Google – The long game

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Google Android is becoming just like iOS or Windows Phone.

  • Everywhere one looks it is become increasingly clear that Google aims to take complete control of Android.
  • This will leave Android devices as vessels for Google’s ecosystem just as PCs are vessels for Intel and Microsoft.
  • Google is not limiting its ambitions to phones but it also includes tablets, chromebooks, TVs, cars and watches.
  • Basically, Google is targeting any electronic device that has anything to do with digitised data in a user’s life and is aiming to put Android on it.
  • This has certain limitations that I have looked at here
  • This will allow Google to collect all the data that these devices generate and learn much more about the user.
  • This data can then be sold to advertisers for their campaigns.
  • In order to maximise usage and user engagement, the experience needs to be easy and fun to use as well as consistent across all devices.
  • To date this has been very far from reality as hardware makers have been implementing their own look and feel in order to differentiate themselves.
  • This has had the effect of making the user experience both fragmented and chaotic.
  • This has confused users and resulted in lower usage of the devices as well as lower loyalty of the user to Android.
  • Google is now moving to fix this problem by taking total control of the user experience from top to bottom.
  • It is doing this by slowly replacing the open source software with its own proprietary code.
  • Once completed, I think it is clear that Google’s software will look just like iOS or Windows Phone.
  • Hardware makers have access to the proprietary code for free but only if they are able to pass a series of tests set by Google.
  • Effectively, this means that Google will soon have end to end control of the user experience leaving the hardware makers as commoditised box shifters.
  • This was clearly the case at the I/O developer conference last week where Google made clear that its offerings for Auto, TV and Wearables will be completely under its control.
  • A consistent experience across multiple devices will ensure that users identify with Google rather than the hardware that they are using.
  • This is essential for long-term revenue growth as the more users identify with the Google ecosystem, the more of their Digital Lives they will live within it.
  • This will result in all of the value accruing to Google and very little to the hardware makers.
  • This is likely to be less true of devices such as cars and watches where the look and feel of the device is a huge factor in the purchase decision.
  • However, for makers of consumer electronics, this is another nail in the coffin of their hopes to earn anything more than commodity margins.
  • Hardware makers with very high share such as Samsung should be able to make 10% margins as long as they can hold onto share but this is far less than it makes today.
  • Hence, in Android it increasingly looks like all the value will accrue to Google leaving it as the only stock to consider when looking at investing in Android.

 

 

Google I/O – Big, fat and happy

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Amazing success keeps Google blind to its weaknesses.

