Sony – Rite of passage pt. II.

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Reactive and defensive needs to become proactive and offensive.

  • Sony has made a move in the right direction but the next steps will be bigger and much harder.
  • Sony has responded to the news that a remote play app. will be available from developer Twisted for PCs (see here) by announcing that it, also is developing an app that will allow users to play PS4 games via a desktop.
  • Because Sony has access to the source code that runs both the PS4 and its controllers, it is in pole position to deliver by far the best experience in terms of fluidity and performance.
  • I expect that Sony will give this software away free to anyone who already owns a PS4 which is bad news for Twisted who needs to charge for the software in order to be able to invest the time in its creation.
  • However, the developer can at least take comfort from the fact that it has almost certainly forced Sony’s hand in terms of delivering features that do not necessarily fit with its own agenda.
  • I hope that this is just the first step and that we will shortly see the remote play app working on all Android devices and being extended to iOS.
  • This would remove a reason to buy a Sony manufactured smartphone but would significantly increase the appeal of the PS4 as a gaming platform.
  • When I look at the RFM Digital Life pie, gaming is the space where users spend most of their time but of the large ecosystems only Tencent has a strong position on mobile.
  • In developed markets Sony and Microsoft are by far the strongest in gaming and I think that this space remains wide open for someone to dominate like Facebook has dominated social networking.
  • Activision Blizzard is having a go at this via its acquisition of King Digital but it has a lot of work to do before it can get there.
  • By contrast, Sony already has a very strong position in console gaming but has so far been unable to think outside of the niche defined by its hardware.
  • I hope that this proves to be the first small step into a larger world and I do see the possibility for Sony to use PlayStation as its launch pad into something much bigger and much more valuable.
  • Unfortunately, Sony has a history of snatching defeat from the jaws of victory and its current structure and culture are not best suited to the actions that this will require.
  • Consequently, I see a reactive and defensive approach to the ecosystem which puts it at risk of losing to Microsoft in the next console generation despite its current dominance.
  • Microsoft, Samsung or Facebook for the long-term is where I would be positioned.

Mobile Ecosystems – One hit wonders vs. Jack of all trades

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Monetisation is hard. Expansion is even harder

  • With growth in the smartphone shipments slowing fast and tablets in negative territory all eyes are turning from user acquisition to monetisation and expansion into other areas of Digital Life.
  • I believe that there are three stages for a Digital Life start-up:
    • One. Get as many users as possible regardless of revenue generation for the service.
    • Two. Monetise the service via advertising or subscription.
    • Three. With monetisation working and generating cash flow, investments can be made in other areas of Digital Life in order to become an ecosystem.
  • Almost all of the Digital Life services companies are at one of these three stages and I think that only Google has really had any success in stage three and that has not been without problems.
  • Almost everybody else has run into trouble at either stage two or three.
  • For example:
    • Twitter has run out of growth because it has fully monetised its segment and has seen no success in other segments.
    • Google has failed to win any traction in Social Networking with Google + and has recently withdrawn.
    • Snapchat recently closed down its content discovery offering because it gained little traction.
    • Tango has just laid of 9% of its workforce as its attempt at e-commerce has failed despite investment and support from Alibaba and Walmart.
    • Facebook has made several false starts to expand from Social Networking and as only now realising how difficult it is to get this right.
  • The net result is that to create an ecosystem both the buy and the build routes are fraught with difficulty.
  • Build
    • Advantage: The new offering can be fully integrated and data shared with the existing successful service such that the data generated is much more valuable. This can be used for more accurate targeting of advertisements or to make the service more valuable if monetising via subscription.
    • Disadvantage: Growing a start-up service from scratch inside an existing company is difficult and very few companies have had any success here.
  • Buy
    • Advantage: The service comes already developed and with an active user base which can be leveraged.
    • Disadvantage: This route is often far more expensive and dealing with successful founders can be highly problematic. In many cases founders will insist on remaining independent meaning that integration is impossible for a considerable amount of time. Only full integration will deliver to the acquirer any value from making the acquisition and this is essential if an ecosystem strategy is to pay off.
  • The net result has been either a one hit wonders (Twitter, King, Snapchat and so on) or a jumble of assets from which there is little direction (Yahoo!, Amazon, Microsoft and so on).
  • This is why the creation of an ecosystem is so difficult and why there are only a handful that are likely to make a substantial return on their investments in the long run.
  • I suspect that the Chinese are better at this than their Western counterparts but their services are so China oriented that they have little relevance outside of the home market.
  • Fortunately, the Chinese market is so big that there is space for three hugely successful ecosystems in the home market alone.
  • Of all the others, the two that I think really understand this issue are Facebook and Microsoft although I am concerned that Microsoft may be thinking twice with regards to the consumer ecosystem.

