Google – Secret Squirrel

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Merging Chrome OS and Android is really about control.

  • I suspect that the real aim of bringing Chrome OS and Android closer together is to allow Google to increase the level of control that it has over the Android OS.
  • The wires are alive with speculation that Google intends to merge Chrome OS and Android with Google’s only response being that Chrome OS is not being “killed”.
  • Both of these operating systems have been under one roof since 2013 and from an ecosystem perspective, it makes a lot of sense to merge them into one.
  • Two important aspects of an ecosystem are:
    • First: the ability to offer a consistent user experience across multiple device types such as phones, TVs, PCs etc.
    • Second: ensuring that software is as consistent as possible across the ecosystem (Law of Robotics No. 7 (see here)).
  • Merging Chrome OS and Android would help improve Google’s performance against both of these metrics, however I think that there is a much more important motivation for this move.
  • RFM research has indicated for some time that the appeal of Google’s ecosystem to both users and software developers continues to be hobbled by the nature of Android.
  • Google’s ecosystem exists as a layer of software known as Google Mobile Services (GMS) that sits on top of the Android Open Source Package (AOSP).
  • GMS is proprietary to Google while AOSP is open source.
  • AOSP controls significant aspects of the user experience and because it is open source, it is very fragmented.
  • This has had a huge impact on the quality of the user experience on Android and deleteriously impacted the ease and fun of use of the Google ecosystem. (Laws of Robotics Nos. 1 & 2 (see here)).
  • Furthermore, Google does not have the ability to distribute any upgrades it makes to the AOSP.
  • Instead, it must wait for device makers and mobile operators to be willing to upgrade the devices that they control.
  • This has resulted in it taking multiple years for new software to make it into the hands of the majority of users, seriously impacting the appeal of the Google ecosystem. (see here)
  • The one way that I see by which Google can rectify these problems is to take over as much of the AOSP as it can and turn an open operating system into a proprietary one.
  • Then Google will have full control of the user experience and should also be in a position to take control of software distribution.
  • Merging Chrome OS and Android into one would allow Google to quietly take much greater control of Android by replacing open source elements of the AOSP with elements from Chrome OS which is not open.
  • Google would still be able to have two versions, but if the core of the software is unified then Google will have moved closer to solving a lot of the problems that beset it.
  • Furthermore, this could be launched at Google I/O 2016 with much fanfare around improving the user experience and unifying code while the take-over of Android goes quietly unnoticed.
  • This would give me much greater confidence around Google’s ability to earn revenues from Android in the long-run and assuage my fears that my numbers are too high.
  • That being said even assuming a good outlook for Android revenues, I really struggle to see much upside in Google and would continue to look elsewhere among the ecosystem players.
  • Of these I would continue to look to Microsoft in the short term and Facebook for the long-term.

Samsung Q3 15A – Coming of age.

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Samsung is starting to look more like a mature, grown up company.

  • Samsung reported reasonable Q3 15A results as the semiconductor powerhouse more than made up for the weaknesses elsewhere.
  • Q3 15A revenues and EBIT were KRW51.68tn / KRW 7.79tn in line with guidance given earlier in the month of October 2015.
  • Samsung shipped 108m units of which 86.4m were smartphones giving it market share of 23% which is a significant improvement on Q2 15A where market share was just 20%.
  • However, this came at the expense of price as Q3 15A mobile revenues increased by just 2% QoQ compared to smartphones units which grew by 16% QoQ.
  • Lower prices also took a toll on margins which fell to 9.0% from 10.6% in Q2 15A but critically, profitability has remained within the range I am expecting in the long-term.
  • This allowed another mighty performance from the semiconductor business (Device Solutions) to underpin Samsung’s financials.
  • In a market where most of its competition is struggling to stay afloat, Samsung grew revenues by 14% QoQ and 29% YoY delivering margins of 22.8%.
  • Samsung is increasing its investments in semiconductors and is showing every sign of being able to stay ahead of its competition.
  • It is this thought process of commodity products in massive volumes that is now being applied to the handset business.
  • It is this that leads me to believe that Samsung can deliver margins of 10-12% in Android handsets despite its competitors only managing 2-4%.
  • The caveat here is that Samsung must continue to out ship its next largest competitor by more than 2 to 1.
  • In Q3 15A Samsung shipped 3.2x more devices than its closest rival, Huawei, meaning that this risk looks very low for now.
  • Samsung’s outlook for Q4 15E is modest and the target is to continue growing semiconductors while keeping profitability in handsets steady.
  • However at the same time Samsung has announced a plan to return a significant amount of cash to shareholders.
    • First. $10bn worth of shares will be re-purchased and cancelled.
    • Second. Over the next three years 30%-50% of free cash flow will be returned to shareholders mostly via dividends but also through share buy backs where the shares will also be cancelled.
  • I see this as a good move as it indicates that Samsung is finally moving to treat shareholders fairly and raises my hopes that further improvements in corporate governance are in the pipe.
  • I view this program as better than many programs initiated by US companies which often fail to cancel the shares they buy back and instead use them for employee stock programs.
  • I have believed for many years that cash returned to shareholders via a buy-back program is not properly returned until the shares are fully cancelled.
  • The outlook for Samsung is one of slow but steady profit growth driven by Device Solutions and on that basis I still think the worst is over.
  • The shares are up 15% so far this month which brings Samsung closer to what I consider fair value.
  • However, this fair value also includes a 20% discount on the basis of Samsung’s shortcomings in corporate governance and shareholder interests.
  • If Samsung is really making improvements in these areas then there is scope for further upside.
  • If I owned Samsung I would not be selling it yet.