  • Every step that Google takes to move its ecosystem forward is a step backwards for Samsung and the other hardware makers.
  • The announcements at Google I/O (developer conference) are not ground breaking, but it is increasingly clear that Google is bent on domination of the digital world.
  • It aims to do this by offering the best Digital Life services across all electronic devices, collecting the traffic and then monetising the data.
  • Android for the TV, PC, automobile and wearable devices were all front and centre at the event but as usual the devil is in the details.
  • For example, these systems are not nearly as compatible as Google would have us believe.
  • For example, developers will need to port their Android applications if they want them to run on chromebooks.
  • Every step forward that Google takes is a step backwards for the long suffering hardware makers.
  • These companies cut each other’s throats in smartphones, tablets, PCs and TVs to put the best hardware in the hand of the user.
  • From this hardware it is Google that makes the real return as lower priced but higher quality hardware means more traffic generated and more data for Google.
  • The hardware makers are completely shut out from this data and revenue bonanza and this includes Samsung since its agreement with Google on January 27th 2014. (see here).
  • Despite these developments, the Google ecosystem still has weaknesses and I believe that I/O has fallen short in a few areas.
  • First: The Google user experience is still sub-par when compared against iOS or even Windows Phone.
  • This is the main reason why usage is meaningfully lower and why I believe that user willingness to try something else is higher than Google would like.
  • Google is trying to fix this by taking ever greater control of the user experience but this will take time, giving the challengers an opportunity to gain some share.
  •  Second: Gaming. This is a huge hole in Google’s portfolio of otherwise superb Digital Life services.
  • Today’s announcements around bringing console quality gaming to Android indicate that Google has not really internalised the importance of this segment.
  • Smartphone users spend 32% of their time on their phones playing games. Tablet users spend much more.
  • The secret to this segment is to be the glue that provides the multiplayer functionality and the communication medium between gamers.
  • It is there that the data collected and there that gaming can be monetised beyond the normal route of selling games for money.
  • Google has so far declined to seriously address this segment and until it does, Sony and Microsoft have a chance to make greater headway with their own ecosystems.
  • Third: Wearables. Google sees Android going everywhere but I suspect that wearable devices will be smaller, better, cheaper with longer battery lives if they run an RTOS rather than Android.
  • Putting Android on a small sensor is like trying to cram full fat Windows 8 onto a smartphone. It does not work.
  • The key for Google in wearables is not the wearables themselves but whatever system that collects and analyses the data.
  • It will be that system that creates the valuable insights into the user and that system that provides the useful services.
  • It is here that Google will be able to generate the user loyalty and stickiness that is so essential to keeping the advertising revenues coming in.
  • This is where Google should be focusing its efforts in wearables rather than trying to put Android on every single device no matter how tiny.
  • Fourth: While there are well over 1bn Android devices being actively used, Google only has access to a fraction of them.
  • Take out non-GMS devices (where Google has no access) and Gingerbread (where the user experience is awful) and RFM calculates that Google has 421m users rather than the much-touted 1bn.
  • Future versions of Android (such as “L”) aim to bring more devices into GMS but even in the best instance, China will remain a world of its own.  Take Home Message
  • It was good to see that Google still has a sense of humour with the release of its cardboard cut-out virtual reality googles and overall the company has had a good day.
  • Its ecosystem is developing nicely and it is moving to address the most glaring of its weaknesses (except gaming).
  • If it can fix gaming on top of all that, its position will become almost unassailable for the likes of Microsoft, Sony, Yahoo! and Amazon.
  • As things stand today, they still have a chance.

Google vs. Apple – Control freak

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Google’s days as a developer of open source software are numbered.

  • With its future in Android now secure, Google has turned its attention to mitigating the biggest risk to its long term growth: Apple.
  • Apple used its developer conference to refer to Android as a “toxic hellstew” that is both chaotic and very insecure.
  • I find that there is merit in this statement but not as much as Apple would have us believe.
  • Google has responded in a recent interview by admitting that the open source route is indeed much more difficult but has stopped short of admitting the real truth.
  • I believe that the real truth is that Google aims to marginalise open source Android into a tiny kernel which has no impact on the user experience.
  • RFM research (see here) clearly indicates that Google is hard at work addressing these issues and will do so by creating its own proprietary operating system on top of Android.
  • GMS is currently the applications that sit on top of Android but over the last year Google has increased the scope of GMS significantly.
  • Google is systematically removing functionality from Android, which is the open source piece, and placing it within GMS which is not.
  • Hence GMS is getting bigger while the open source piece becomes smaller and increasingly less relevant.
  • GMS is not open source and is in fact completely controlled by Google.
  • I expect that over the next year or so this trend will intensify until Android is nothing more than a kernel with all the key functionality being coded in GMS.
  • In effect, Google will have created proprietary OS (GMS) just like iOS or Windows.
  • RFM research indicates that Google is doing this in order to fix the usability and security issues that make Android both less useable and less secure than either Windows Phone or iOS (see here).
  • By having total control of user experience, it will be able to manage security as well as implement its own consistent user experience across all GMS devices.
  • Effectively, Google will solve its usability and security issues in the same way that its competitors do: by having its own proprietary OS.
  • The casualty here will be Android which will become so small that it is almost irrelevant in the user experience as are the kernels that sit under Windows Phone and iOS.
  • This will further limit handset vendors’ ability to differentiate on GMS Android and also make it much more onerous to have one’s own version like Amazon and the Chinese do.
  • Google needs to catch up with iOS and Windows Phone in terms of the user experience and this strategy will ensure it has the best chance of success.
  • Google remains the only company likely to see any growth from Android and remains, alongside Microsoft and Yahoo!, the only stocks to look at in the mobile ecosystem.

