Apple – Shopping trip

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Digital Life services are what Apple needs to secure its future.  

  • Next week sees Apple host its overhyped WWDC developer’s conference in Silicon Valley.
  • It is at this conference that Apple typically launches its software innovations leaving devices for other events.
  • Hype has focused around wearables, health and smart home but none of these are likely to do anything for Apple in the immediate term.
  • Wearable are a solution looking for a problem (see here) and unless Apple has come up with a use case that suddenly makes these devices a must-have, demand is likely to remain very soft.
  • Health (see here) is likely to remain hobbled by the lack of unobtrusive and reliable sensing devices and smart home looks like nothing more than a certification procedure for devices to work with iOS.
  • What I am looking for from Apple are moves to address its very weak Digital Life offering.
  • Apple is brilliant at delivering the apps and services of third parties onto its devices but its home grown services are very limited in scope and are often substandard.
  • Apps and services are not part of Apple’s core strength and this is why I suspect the Beats is the first of many M&A deals over the next few years.
  • The fit with Beats is quite good in that headphones expand its hardware reach and the streaming music service is complimentary to iTunes
  • However, Apple has to offer much more of its own services to users if it wants to preserve its edge and maintain its very high margin in a rapidly commoditising industry.
  • Apple has struggled to create many of these services itself and this is why I can see it repeating Yahoo!’s strategy of growing its way around the Digital Life pie by acquisition.
  • I am hopeful that Apple will be able to do a better job than Yahoo!
  • I am still waiting for a coherent and integrated offering from Yahoo! for mobile devices.
  • Unless the market chatter has got it wrong, WWDC is shaping up to be a pretty boring event with very little launched that will actually drive Apple’s top and bottom lines any time soon.

 

Mobile Health – Carts and horses

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The realisation of this dream is years away.  

  • Samsung held an event in San Francisco where it elaborated on its ambitions for mobile health.
  • The timing of this event is very convenient with Apple’s developer conference due to kick off next week were a foray into mobile health is expected to be launched.
  • Two main ideas were launched:
    • First: Simband. This is a concept device into which sensors will be embedded to offer monitoring of heart rate, stress levels, blood glucose, blood pressure, oxygenation and so on.
    • The device is not a Samsung-only device but also aims to embed sensors from other companies in order to maximise the capabilities of the device.
    • Second: Sami. This is a cloud based offering where all the data is collected, stored and analysed.
    • Sami is where the services that bring the device alive will be offered and offers Samsung an opportunity to get some traction as a provider of digital services.
  • I have long believed that the case for this type of monitoring is very strong as it will be able to have a significant impact on healthcare costs which is becoming a critical problem in economies with ageing populations.
  • However, the biggest problem is the sensors themselves.
  • To offer this kind of monitoring, large amounts of clunky equipment have to be attached to the patient and I suspect that it is going to be a very long time before sensors are sufficiently small, reliable and unobtrusive enough to be constantly worn.
  • Even the simplest biometric data such as the heartbeat cannot be reliably monitored in a device that’s simple and unobtrusive to wear.
  • This is why the Samsung Gear Fit and the Galaxy S5 will only take the users pulse at a specific time. They will not monitor it over an extended period.
  • This is because the laser technology used to monitor the heart rate is notoriously unreliable.
  • This shortcoming basically ensures that the launch of cloud platforms and apps to track a user’s vital signs is putting the cart before the horse.
  • Users are not about to start manually entering all their data into an application and because there will be no continuous monitoring; the idea currently has no value.
  • This is why the most interesting area of this part of the tech industry is in the development of the sensors such that they are capable of fulfilling this dream.
  • Here Samsung is very well placed as the DNA of the entire company is based on making other company’s ideas better, smaller and cheaper.
  • How to monitor these vital signs is well known but doing so in an unobtrusive and reliable way is still pretty far away.
  • Hence, I am expecting a lot of noise in this area this year but very little substance.
  • This is a great area for Samsung but it will never offset the large decline in handset profitability that RFM sees coming in the next four years (see here).
  • Hence, RFM expects earnings to decline for 4 years and thinks that holdings should be reduced to finance increased positions in Google.

