8.
  •  This would be a chink in the armour of Windows pricing that is been pretty firm for many years.
  • Microsoft has gone to great lengths to preserve its ability to charge royalties on the software it provides for mobile devices (see here).
  • There is no reason for it to change that as the result to me looks like a lose lose.

Snapchat – Reality check

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Snapchat is valued at $500m not $2bn-$3bn

  • A look at the regulatory filings strongly suggests that the current valuation of Snapchat is $500m not the $2bn-$3bn that is being thrown around.
  • The event of raising capital at Snapchat has led to an updated certificate of incorporation being filed.
  • Snapchat is affecting a series C round and is issuing 1.6m shares at $34.09.
  • Looking through the filing other facts are apparent.
  • Firstly, that the company is authorised to issue 98.07m shares of which 60.0m are common equity.
  • Secondly, that the company has carried out three rounds to date: a series A preferred, series A1 and a series B.
  • I am making two assumptions:
    • First: That these three rounds represent all of the equity issued to date.
    • Second:  That there are no options in issue. This is a big one and could lift my estimate of the share count by 20% easily.
  • Taking all of these facts together it is easy to see how people get confused.
  • Commentators have taken the series C round price of $34.09 and multiplied it by the total number of shares that the company is authorised to issue.
  • This gives $3bn for all the authorised shares and $2bn for just the common equity.
  • The key here is that authorised shares are not necessarily the number of shares that have been issued.
  • A company must seek permission from the shareholders to issue shares (the authorised share count) before actually issuing them.
  • They are not part of the capital of the company until they have actually been issued and paid for.
  • Hence, the value of Snapchat is in fact the price per share of series C ($34.09) multiplied by the number of shares that have been issued.
  • When one maps out the four rounds of fund raising, the numbers start to make sense. (see here for more details).
  • By my count shares in issue are 14,696,232 pre series C and 16,296,232 after series C.
  • This gives a pre money valuation of $500m and a post money valuation of $555m.
  • This is a much more reasonable valuation and is much closer to my own valuation of Snapchat of around $300m.
  • I suspect that the series C will also put an end to rumours of acquisition as the company should have enough money to begin the critical task of monetisation.
  • By my reckoning Coatue Management will end up with a 9.8% stake in Snapchat.
  • To see a return on this investment Snapchat will need to start showing some revenues as a $300m valuation for a company with 60m users (Q4 13E) and no revenues is pretty generous.

 

Nokia – Dance with the devil

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A switch to Android from Asha might just work.

  • It looks very much like Nokia has decided to participate in the race to the bottom and will be making low end Android devices.
  • However, where LG, HTC and Motorola will all fail, Nokia might just succeed.
  • This would be forked version of Android that Nokia maintains and looks after and would probably replace Asha over time.
  • This would have the huge advantage of opening Nokia low end devices to the enormous app. ecosystem but the also have disadvantage of a higher level of cost to maintain the code.
  • Effectively, Nokia will have to replicate the Android organisation inside Google and assume responsibility for every line of code in its Android handsets.
  • This is a level of cost that its competitors will not be incurring and so Nokia will have to make it up elsewhere.
  • This will be much more expensive than maintaining the Asha code line but as long as volumes are higher to compensate and the Nokia user experience improves, this should not be a problem.
  • At the ultra-low end of the market Nokia has talents that the other Android makers lack.
  • Back in the heydays of 2004-2008, Nokia regularly reported margins of over 20% on the cheapest devices it made.
  • It was able to do this through a combination of scale, platform, logistics and brand.
  • I believe that some of this heritage still lurks inside Nokia and it is this know-how that could allow Nokia to make a reasonable return on low-end Android where its competitors currently fail.
  • Using Android will allow Nokia to compete on a level playing field with other handset makers in this space but participating in the race to the bottom is risky.
  • No matter how good Nokia’s DNA is, almost everyone is losing money in low-end Android and this will keep a lid on any turnaround.
  • Hence, while this could be a move that solves one of the biggest problems of Asha (apps) it is not without risk.
  • It will take a herculean return to form to pull this off but it is not as dumb a move as it sounds.
  • It will be Microsoft that reaps the benefits or pays the price for this radical move as any impact on Nokia’ share price has already been crystallised.

Yahoo! – Eye off the ball

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Yahoo needs to stop shopping and get integrating.

  • Yahoo! is in line to make yet another acquisition but I am starting to wonder whether or not it has already shopped enough.
  • The latest target is imgur, a photo sharing site that has 100m users and a small amount of revenue.
  • Imgur is like Instagram in that it is a socialised way of editing and sharing pictures using a computer, tablet or smartphone.
  • This is not going to come cheap as the company is not in need of money, has a large number of users and even some revenues.
  • This would lead to me estimate that Yahoo! will have to pay somewhere around $300m for this business.
  • This is all well and good but why (other than the users) would Yahoo! want this website when it has Flickr?
  • Flickr has recently been revamped to offer a much better cloud photography experience and could easily be extended to offer the kind of experience that imgur offers.
  • The answer has to be the user base but this is only going to get Yahoo! so far.
  • Yahoo! has spent quite a lot of shareholder funds on acquiring a large number of start-ups but very little progress seems to have been made in developing these acquisitions.
  • Yahoo! now has one of the most extensive Digital Life offerings available but it remains very fragmented.
  • Single sign on, mobile, a consistent user experience and integration of user data remain a distant dream.
  • This is what is holding Yahoo! back rather than a shortage of assets.
  • This why I believe that the time has come to stop shopping and to get integrating and developing.
  • When the user experience becomes more consistent, more mobile friendly and more identifiable as a Yahoo! experience, then the value will really begin to be realised.
  • Unfortunately, at the moment Yahoo! seems bent and buying everything that it could possibly want and is only worrying about what to do with those assets at a later date.
  • I like Yahoo! as no-one is giving it any credit for a turnaround of its core businesses where I see real potential.
  • Instead the stock simply trades on the valuation of its stake in Alibaba.
  • This creates the potential for much more upside if Yahoo! can just stop buying companies and get on with developing the assets it already has.
  • Yahoo! remains one of my favoured ways to look at investing in the mobile ecosystem.