 

 

Yahoo! – The aviator

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Finally, some positive signs from mobile.

  • I have been concerned for some time about the lack of progress at Yahoo! (see here and here) but there have been some positive signs.
  • Yahoo! acquired Aviate, a home screen curation app., last October and it is finally being made available to users.
  • Now known as Yahoo! Aviate, the app. presents the user with a range of options for content and services based on his recent activities, current location and context.
  • For example when the app. detects that the user is in a moving vehicle, a range of music and mapping options are presented.
  • It provides news and weather apps. in the morning and productivity options while at work.
  • At the moment Aviate is remaining completely agnostic but if Yahoo! wants to make the most of this functionality, it will have to be eventually migrated primarily to Yahoo! content and services.
  • This may cause some problems as most acquired companies are promised autonomy these days but their parents will get no value out of them if they remain that way.
  • Whats App and Facebook (see here) is a classic example.
  • I am assuming that as time passes the requirement for autonomy will be carefully reeled in by Yahoo! and under that scenario Aviate could become a key app for Yahoo!
  • For over a year, I have been waiting for Yahoo! to do something with its acquired assets and move its superb fixed Internet usage into mobile.
  • Aviate could be the glue that places Yahoo!’s content and services at the front and centre of the user experience.
  •  It is the first sign of a coherent move into mobile that I have seen.
  • I hope that this is just the beginning.
  • Putting all of the acquired services into mobile in a way that easy and fun to use could see usage and loyalty to Yahoo! properties increase.
  • This would have a commensurate increase in revenues and profits over time.
  • There remains a very long way to go before Yahoo! is in real contention as mobile ecosystem but taking action ahead of the Alibaba listing is a good idea.
  • This should mean that there will already be some strategies in place to monetise mobile when investor attention returns to its languishing core businesses after the Alibaba IPO.
  • Yahoo! remains my dark horse in the ecosystem space alongside Microsoft and Google.

 

 

Google – Ins and Outs (I/O).

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Developer conferences are where the ecosystem evolves.

  • Developer conferences are becoming increasingly important as the relevance of the device continues to decline.
  • Google will host its 2014 I/O conference this week and it is here that a glimpse of what is really planned for the Google Ecosystem over the next 12 months will be given.
  • As the ecosystem becomes more and more important, it is the developer conferences where the key announcements are being made with device launch events becoming less and less relevant.
  • This has really come into focus this year as Microsoft’s Build, Apple’s WWDC, Facebook’s F8 and now Google’s I/O have been where all the really important announcements have been made.
  • This is a further sign that devices are increasingly commoditised and that the value from which profit margin is being derived in the mobile device industry is coming from the ecosystem.
  • Developers are a critical part of the ecosystem and consequently how an ecosystem loves and nurtures its developers is key to its long term success.
  • Google’s I/O conference runs from June 25th to June 26th and I am expecting two major developments.
  • First: Gaming. Gaming is a huge part of Digital Life and yet Google still declines to properly address the segment.
  • Last year’s I/O saw some half-hearted attempts to address gaming but this year I am expecting something more.
  • There are already signs that Google is working on this (see here) and I am hopeful that some of this is ready for launch.
  • Google does not necessarily have to offer the games themselves but merely be the glue that ties gamers together when they go on line to play and download games.
  • The rumour mill has been very quiet on this issue recently but I think it is one of the most important issues that Google needs to address.
  • Second: wearables and here I think that Google has got it wrong.
  • Wearables are mostly tiny devices that are going to have a single purpose or function.
  • In effect, they will be like sensors that collect analogue data, digitise it and send it on to a larger device like a smartphone that can interpret it and make is useful.
  • Hence, they are not likely to be devices to which third parties will be writing applications.
  • Putting Android into a tiny device like this is exactly the same as trying to shoe horn a full version of Microsoft Windows into a smartphone.
  • This has been tried and tried and tried but every time it fails.
  • Hence, I suspect that using Android in a wearable will result in a large, expensive device with awful battery life.
  • The Samsung Galaxy Gear was a good example of this.
  • Therefore, I suspect that most wearables that give a good user experience, will run an RTOS (Real Time Operating System) which will enable tiny devices to fulfil their purpose and have a very long battery life.
  • Google should be focusing on making Android the data collection and aggregation point for all of these devices rather than trying to put the OS on the devices themselves.
  • It is in the data where the value for Google lies and it is in the aggregation of that data where I expect Google to eventually focus its efforts.
  • Google remains the only company I would look at in the Android ecosystem as it is slowly but surely subjugating all other players to its will.