AAPL, TWTR, BABA – Mixed Bag

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Apple in line, Twitter miss and Alibaba beat.

  • Apple reported a steady quarter while Twitter’s problems remain unresolved and Alibaba used mobile to defy the slowing Chinese economy.

Apple

  • Apple reported a steady quarter and set itself up for a good holiday quarter despite troubling rumblings from its supply chain.
  • Fiscal Q4 15A revenues / EPS were $51.5bn / $1.96, very slightly ahead of consensus at $51.0bn / $1.88.
  • 48m iPhones (48m consensus), 9.9m iPads (10m) and 5.7m Macs (5.6m) shipped and it was mainly the strength of iPhone ASPs revenues were able to beat expectations.
  • As a result of better prices, gross margins were also strong coming at 39.9% compared to consensus of 39.3% and guidance of 38.5% – 39.5%.
  • Apple Watch saw a sequential increase in shipments which leads me to think that shipments were around 3.8m units.
  • A sequential increase is good news as this sets a floor for volumes, but it is way below what the bulls were forecasting prior to the device’s launch.
  • China remained Apple’s strongest market with revenues doubling YoY, 25 stores and a healthy outlook.
  • Apple remains the only non-Chinese ecosystem to have any real traction in this market.
  • Guidance for fiscal Q1 16E was $75.5bn – $77.5bn with the midpoint at $76.5bn slightly below consensus at $77.0bn.
  • Competition has weakened over the last 2 quarters and so I think that Apple is very unlikely to miss expectations in January 2016.
  • However, I don’t think it will beat either meaning that the shares are unlikely to have a strong rally leaving Apple as a good place to park capital but not one that one would consider for outperformance.

Twitter

  • The gloss of Jack Dorsey’s appointment as CEO was well and truly tarnished by yet another quarter clearly showing that Twitter has ground to a halt.
  • Q3 15A revenues / adj-EPS was $569m / $0.10 ahead of consensus at $559m / $0.05 but the story remained user growth and guidance.
  • MaUs grew by 1% QoQ to 320m below consensus of 324m as it is clear that Twitter continues fail in moving away from just being a news dissemination system.
  • Twitter has adopted video in a similar manner to Facebook, but it has yet to see video drive a meaningful improvement in overall user engagement.
  • In order to begin growing once again, Twitter must break-out of its mould and begin addressing the other activities that users enjoy on smartphones and tablets.
  • Its segment represents just 16% of the time spent on a mobile device and consequently its ability to monetise is fundamentally limited.
  • This fact was inherent in Q4 15E guidance where revenues are expected to be $695m-$710m missing consensus of $741m by 5%.
  • The problem is that its current strategy remains to improve on what it has rather than to take the company in a bold new direction.
  • A bold new direction requires a dedicated, focused and highly engaged leader which Twitter simply does not have.
  • Instead Jack Dorsey has to spend a good portion of his time running Square and bringing this company to IPO.
  • Hence, I see no bold moves and suspect that the current strategy will deliver marginal improvements at best.
  • I see further disappointments ahead and think that the shares will continue to fall.