LG G3 – Deadly race

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The G3 will enrich Google, no one else. 

  • LG has released another update to its flagship that will ensure that competition in Android will be faster, harder and more painful.
  • The G3 has a 2.5Ghz Snapdragon 801, a 5.5” quad-HD display with 538ppi, 13mp camera, Image stabiliser, dual flash and so on and so on.
  • It is a worthy competitor to the Galaxy S5 and the HTC One M8.
  • Thanks to its deal with Google (see Samsung & Google – Gorilla War), the Galaxy S5 has shipped without Samsung’s ecosystem meaning that it too really only competes on specification with its rivals.
  • It is here that the problem becomes obvious.
  • These devices compete against each other almost solely on hardware specification creating a deadly race to the bottom in terms of device price.
  • This will ensure that unless volumes are massive, profits will remain very low.
  • The Android market remains a brutal cutthroat environment where no one is going to make a decent return unless it can get a market share in the smartphone market of more than 10%.
  • This means annual volumes in excess of 110m units and only Samsung is shipping more than that number.
  • Hence, profitability in this market is likely to remain dire with 3-4% operating margins in the best instance.
  • Samsung should see good profitability this year but this is going to start to rapidly erode as it has ceded all its ecosystem ambitions to Google. (see Samsung & Google – Gorilla War)
  • The only real winner from this launch and the Android market is Google which through its influence has ensured that its ecosystem, and only its ecosystem, will be available on the best specified devices offered to users at the cheapest price.
  • This is why RFM forecasts that Google will earn $6.1bn in revenues from Android devices this year growing to $11.6bn in 2017E.
  • The Android makers are busy fighting each other for share but it is Google that is really bleeding them dry of profitability.
  • Google remains the only stock one should look at in Android and holdings in any Android handset maker should be sold off to finance a position increase in Google.

 

 

 

Research Publication – Samsung & Google – Gorilla War.

MAY 27th 2014: Radio Free Mobile deepens its flagship research product with the publication of: Samsung & Google – Gorilla War – An in depth analysis of the Google/Android ecosystem.

Google vs Smasung Cover

There is no money in Android. The value is in the ecosystems that sit on top of it. Samsung has mistakenly assumed that it can maintain its 18% handset margins by focusing on hardware. Consequently, it has been willing to cede complete control of the ecosystem to Google. This has ensured that Google will grow nicely driven by mobile advertising revenues while Samsung experiences declining earnings. RFM believes that holdings in Google should be increased, financed by holdings in Samsung.

  • Android. No one except for Samsung makes good money in Android devices. Samsung has hardware differentiation, scale and brand but commoditisation will take its toll. Without scale or an edge in components or the ecosystem, an Android handset maker can hope for 3-5% EBIT margins in the best instance.
  • Gorillas The two Gorillas in Android have been squaring off against each other for some time. Samsung’s move to customise the Android user experience and to offer its own Digital Life services in competition to Google puts Google’s revenues at risk. At the same time, Samsung has to move in this direction in order preserve handset differentiation from where a good part of its profits are derived.
  • Guerrillas. The result has been a deteriorating relationship between the two over the last year. Recently, Google has been able to take advantage of indecision and conflict within Samsung to ensure its long term goals. The agreement of 27th January 2014 was really about the ecosystem and in the clandestine war; Google has by skill or by luck won a crushing victory against Samsung.
  • Samsung. Samsung is a great company. It holds global leadership positions in handsets, memory, TVs and display panels. Handsets earn 18% EBIT margins and make up 70% of group EBIT. Ceding the ecosystem to Google and getting virtually nothing in return has all but guaranteed handset margins will decline over the next 4 years. Handset EBIT is so big that its decline will overwhelm growth elsewhere, leading to a contraction of earnings in the medium term. This is why RFM believes that there is 16% downside to the share price.
  • Google. Mobile is the engine of growth at Google which is why it had to be secured at all costs. With Samsung out of its ecosystem, Google should now grow steadily over the medium term. Even with a hefty discount applied for shortcomings in corporate governance, RFM still sees 15% upside in Google shares. 