Wearables – Missing link

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  • Key to wearables still missing
  • The wearables space is on fire today with talk of new devices from Fitbit as well as yet another potential iWatch.
  • Fitbit has applied for trademarks for a Fitbit Surge, a Fitbit Charge and PurePulse.
  • The most significant of the three is the PurePulse which will be a wrist mounted optical heart rate monitor that also monitors activity adding another dimension to the data generated.
  • The use of a heart rate helps the device understand activity intensity as well as exertion.
  • This gives a much better picture of user activity and makes the pedometer function much more useful.
  • The Fitbit Charge is an upmarket pedometer aimed at runners with GPS, atmospheric sensors and the corresponding functionality, while the Fitbit Surge is an updated pedometer aimed at the more casual end of the market.
  • The PurePulse is significant as it will aim to offer continuous heart rate monitoring from a wrist mounted, light based sensor.
  • To date a number of companies have tried to offer this functionality but the limitations of using light to monitor a heart rate have rendered the devices worse than useless.
  • The Galaxy Gear Fit only gives a heart rate reading when a button is pressed as the device is incapable of holding the signal on a continuous basis.
  • If Fitbit has managed to solve this problem, where everyone else has failed, then it may have a hit on its hands.
  • Given its track record in hardware reliability and the total failure of other devices, my hopes are not high.
  • Hence, I see no reason to change the view that wearables are a solution looking for a problem and the view that technology for biosensors remains a long way away from being mass market ready. (see here)
  • Elsewhere, yet another iWatch prototype has emerged, this time manufactured by Quanta with a 2.5 inch screen.
  • This device also features a heart rate monitor and will also feature wireless charging.
  • The device is reportedly (Reuters) going into mass production in July which will be the key signal that this is a device that will actually be launched.
  • Unless Apple has figured out a use case for this device that makes it a must have, it is likely to be a failure.
  • This is because to date the limitations of a wrist mounted device have vastly outweighed any real benefit.
  • If this device is based on iOS, then the battery life is likely to be awful.
  • Net net, I see nothing hear that is likely to make me reassess my view of the wearables segment and would not be surprised Apple decline to launch this latest prototype.
  • I need to see a huge improvement in reliability from Fitbit as well as a real solution to the heart rate monitoring problem in order to think that this segment might start moving in the near future.

 

 

 

 

 

Amazon – No Fire sale

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Expensive phone with no ecosystem does not make a hit.