Alibaba

  • Alibaba reported good fiscal Q2 16A results as growth in transactions from mobile devices helped offset the overall drag from the slowing Chinese economy.
  • Q2 16A revenues / EPS were RMB22.1bn / RMB3.63 compared to consensus at RMB21.3bn / RMB3.45 triggering a small relief rally in the shares which have been pummelled by the broader sell-off in China.
  • Total transaction volume (GMV) was up 28% to RMB713bn ($112bn) and was mostly driven by the increase in user numbers which grew to 386m of which 346m were on mobile and responsible for 62% of GMV.
  • Cash flow from operations was RMB15.1bn (US$2.3bn) leaving the cash balance at a very healthy $16.7bn.
  • I believe that this is of paramount importance as the next stage of Alibaba’s growth is going to require meaningful investment.
  • Alibaba has built a strong base of mobile users and the next stage of its evolution is to expand the services that it offers to those users such that they increasingly engage with Alibaba.
  • It is from this increasing engagement that long term revenue growth is likely to be derived as the e-commerce business is now so large that it will be difficult to maintain the current rate of expansion.
  • This is where the O2O (online to offline) strategy (see here) and Digital Life services come into play, all of which Alibaba is aggressively expanding.
  • In this space Baidu, Tencent, Xiaomi and China Mobile are also all vying to take a leadership position.
  • The problem is that RFM estimates that the Chinese market is large enough for three to be very successful.
  • This means that two will fall by the wayside but with its current size and resources, Alibaba is unlikely to be one of them.

Mobile Payments – Horrible trade-off

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Security and a good user experience are almost mutually exclusive.

  • I continue to believe that the trade-off between ease of use and security remains the single biggest impediment to the take-off of mobile payments.
  • In 2012 every man and his dog was creating an app store as this was then a major differentiator in the user experience.
  • In 2015 we are seeing the same thing again with mobile payments as every bank, ecosystem and payments processor wants to own the customer when it comes to paying for goods and services.
  • Unfortunately, in this mad scramble almost everyone has forgotten that unless paying with a mobile phone is much easier than presenting a plastic card, no one will bother.
  • This is where almost everyone falls over because those that have designed the solution almost always know nothing about the user experience.
  • One only has to look at the Merchant Customer Exchange (MCX – see here), Chase’s recently announced mobile wallet or any solution based on QR codes to realise that consumers will loathe using these offerings.
  • These solutions have addressed the problem from the security angle and a desire to ensure that fraud rates are at least as good if not better than the existing plastic cards.
  • Unfortunately, this thought process lays bare the critical problem with security and mobile payments in particular.
  • This problem is that good security and a good user experience are almost always mutually exclusive.
  • This means that a secure service is horrible to use and an easy and fun to use service is insecure.
  • So far, I do not think that anyone has come close to solving this problem as even Apple Pay is still experiencing fraud rates that are far above where they need to be to see real traction.
  • In actions where the user has no choice (like airport security) ease of use does not matter but where one is trying to entice a user to try something new, it is of paramount importance.
  • Hence, it will be the service that solves this problem that will win.
  • At the head of this race has to be Apple which has done a good job in putting together an easy to use, end to end service but now it has to help its partners to bring the fraud rate down.
  • I think that the banks, merchants and credit card companies have no chance as their understanding of how important it is now to provide a good user experience is almost non-existent.
  • Google also has a good opportunity here, but I think it will continue to be hobbled by the inherent fragmentation and insecurity of the Android platform upon which it is based.
  • I suspect that users will be using plastic for much longer than those investing heavily in mobile payments would like us to believe.

 

Apple Music – Pandora’s box.

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I think Apple is going after radio more than streaming.