Click here for full summary and purchase options

 

HPQ Q2A– Slash and burn.

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No strategy means no recovery.

  • Hewlett Packard reported Q2 14A results earlier than expected as it announced another 11,000-16,000 jobs are to go on top of the 34,000 already announced.
  • Revenues and EPS were $27.3bn / $0.88 compared to estimates of $27.4bn / $0.88.
  • This is the second quarter of flat YoY revenues which is reasonable performance given the weakness in the PC market but it is not enough.
  • HPQ wants to become a growth company again and in this vein it has decided to trim another 11,000-16,000 jobs.
  • This will have the effect of providing a one-time boost to EPS as costs fall but cutting resources also runs the risk of reducing revenues.
  • The problem with HPQ is very simple:
  • The company wants to grow but has absolutely no idea how it is going to achieve that.
  • Cutting more jobs is not the answer and looks to me to be a knee jerk reaction in response to shareholder demands for management action.
  • HPQ has some good businesses but they need to be updated so that they can evolve with the changing needs of the market.
  • Unfortunately HPQ seems to have no idea what to do and is standing paralysed in the headlights of a changing market.
  • Leo Apotheker had many faults but at least he had a strategy for where HPQ needed to go to find growth.
  • HPQ’s competitors are not standing still and there are very real risks that market share is lost as nimble and ambitious competitors take ever larger bites out of HPQ.
  • Meg has stabilised the ship but now she must decide upon an ambitious strategy to take HPQ forward.
  • Without a strategy, HPQ will start to lose market share causing revenue declines over time.
  • The time to decide is now as slash and burn will not provide growth.
  • Until there is some decisiveness from management, all the risk in the shares is to the downside.

 

 

Lenovo Q4A– The thin red line.

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Lenovo can only just afford its strategy

  • Lenovo reported reasonable Q4 14A results but the addition of Motorola will almost tip Lenovo into the red.
  • Q4 14A Revenues / Net Income were $9.4bn / $158.3m compared to forecasts of $9.0bn / $163.6m.
  • On a YoY basis the results look much better with revenue up 19%, and EBIT up 28% but it is clear that margins remain under intense pressure as the company tries to gain market share.
  • Lenovo is now the global number 1 in PCs with 17.7% share, No 3 smartphone marker with 6.3% share (including Motorola) and tied with Asustek for the number 3 position in Tablets.
  • These leadership positions come at a cost as the company remains barely profitable with operating margins of just 2.5% in Q4A.
  • This amounted to $231m, which is very close to the amount the Motorola loses every quarter.
  • Lenovo has only $3.9bn in the bank will be meaningfully impacted when it comes to paying $2.66bn for both transactions (Motorola and IBM) as well as the capital that will be required to turn them around.
  • In order to make a decent go of its handset and tablet business, Lenovo needs to increase market share meaningfully as Android is a commoditised market where scale is everything.
  • In PCs it is showing that it can be much more innovative than its competitors when it comes to form factor innovation to take advantage of the functionality offered by Windows 8.
  • If it can do something similar in smartphones and tablets and gain meaningful share then Lenovo has a chance.
  • Lenovo has the ambition but I am not yet convinced that it can execute in smartphones and tablets where so many have failed.
  • Its cash balance is not huge and investments will have to be made very carefully if management is going to pull this off.
  • 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.
  • Lenovo is one to watch but things are going to get worse before they get better.

Microsoft– Mercy killing.

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A guaranteed flop wisely killed prior to launch.

  • Microsoft launched the Surface 3 at an event yesterday in New York but conspicuously absent was any mention of a smaller device to compete with the iPad Mini and 7-8” Android devices.
  • Given the vivacity of the rumour mill, I suspect that this device was killed at the last minute.