  • Amazon has launched its Fire smartphone but its cost and limitations will put a smile on the faces of Apple, Google and Microsoft.
  • The smartphone Fire is a high end device with a HD screen with some funky 3D graphics effects, 2.2Ghz quad-core CPU, 2GB of RAM and 32GB of storage.
  • The first problem is that the screen is too small for a device in this price category but I suspect that this is because of the limitations of implementing the 3D effect in a glasses-free manner.
  • This is especially the case when considering the fact that the device comes at $199 from AT&T with a two year contract or $649 with no contract.
  • Effectively Amazon is asking users to spend the same money that they would on an iPhone for a gimmicky device that has no ecosystem and very few apps.
  • One cool feature is the ability to recognise an object via the camera and then take the user to the website to buy that item but I suspect that the novelty of this will soon wear off.
  • Amazon is continuing to make the mistake of releasing the smartphone before its ecosystem is ready to make it compelling.
  • This device is not going to pull users in as the device is the same price as the iPhone and then user has to pay another $99 to get access to the services.
  • This will ensure that outside of the Amazon Prime ecosystem, there is no reason whatsoever to own this device.
  • Furthermore, I suspect that a lot of Amazon Prime users already have a Kindle Fire and so this is not going to add very much to the ecosystem which is already very tablet centric.
  • In the grand scheme of things Amazon’s ecosystem is tiny as RFM forecasts that it had 21.1m registered users at the end of calendar Q1.
  • This is miles short of the 100m which RFM believes is needed for critical mass and hopelessly adrift of the magic 300m needed to make some real money.
  • Having a credit card relationship with Amazon does not make the user part of its ecosystem but it does give Amazon an opportunity.
  • Amazon needs to maximise that opportunity by making its ecosystem compelling and then release a handset not the other way round.
  • The result of this launch will be a handset that ships almost no volumes and loses Amazon money.
  • I remain unconvinced that Amazon has a real ecosystem strategy as its moves in this direction feel like random experiments.
  • Until things become more coherent, Amazon is likely to remain a great retailer and a great cloud computing provider but nothing more.

 

Nuance & Samsung – Private preference

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Nuance looks good for private equity not Samsung.

  • Nuance is a provider of speech and language technology that is used by Apple in its Siri digital assistant.
  • It has fallen on difficult times and with the recent addition of an activist investor, is feeling pressure to release some value.
  • Hence, it appears very likely that the company is entertaining suitors, one of which seems to be Samsung Electronics.

Samsung & Nuance

  • Samsung is a company at the top of its game but RFM believes that earnings are going to decline for the next 3 ½ years at least. (see here)
  • Samsung has ceded control of the ecosystem to Google leaving it with a commoditising handset business.
  • This is likely to result in a decline in handset margins from their current 18.4% to 11.3% in 2017E.
  • Outside of the ecosystem RFM believes it is possible to earn a good and sustainable return by being the provider of value added technology.
  • Both MediaTek and Qualcomm do well in this regard.
  • Nuance falls into this category but being owned by Samsung could cause a substantial collapse in revenues.
  • This is because many of Nuance’s customers may view Samsung as a competitor and would not want to be dependent on the technology of a competitor.
  • Hence, to get value from Nuance, it would have to add enormous value to its own products in order to make up from the revenue loss caused by customer losses.
  • This, combined with the fact that the kind of problems faced by Nuance make it ideal for a private equity deal, leads me to believe that private equity will pay much more for Nuance than Samsung will.

Nuance and private equity

  • Nuance has got itself into a difficult position.
  • Its financial performance has not been great over the last few quarters although some new products have been introduced that could improve the financial position.
  • The two other big issues with this company are that it is quite indebted and management compensation is extremely high given the amount of profit that is generated.
  • These factors make Nuance ideal for a privatisation where the company is taken over, cleaned up and then returned to the market at a much higher valuation.
  • I suspect that this would be the alternative most pleasing to Carl Icahn who holds a 20% stake in the company.
  • In this scenario, I would expect him to hold onto his stake until the private equity shop exits.

Take Home Message

  • It is easy to see why Samsung might be interested in this company, but I suspect that a private equity outfit is likely to be prepared to pay more to acquire the shares.
  • This combined with the fact that the kind of changes that are required to improve performance are best suited to a private equity transaction, are likely to push any deal in this direction.
  • Hence, I think it very unlikely that Samsung will acquire this company.
  • Should be wrong, it is likely to further increase my concerns around Samsung and push my valuation of KRW1,200,000 per share even lower.
  • I remain very cautious on the outlook for Samsung Electronics.

 

Research Publication – Mobile Ecosystems – Command and Control

Radio Free Mobile updates its flagship mobile ecosystems research product with the publication of:

Mobile Ecosystems – Command and Control. (Click here for details and purchase options)

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Ecosystem importance continues to rise. Handsets and tablets are commoditising fast and only those that have an ecosystem or can supply value-added-technology have a chance at sustainable profitability. RFM sees good user growth for the next few years but already the ecosystem players are moving to cement control of their ecosystems. The end result is likely to be a series of proprietary ecosystems meaning greater fragmentation to cope with for both application developers and technology suppliers. 