  • Pandora reported bad Q3 15A results and guided weakly mostly as a result of losing users caused by the launch of Apple Music.
  • This further reinforces my view that the real target of Apple Music is radio rather than recorded music streaming.
  • Q3 15A revenues / adj-EPS were $312m / $0.11 just short of consensus at $313m / $0.10 but it was in the subscriber figures and outlook for Q4 15E were the trouble really started.
  • While the number of listeners increased 2% YoY, it fell by 1.6% QoQ to 78.1m which came as a huge shock to the market.
  • Furthermore, Q4 15E revenue guidance was 7% light with $325m-$330m forecast compared to consensus at $352m.
  • The real problem was the decline in subscriber numbers and the tacit admission that Apple Music has had an impact.
  • This sent the shares down 35% on Friday 23rd
  • This, combined with RFM’s research leads me to believe that Apple is in fact chasing the opportunity in radio much more than in recorded music.
  • As one music industry executive appropriately put it: “Apple has parked its tanks on Radio’s lawn”.
  • When one looks at the numbers this becomes obvious.
  • Despite grabbing all the headlines, the recorded music industry is currently worth around $16bn while radio advertising is worth around $44bn per year.
  • Even though streaming has kicked the recorded music industry back to growth for the first time in many years, radio is a much riper plum to go after.
  • Apple’s music streaming service is still only half-baked and has come in for much criticism (see here) but its radio station, Beats 1, has been well received.
  • Furthermore, RFM research indicates that radio stations Beats 2,3,4 and 5 are in development and the plan there is have them advertising funded.
  • In radio, Apple is competing against broadcast radio which is a much softer target than its much bigger and better rival in streaming.
  • Furthermore, as the opportunity is 3x the size of recorded music and 30x the size of the streaming market, the scope for returns is much higher.
  • This fits with RFM research which indicates that Spotify, Deezer and Tidal have yet to see any meaningful impact on their subscriber acquisition numbers from the launch of Apple Music.
  • However, for Pandora and Sirius XM, this is an extremely worrying development.
  • Pandora has attempted to brush this off as a one-time blip but it is at a massive disadvantage compared to Apple.
  • Every iOS device with iOS 8.4 or better is now set up for Beats 1 and its descendants making it the default streaming radio station on over 400m devices.
  • History has shown that being the default setting or option on a device confers a huge and often unsurmountable advantage (see here).
  • Hence, I suspect that Pandora’s user numbers are not going to recover and over the next year or so may establish a downward trend.
  • Pandora’s still has many more users, more experience and much more data to play with but it has to immediately step up and make its service much better than Apple’s.
  • Failure to act immediately will result in Friday’s correction being just the beginning of a long and painful kiss goodnight.

 

 

GOOG, MSFT & AMZN – Three for three.

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Three strong earnings reports but for very different reasons.

  • Microsoft, Alphabet and Amazon all saw strong after-hours performance following their results but for very different reasons.

Alphabet

  • Alphabet reported good results as traffic growth from mobile and YouTube were somewhat stronger than expected.
  • However, it was the promise of better fiscal discipline, transparency and a $5bn share buyback that underpinned the after-hours rally in the shares.
  • Q3 15A revenues ex-TAC / adj. EPS was $15.1bn / $7.35 just ahead of consensus at $15.0bn / $7.24 and RFM at $14.5bn / $7.43.
  • The good news really came as Google outlined its intentions for its disclosure from Q4 15E under its new Alphabet holding structure.
  • Alphabet has committed to disclosing revenue, profitability and capex for both the core business (Google) and a single unit referred to as Other Bets.
  • Other Bets is all of the other businesses such as Access, Energy, Google X, Driverless cars, Nest, Life Sciences, Ventures and so on.
  • This is much better disclosure than I had been expecting and the hope is now that the core Google business will prove to be much more profitable than investors have previously given it credit for.
  • That being said, it is the profitability of Alphabet that determines what the shares are worth and in that regard, not much has changed.
  • I still remain concerned with Google’s ability to control Android and with that, grow its revenues from this platform long-term.
  • I think that Android remains central to Google’s revenue growth in the medium term and there was nothing in these numbers that calmed my fears.
  • The shares have had an excellent run and I am more actively looking for a better opportunity.

Microsoft

  • Microsoft reported good fiscal Q1 16A results as Azure and Office 365 more than offset the weakness from the PC market.
  • This was augmented by solid guidance for fiscal Q2 16E despite the ongoing headwinds coming from the strong US$.
  • Q1 16A revenues / Adj. EPS were $21.7bn / $0.67 compared to consensus at $21.0bn / $0.57 and RFM at $21.3bn / $0.66.
  • Guidance for fiscal Q2 16E was good with revenues / implied EBIT expected at $24.8bn-$25.4bn / $7.0bn compared to consensus at $25.1bn / $6.9bn and RFM at $25.8bn / $7.6bn.
  • Windows OEM licensing declined less than expected and declines in on premise Office revenue was more than offset by Office 365.
  • Cloud based revenues continue to be very strong but backing out Azure, shows that the revenue run rate is about $400m per quarter.
  • This is less than I have previously forecast and much less than the $2.1bn reported by Amazon this quarter (see below).
  • However, it is worth noting that a very large number of Amazon’s customers run Microsoft systems in their clouds and I do not believe that the Amazon figure excludes licence revenues that it has to pass back to Microsoft.
  • Microsoft will not be booking these figures in cloud but in enterprise licences.
  • These results continue to give me confidence that Microsoft is executing very well on its primary mission to deal with the legacy issues of Windows license revenues and on premise sales of Office software.
  • The strategy around the Digital Life and Digital Work ecosystems (missions 2 and 3) and putting them both together in a seamless, easy to use and fun way is still badly defined.
  • Hence I remain uncertain as to whether Microsoft will succeed with its other missions (see here).
  • Fortunately, success in the ecosystem is not required to still see upside in the shares which I think can can easily reach $60.
  • Microsoft remains one of my top choices.