Surface 3

  • The Surface 3 is a powerhouse but with the price tag to match.
  • It has a 12” 2160×1440 screen and comes in three flavours: the 4th generation Intel i3, i5 or i7.
  • The device starts at $799 for i3/64GB of onboard storage going all the way to an eye watering $1,999 for the i7/512GB of storage.
  • This is yet another indication that Intel’s need to hold onto 60%+ gross margins is a major drag on the market’s acceptance of the tablet form factor to replace laptops.
  • The Surface 3 does not compete with the iPad, instead it aims directly at the MacBook Air.
  • In this regard, it fares reasonably well as it is lighter, more versatile and offers better compatibility with other areas within the enterprise.
  • However, the price is going to limit volumes and RFM considers this device to be a PC not a tablet.
  • This device is a change of direction for the Surface towards the laptop market and deliberately leaves a big gap which I expect will soon be filled.

Surface Mini

  • The decision not to launch the mini speaks volumes about where Microsoft is going to go next.
  • The Mini was a Qualcomm powered device with a 7” or 8” screen and running Windows RT.
  • I have long believed that Windows RT is dead in the water (see here) and if launched would have proved to be nothing more than an embarrassment.
  • Furthermore, the Lumia 1520 (6” Windows Phone) is only one step away from being able to fill this space.
  • Its long battery life and much greater market acceptance make Windows Phone a much better proposition for a consumer tablet offering than Windows RT.
  • Hence I suspect that the Windows RT tablet has been killed off and the Surface moved up into the laptop market to make space for Windows Phone in the consumer tablet market.
  • Hence, I am expecting some modifications to Windows Phone to make it more tablet friendly and then the launch of several consumer oriented tablets probably towards the end of the year.

Take Home Message

  • The Surface is now a PC and users will purchase it on that basis and with that use case in mind.
  • This leaves space in the consumer tablet market which I expect to soon be filled with larger screen Lumia Windows Phone products.
  • This is a good sign that Microsoft is developing under new leadership to change with the market rather than trying to bend it to its will.
  • Everything I have seen since Nadella has taken over is increasing my hopes that Microsoft intends to become an ecosystem company which I believe gives the shares plenty of long term upside.
  • Along with Yahoo! and Google, Microsoft is one of my favourite plays on the digital ecosystem.

 

 

Google – A twitch upon the thread.

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Sony and Microsoft need to head Google off at the pass.

  • Google is absent from gaming which in my opinion is the single most important Digital Life service in terms of the time that users spend with their devices.
  • However, it now looks as if Google is finally starting to move on this space as YouTube looks set to acquire Twitch for $1bn (Variety).
  • Twitch is a YouTube-like website where gamers can upload or even broadcast their gaming experiences to share and chat with other gamers.
  • The service already has 45m users and the users here are more valuable than usual as they are highly engaged and their interests are very specific.
  • This makes them more receptive to the right kind of advertising and hence the price that advertisers will pay to market to them will be higher.
  • The beauty of Twitch is that it is platform agnostic meaning that gamers from both PlayStation and Xbox can share videos of the same game and chat to each other.
  • Xbox Live and PlayStation Network are unable to do this which leaves space for Twitch to exist.
  • On top of acquiring Twitch, Google is thought to be preparing its own console for the market based on Android which will obviously lead it into gaming on mobile devices.
  • Gaming is an important piece of the ecosystems of both Microsoft and Sony (Sony in particular) and neither of them can afford to have Google swoop in and offer something over the top of both of them.
  • Hence they need to:
    • Either one of them buy Twitch from under Google’s nose and keep it independent
    • Or come to an agreement where there is enough functionality and interoperability between XBox Live and PlayStation Network to render Twitch obsolete.
  • Either of these two strategies would have the effect of relegating Google’s coming console to an also ran meaningfully reducing its threat in my opinion.
  • This would also have the effect of lessening the impact of a Google gaming system for its own ecosystem as both Sony and Microsoft are currently miles ahead in that regard.
  • Google has very deep pockets and is more than happy to experiment until it gets its services right.
  • Hence as the challengers in the Digital Ecosystem, neither Microsoft nor Sony can ignore this twitch upon the thread that is telling them that Google is coming.
  • My fear is that these two are so busy fighting each other that they have not seen the big shark coming.