Xiaomi – Reality check pt. III

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Stagnation puts an 87% hole in the valuation.

  • In 2014, Xiaomi was growing very rapidly, had a valuation of $45bn and there was talk of an IPO being done at $100bn.
  • Consequently, it could afford to splash-out on the best components as no one cared whether Xiaomi was making any money or not.
  • By early 2015, it was clear that problems were emerging as growth ground to a halt and nothing that Xiaomi has done since has been able to re-start it.
  • I have long argued that Xiaomi has ground to halt because there is only so much volume that can be sold through the Internet (see here).
  • This has been compounded by competitors catching on and mimicking its style meaning that it no longer really stands out from the crowd.
  • This is why the ecosystem is so important.
  • By developing its own ecosystem, Xiaomi will have something that no one else can copy and I still think that this is the only route that Xiaomi has to reaching substantially better profitability.
  • Xiaomi must either start growing its volumes again or it must create value for its devices through the development of an ecosystem.
  • Both of these routes require significant investment in the short-term which puts Xiaomi in a very difficult position.
  • Its Android competitors (Samsung and Huawei) and its ecosystem competitors (Baidu, Tencent and Alibaba) all have strong internal cash flow giving them the ability to invest.
  • Xiaomi does not as it is barely profitable meaning that a big increase in investments will require it to return to the market for more money.
  • This is where the real problems begin as it is very unlikely to be able to raise money again at $45bn meaning raising the spectre of a down round.
  • I have previously valued Xiaomi at $21bn (see here) but I can see downside risk to this unless either growth or margin starts to go in the right direction.
  • In 2014, the $45bn valuation was arrived at by assuming that Xiaomi was the next Apple and applying the same EV/Sales multiple.
  • The fact that Apple has a high EV / Sales multiple because it is extremely profitable was deemed not to be an issue due to its very high growth at the time.
  • However, I have long believed that a comparison to EV/EBIT is far more appropriate as this accounts for the fact that Apple makes money and Xiaomi does not.
  • Apple is currently trading on EV/EBIT of 6.4x 2016E and 6.3x 2017E
  • If I assume that Xiaomi generates 4% margins on $22.8bn (91.2m units x ASP $250) of revenues in 2016E and $23.3bn (93m units x ASP $250) in 2017E, I end up with profit forecasts of $912m in 2016E and $932m in 2017E.
  • Applying Apple’s EV/EBIT multiple gives a valuation of Xiaomi of just $5.9bn some 87% below the current valuation of $45bn.
  • In 2014, I was prepared to value Xiaomi’s EBIT at a 300% premium to Apple’s because of its much higher growth but that is no longer the case (see here)
  • Consequently unless Xiaomi can re-start real growth or substantially lift its margins there is no way anything close to $45bn can be justified.
  • I can see hefty write downs coming.

Sony – Rite of passage.

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Sony needs to embrace the hackers not shut them out.