Amazon

  • Amazon reported strong Q3 15A results underpinned by a surprise profit and the promise to generate profits in Q4 15E.
  • Q4 15E is a quarter when Amazon has typically slipped back into losses as it drives for market share during the holiday shopping season.
  • Q3 15A revenues / EPS were $25.4bn / $0.17 compared to consensus at $24.9bn / LOSS $0.13.
  • Once again it was North America that really drove the results with 3.5% operating margin reported.
  • This was materially enhanced by Amazon Web Services which reported revenues of $2.1bn up 78% YoY and EBIT of $525m.
  • OPEX did not grow as quickly as many had feared due to the greater discipline that now surrounds how Amazon makes its investments.
  • Amazon was badly stung by the disaster of the Fire phone and it has tempered its expectations in hardware accordingly.
  • Guidance was fair with revenues / EBIT of $33.5bn – $36.8bn / $0.08bn – $1.28bn compared to consensus at $35.1bn / $1.2bn but it was the hope that losses are now really a thing of the past that really drove the shares upwards.
  • Amazon has made a habit of slipping in and out of losses and of wasting larger amounts of money on badly thought out experiments in consumer electronics.
  • If this can now reliably be put to bed, then the shares are likely to have a much steadier time of it going forward.
  • However, I continue to have issues with the valuation as at $616 the shares are trading at 112.0x 2015E PER and 72.0x 2016E PER.
  • This is already pricing in a lot of profit and margin that has not yet materialised.
  • Amazon has been doing the right things to improve its financial performance but its long term strategy around the consumer ecosystem is still very shaky.
  • There are plenty of other companies with growth, much better profitability trading at a fraction of the valuation.
  • Microsoft, Samsung, Facebook and Apple all fit this bill comfortably.

 

 

Alphabet – All the wrong moves.

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I am increasingly troubled with the outlook for Google.

  • The outlook is becoming increasingly uncertain as Google is running out of growth and its moves to rectify the situation are not convincing in any regard.
  • Google, or Alphabet as we must now call it, has unfurled three new strategies to halt the inevitable decline in its growth rate and unfortunately, I don’t think that any of them are going to work.
    • First: China. After leaving the market 5 years ago, Google needs to get back in because growth elsewhere is drying up.
    • Unfortunately, during that time 4 local giants have emerged each of whom have already built a very sizeable position in the home market.
    • Furthermore, I continue to believe that even if the Chinese allow Google back into the market, it will be competing with one arm tied behind its back (see here).
    • Google has missed this opportunity and strategic investments (such as Mobvoi) are very unlikely to help.
    • I see the Chinese market as Chinese ecosystems for Chinese users with very little foreign presence other than Apple.
    • Second: Video. Google has followed in Axel Springer’s footsteps (see here) and launched a subscription service called YouTubeRed for YouTube which will be free of all advertisements.
    • To sweeten the deal, users will be able to download videos for offline viewing.
    • This is Google simply allowing users to pay with cash for the YouTube service rather than with personal data and advertisements.
    • The weakness of this strategy is that the subscription at $9.99 per month is so ridiculously expensive that I think that it will get no traction.
    • Third: Enterprise. Google has launched a promotion for the enterprise whereby companies that switch to Google Docs do not have to pay until their current contracts expire.
    • Google Docs currently costs $50 per employee per year which could amount to a very significant discount for a company with hundreds of employees.
    • I think that this would have been attractive 2 years ago when Office was only available on Windows and was very expensive.
    • Now Office is available for free on smartphones and tablets with screens under 10” in size and includes most of the basic editing functions that are possible on those devices.
    • Office is much more widely used and despite claims to the contrary, the fidelity of converting an Office document to Google Docs and back again is poor.
    • Furthermore, Office 365 offers much more than just documents with enterprise class communications, cloud storage and collaboration.
    • Gmail and hangouts can hardly be described as enterprise class either in terms of their functionality or their robustness and stability.
    • I think that this push from Google is coming too late as Microsoft has already done enough to remove the incentive to use anything else.
    • Its huge installed base which regularly share documents with each other is another major barrier to switching.
  • The net result is that I don’t think that these three strategies are not going to drive a resurgence of growth which consequently remains almost completely dependent on Android.
  • This is where I get worried because RFM research (see here) has found the first signs of a weakening in Google’s ability to control Android.
  • If this continues, then Google will no longer be able to dictate terms to Android device makers meaning that its revenue growth Android may well come under pressure.
  • When I take this on-top of the other challenges that Google is facing in Android and the recent rally in its share price, I completely lose my enthusiasm.
  • RFM estimates that the shares are worth $636 if nothing goes wrong with its revenue growth from Android.
  • Hence, it all looks like downside from here.
  • Selling Google to finance a position in Microsoft, Facebook or even Samsung looks like a sensible move.