Motorola – Buying numbers

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The Moto G will be good for units but awful for profits.

  • Motorola is taking a leaf out of Nokia’s book but is taking the strategy one step too far.
  • Shipments of the Moto X have been very disappointing leaving Motorola with little option other than to give the hardware away.
  • With a 4.5”, 329ppi screen, a 1.2Ghz processor and a nice look and feel, the Moto G looks like a $400 device but it is going to be selling for $179.
  • Compromises have been made on wireless connectivity (No LTE), camera and audio quality and memory but the price point is so attractive that these are minor considerations.
  • At this price Motorola should see some volume which should help in its battle to recover market share that has halved in the last year. (see here).
  • The problem is profitability.
  • RFM research reveals that margins will be terrible which will do nothing to reverse the $200m of red ink that Motorola prints quarter in, quarter out.
  • Teardowns reveal that the device costs around $123 to build.
  • Add on 15% wholesale margin and 25% retail margin and the real cost to Motorola is somewhere around $177.
  • This is before any expenditure has been made on sales and marketing and before any R&D expenses have been amortised against the device.
  • I would expect at least another $20 per device of cost needs to be added to the income statement before a real measure of profitability can be obtained.
  • This leaves the device costing $197 but selling for $179 giving an EBIT and cash loss per device of $18 or EBIT margins of negative 10.1%.
  • Therefore if the Moto G is a success, I would expect Motorola’s margins to worsen not improve.
  • Of course if it were to sell 30m units, this would be a different story but I think that this is very unlikely.
  • Nokia’s case is quite different. Firstly, it does not sell the devices at such huge losses and secondly, it is far better at leveraging scale and platform to its advantage.
  • Hence, as volumes continue to ramp, I expect Nokia’s margins to gradually improve.
  • Why is Google throwing money away by continuing to support Motorola?
  • The only rational answer, other than engineering disease (see here), is insurance.
  • Samsung owns half the market for Google Android devices and I am convinced that when it is ready, it will take Android and the developers off in its own direction. (see here).
  • This will cut Google off from a market that this year will generate $4bn-5bn in advertising revenues.
  • Hence, it must maintain a route to market over which it has control in order to mitigate the risk that Samsung cuts it off.
  • I think that think that this is a question of when not if and this is the real reason why Google is prepared to squander vast amounts of shareholder money on Motorola.
  • This is likely to be the biggest battle in the technology industry over the next 3-5 years.

Nokia USA – Broken curse

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The curse of the US market looks to have been broken.

  • Figures for the US smartphone market show that Nokia looks to have finally broken the market share curse that has plagued it since the days of TDMA.
  • Figures from Counterpoint (see here) show that Nokia’s market share has increased massively both YoY and QoQ.
  • Nokia now stands at 4.1% US smartphone market share compared to 1.4% in Q2 13 and 0.7% in Q3 12.
  • The losers have been Motorola, LG and BlackBerry.
  • Nokia has released a lot of models into the US market but I suspect that this is not the reason for the gains.
  • Quite simply the Lumia 520 ($175 unsubsidised) offers fantastic value for money and undercuts its competitors (with the same specification) by at least 20%.
  • Nokia’s re-emergence in the US market has been all about having a decent phone at a cracking price and the desire of the operators to have a third ecosystem.
  • With Apple and Samsung jointly tied in first place at 33.7% each, the US market has become a duopoly which is terrible news for the operators.
  • The rise of the iPhone has created a systematic loss of bargaining and brand power for the operators which has led them to welcome Nokia back with open arms.
  • This combined with the great value that the device offers is what has driven the resurgence witnessed in the US market.
  • However, Nokia and Microsoft’s job is far from done.
  • People are not buying Windows Phone because they love the experience.
  • They are buying it because it is cheap.
  • This is a great way to seed the market but much more needs to be done.
  • The Windows Phone offers a good experience and Microsoft services are of high quality and offer good coverage of Digital Life.
  • Microsoft needs to let Android users know about this and explain to them why they should buy a Windows Phone.
  • To date, all it has done is to let them know that it exists.
  • This requires a huge change in the marketing strategy as well as total overhaul of the retail experience.
  • When this is done, then I can believe that Windows Phone can really claim its rightful place as number three with market share of 20%.
  • Until then it will remain the champion of the cheap and cheerful.
  • This is great for headlines such as these but lousy for profits.