  • Handset hell. Google has now taken complete control of its ecosystem leaving all of the Android makers with no way to differentiate other than hardware. This will ensure that better and better specifications are made available at lower and lower prices. The only beneficiary from this is Google and RFM continues to see a huge transfer of value from the handset makers to Google over the next 4 years.
  • Ecosystem heaven. The other major ecosystem players either make their own handsets (Apple and Microsoft) or else implement their ecosystems on top of open source Android. Growth will be steady and returns will be earned by monetising traffic (Google and Yahoo!), charging users for software (Microsoft) or through premium device pricing (Apple).
  • Command and control. Most of the major ecosystems are now tightly controlled and the chaos that reigns in Android is a major drawback for all the ecosystem players that base their offerings on it. RFM sees all of these players, and Google in particular, moving to gain more control over all aspects of their ecosystems. This is likely to result in Android becoming a series of proprietary ecosystems based on an open source Android kernel. This has significant implications for both application developers and component suppliers.
  • iOS. Apple already has complete control of iOS but is very weak when it comes to Digital Life services. RFM sees Apple moving to define the future of Digital Life rather than trying to compete in an already crowded field.
  • Microsoft is changing. The new broom is showing all the signs of turning Microsoft into an ecosystem company. This is good news for the long term outlook but there are still huge hurdles to overcome.
  • Others. Sony and Yahoo! are ahead of the rest of the pack but still have a lot to do before they will begin to earn a return on the investments made to date. 

Click here for purchase options

 

 

PCs – Two tides

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RFM continues to see the growth in the PC market in 2014E.

  • Intel increased its Q2 guidance as end-of –life XP machines are being upgraded much more quickly than expected.
  • Q2E revenues will now be $13.4bn-$14.0bn up from previous guidance of $12.5bn-$13.5bn. This represents a mid-point increase of 5.3% and is nicely ahead of consensus at $13.0bn.
  • Intel also lifted is FY14E revenue expectations from “approximately flat” to “some growth”,
  • This is good news as it implies that Intel sees the strength of Q214E continuing for the balance of 2014E.
  • Intel is attributing the sudden strengthening of demand to an increase in corporate PC shipments in response to Microsoft’s ending of support for Windows XP.
  • Microsoft is no longer issuing security patches for Windows XP which, combined with a recent surge in cyber-attacks and successful hacks, has made companies expedite the upgrade.
  • Upgrading a PC to Windows 7 or Windows 8 from XP will require a new machine in most instances and Intel’s strength is likely to be echoed by the rest of the PC supply chain.
  • XP represents one rising tide but I continue to believe that tablet PCs will also drive the market in H2 2014. (see here).
  • Computex saw the launch of very powerful PCs with no fans and all the workings crammed into a 7.2mm thick tablet.
  • These devices are not going to be cheap but it is clear that they are aimed at replacing laptops not iPads or Galaxy Tabs.
  • I expect to see more of these devices in the market in H2 2014E at prices low enough to kick start the beginnings of a laptop replacement cycle.
  • This is the second tide which I expect to lift the PC market out of its slump and allow it to show some growth in 2014E.
  • (RFM classifies Windows 8 tablets as PCs because they compete with laptops not content consumption driven devices like the iPad and Galaxy tabs).
  • Consequently, I expect a round of upgrades for Intel and the PC supply chain which I am looking to be repeated towards the end of the year as hybrid tablet PC sales kick in.
  • The rising PC tide floats all boats and this adds momentum to RFM’s positive stance on Microsoft.
  • Intel, Microsoft, HPQ, Lenovo, Asustek and even HPQ will benefit from this trend.
  • I would look to Microsoft, Intel and Asustek as the best way to gain exposure to a better than expected performance from the PC market in 2014E.