Yahoo! Q3 15A – Scratching for scraps

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The ecosystem is Yahoo!’s only chance at a turnaround.

  • Another lacklustre set of results further underscores that Yahoo!’s inability to execute on its assets is the main reason for its underperformance.
  • Furthermore, it appears that Yahoo! has simply been buying revenue growth as all the improvements seen in the top line this quarter were more than eaten up by growth in traffic acquisition costs (TAC).
  • Q3 15A revenues-ex TAC / EPS were $1.0bn / $0.15 missing consensus of $1.03bn / $0.16 and falling by 8%YoY and 70% YoY respectively.
  • The worst culprit was search revenue which grew by 13% YoY but after TAC was deducted, it saw a 13% YoY decline clearly indicating that Yahoo! has simply been buying revenue growth rather than adding any value of its own.
  • It is here where I find the critical flaw in Yahoo!.
  • Outside of a few desktop services like mail, sports and finance, it adds very little value to users which is why it has to pay away its revenue growth to those that do.
  • To rub salt into the wound Yahoo! was proud to announce that during Q3 15 mobile generated $270m in GAAP revenues growing 31% YoY.
  • I continue to conclude that Yahoo!’s inability to execute on its assets is costing shareholders 89% of the mobile opportunity.
  • Yahoo! has good coverage of Digital Life which combined with its 500m monthly users means that it should have generated far more revenue than this.
  • Benchmarking Yahoo! against Google, Twitter and Facebook leads me to conclude that Yahoo! should have generated something like $2.5bn in revenues from mobile rather than $270m.
  • This is further underlined by the fact that its competitors are all seeing revenue growth while Yahoo! struggles to keep its revenues flat.
  • This continued inaction led to more disappointment in guidance with Q4 15E revenues expected at $920m-$960m, missing consensus of $1,079m by 13%.
  • What Yahoo! needs to do is put its assets together in an integrated, easy and fun to use way and push them onto mobile devices.
  • This would create a consistent environment where users could live their Digital Lives with Yahoo! and critically, enjoy doing so.
  • This would also allow Yahoo! to have a much deeper understanding of its users and thereby be able to monetise them much more effectively.
  • I continue to believe that Yahoo!’s inability to do this is what is causing it to miss out on 89% of the opportunity in mobile.
  • Without this, Yahoo! is left scratching for the scraps, being forced to form partnerships with its stronger rivals and pay away large proportions if not all of the revenues that it earns to others.
  • I fear that the outlook will continue to deteriorate from here.
  • There are far better places to look for exposure to the digital ecosystem.

Apple Music – The power of default

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Pre-installation and default remain very powerful.