 

Apple & Google – Admission of weakness.

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An Apple / Samsung settlement is becoming more likely.

  • Apple and Google have dropped all of their outstanding litigation and will work together to reform patent law.
  • This is not nearly as exciting as it sounds because:
    • First. The agreement was reached without the signing of a cross licence making this “second class settlement”.
    • Second: The suits were dropped “without prejudice” which means that they could refile should they wish to do so.
  • A second class settlement is one where the companies simply drop their suits and walk away.
  • Effectively what has happened is that Apple and Google have looked at their outstanding litigation and both decided that it is not worth continuing to fight it out.
  • This is a pretty clear sign that the patent portfolios of both companies are weak and this has direct and positive implications for smartphone makers who have no real IPR of their own.
  • They will now be less fearful of litigation.
  • I suspect that the transfer of Motorola to Lenovo has also been a factor in Apple’s decision as the real “culprit” in Apple’s mind is the Android software which is not written by Motorola.
  • Now that Motorola will be owned by Lenovo, Apple once again is stuck as Google now has no tangible Android products against which it can assert its IP.
  • It is clear that Steve Jobs strategy to destroy Android through patent litigation has failed but at the same time so has Google’s strategy to protect Android makers from litigation.
  • This settlement has no direct implications for the battle between Apple and Samsung other than it is another sign that Apple’s patent portfolio is much weaker than Apple would have us believe.
  • However, it increases my hopes further that Apple and Samsung will come to a cross licence before the end of this year.
  • This is the second event that I believe will make Apple more willing to negotiate with Samsung on more reasonable terms.
  • The first was the very low damages awarded to Apple in its recent victory over Samsung (see here)
  • I would also expect Google to drop is lawsuits against Microsoft as the incoming Nokia handset business already has a licence for the Motorola patents that Google acquired.

Take home message

  • This second degree peace is further indication that the patent wars are starting to wind down.
  • The White House has hit rightly destroyed the value of injunctions for standard essential patents (see here) and now the court system has set a precedent for awarding low royalties.
  • I believe that this will make the technology industry less litigious, more open to negotiations and most importantly of all less greedy.

Windows Phone – On the podium

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Windows Phone is 3rd but it’s very far to 2nd.

  • Windows phone has moved up into third place when it comes to smartphone usage but it is a very distant third and only just ahead of Blackberry.
  • The latest data from Chitika shows that in the last three months, Windows Phone share of mobile internet usage in North America has held steady at 1.0%.
  • 2nd place is Android at 44.5% with iOS still in first place at 53.1%.
  • These findings are completely consistent with Radio Free Mobile’s ecosystem analysis.
  • This has shown that Microsoft’s share of the mobile ecosystem has held steady at 2.9% for the last three months while Blackberry has declined from 1.9% to 1.4%.
  • It is worth bearing in mind that RFM’s figures are global whereas Chitika’s analysis is for North America only.
  • Windows Phone’s share in North America is below its global average and hence there is no meaningful conclusion to be drawn from the fact that its share of usage is way below its ecosystem share.
  • Windows Phone has held share flat for the last few months as market share in units shipped has dipped due to the take-over by Microsoft as well as a period with no new device launches.
  • Now that the acquisition is complete, new device launches should pick-up and I am hopeful that market share should begin to pick up from Q2 14E onwards.
  • BlackBerry on the other hand looks set to continue its decline.
  • Its user experience is unappealing to users meaning that it is really only the corporates who will be interested in the proposition.
  • Upgrades from BES5 to BES10 seem to be going better than anticipated as I suspect that BlackBerry is pulling out all the stops to keep its customers.
  • Hence, there may be a tiny niche for BlackBerry in the very security conscious part of the enterprise market like governments and financial institutions but whether this can translate into a sustainable business is unclear.
  • I would still prefer not to take the risk and continue to prefer the fortunes of Microsoft to those of BlackBerry.