  • The latest figures from Apple on its music service are better than I thought they would be given the substantial weaknesses that still exist when comparing the service to market leader Spotify.
  • Apple Music now has 15m users of which 8.5m (56.6%) are on the 3 month free-trial.
  • This leaves 6.5m users that are now paying for the service giving Apple annualised revenues of $780m.
  • However, how many users have forgotten to cancel the service and will do so after the first month when they receive the bill is unclear.
  • Either way, this is pretty good performance and implies that around 60% of users who trial the service go on to pay for it.
  • This is completely at odds with the feedback that the service has received where Spotify offers a better experience with a much richer feature set at the same price.
  • This is one of the clearest demonstrations yet of how important it can be to control the platform upon which a service is to be sold.
  • Apple Music was installed by default on iOS devices that upgraded to version 8.4
  • The Apple Music icon was prominently featured and the trial can be started with a single button push.
  • Furthermore, as Apple already has a credit card relationship with every iOS user, if the user does nothing he becomes a paying user at the end of the trial.
  • This combined with the strength of Apple’s brand is a major reason why an inferior service has been able to get reasonable traction.
  • The question is whether it can keep it.
  • I continue to think that the risk for Spotify is not in losing users but in a slowdown in new users signing up because they have gone with the easy default option.
  • So far, I do not think that Apple Music has had an impact on Spotify’s performance because I see the market being big enough for more than one player.
  • However, Spotify needs to step up its marketing and help users realise how its service is better than Apple Music for the same price.
  • The first step would be to re-run the year end 2014 campaign where users were offered three months of the paid service for $0.99.
  • It is easy for existing users to understand how Spotify offers a better service but for new users it is not obvious at all.
  • In these sorts of situations users will tend to go with a brand they know and it is not difficult to argue that the Apple’s brand is far stronger than Spotify’s.
  • On Android it will be a completely different story and here, I think that Apple will really struggle to gain traction.
  • In fact I think that Apple is only releasing an Android version of its service to ensure that its family plan will be usable by all members of the family.
  • It is not unusual for a household to have devices on multiple platforms and the family plan on Apple Music is the one area where it is cheaper than Spotify.
  • The net result is that I remain unconcerned regarding the impact of Apple Music on Spotify but the key quarter to watch will be Q4 15E which is when users will have been paying for the service for a full quarter.

 

Alibaba – Empire builder

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Those with resources now have a substantial advantage.

  • Alibaba is moving to increase its grip on the Chinese market by bidding $3.5bn for the 81.7% of Youku that it does not already own.
  • Youku is the Chinese equivalent of YouTube and has around 500m active users compared to Alibaba’s core e-commerce offering which has around 350m.
  • This is yet another big step by Alibaba towards becoming an ecosystem rather than just an e-commerce platform.
  • In order to do this, it has to properly address the activities where spend their time on smartphones and tablets.
  • Taking Youku on board gives Alibaba a very strong position in the 4th most important Digital Life service (media consumption).
  • However, key to this acquisition will be integration.
  • Youku needs to be integrated into Alibaba such that its users and their data all become part of the Alibaba family.
  • If Youku continues to operate independently, then much of the value that Alibaba could reap from this acquisition will be lost.
  • I suspect that this acquisition is as much about keeping everyone else out as it is about expanding the Alibaba ecosystem.
  • RFM sees 5 players (Baidu, Tencent Alibaba, Xiaomi and China Mobile) all trying to dominate the Chinese market.
  • Alibaba will now have a platform to offer paid content like Netflix and Amazon Prime as well as a place to create an encyclopaedia of video content like YouTube.
  • This acquisition will also put Xiaomi further onto the back foot.
  • Its key Digital Life offering in the Chinese market is media consumption and the vast majority of the usage that it gets on its devices is users engaging with this service.
  • On almost all of the other services it has no offering and it is these blanks that the company badly needs to fill.
  • Couple this with a loss of momentum in 2015 and a resurgent Huawei in the home market, and it is clear that Xiaomi is finding life much more difficult this year.
  • In its home market, its current rivals are the handset makers but this is soon going to change.
  • To create an ecosystem from which it can earn a decent margin Xiaomi is up against Alibaba, Tencent, Baidu and China Mobile all of home are engaged upon the same strategy.
  • These four have a huge advantage as they are bigger and more cash generative such that when an opportunity such as this comes up they can act quickly and decisively.
  • This means that they will have the advantage when it comes to acquiring and building the assets needed to have a successful Chinese ecosystem.
  • RFM predicts that the Chinese market will end with an addressable market of around 900m users which is just enough for three ecosystems to be big enough to earn high returns.
  • Hence, it is those with the resources to invest now that are likely to come out on top over the longer term.
  • I continue to think that Xiaomi is going to have a difficult time and is likely to need more money.
  • With the last round being done at a valuation of $45bn and the peak of its momentum, a down round is not an impossibility.