  • How Sony reacts to software developed to allow remote play of games on the PS4 will give a good indication of how well Sony really understands the market that it is trying to address.
  • A software developer known as Twisted (see here) has already modified the Sony PS4 Remote Play app to allow users to use any Android device rather than one made by Sony.
  • This week it is releasing a PC version of this functionality but will be charging $10 for the software.
  • This will allow users to play PS4 games on PCs that are on the same local network as the PS4.
  • This is pretty much what Microsoft has promised with Windows 10 and Xbox One.
  • There are two weakness in Twisted’s offering:
    • First: Sony is perfectly capable of shutting this unofficial access down by updating the PS4 firmware.
    • Second: The modifications are unofficial meaning that they are tricky to implement and may not offer the best user experience.
  • I think that if Sony is smart it will follow Twisted’s lead and enable Remote Play to run superbly on as many devices as possible.
  • This is because I think that the battle for the next console generation will be fought in the user experience and the ecosystem.
  • When I look at how well the PS4 fares against those two metrics, it is miles behind the Xbox One.
  • Hence, I think there is a real risk that it loses a massive amount of market share next time around.
  • Enabling Remote Play on as many devices as possible would enhance the appeal of the PS4 as a gaming platform and demonstrate that Sony understands where the value in this proposition lies.
  • Sony should either write the apps itself or allow others to do so such that any smartphone, tablet or PC can run PS4 games remotely to a very high standard of quality.
  • The problem with this is that it requires Sony to understand that the added value to its PlayStation platform of Remote Play will be much greater than any differentiation that this feature creates for its mobile devices.
  • Sony’s recent re-organisation into separate legal entities (see here) effectively makes it a conglomerate once again which will make this kind of broader thinking combined with rapid action very difficult.
  • Consequently, I expect that Sony will close the door on these sorts of modifications believing that it can only grow its revenues by selling its own hardware.
  • This combined with the fact that Sony seems to be happy with its current PS4 offering (see here) leads me to believe that Sony will do nothing about its user experience and the ecosystem until it is too late.
  • I think that Microsoft could easily dominate the next generation of the console leaving Sony to go the way of Sega and Nintendo.

BlackBerry – High jump.

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BlackBerry’s target of 5m devices looks much too high.

  • The new BlackBerry Priv and its rumoured successors are aimed at such a narrow niche that I doubt that they will ever make money.
  • Once this realisation has sunk in, I think that BlackBerry will abandon its hardware business and focus on its software business which has recently been bolstered with the acquisition of Good (see here).
  • I think that the main problem with this new line of attack in hardware is that apart from a tiny segment of the market, the smartphone user no longer cares about having a physical keyboard.
  • This is very similar to the issue that killed Nokia’s smartphone business in 2007.
  • Prior to the iPhone, a smartphone had to be a good phone first and everything else second and Nokia’s entire line up was based upon that supposition.
  • The arrival of the iPhone turned this on its head such that mediocre phone performance was no longer a barrier to selling devices.
  • It was Nokia’s inability to see that the market had changed led to it losing almost all of its market share.
  • Something very similar has happened in the enterprise segment.
  • Prior to 2007, an email device had to have a decent physical keyboard upon which to type.
  • However, Apple has made the touch-based form factor so popular that almost all users have learnt to adapt to typing on a screen keyboard which has obviated the need for a physical one.
  • There are some hard-core users in the financial and government who will love this device but these very few and far between.
  • These days, there is very little need for a physical keyboard which is why I think that BlackBerry’s Priv line of devices will only sell in tiny volumes.
  • In Q3 15A, Counterpoint Research estimates that BlackBerry sold just 700,000 units meaning that the Priv has to be a knock-out success just for BlackBerry to break even.
  • The problem here is that the smartphone market is slowing down and becoming even more competitive and into that mix there is a new device with a feature that almost no one cares about.
  • Furthermore, this device is so expensive that only users who care passionately about a physical keyboard are likely to buy it.
  • Consequently, I expect BlackBerry to miss its target of 5m units and to withdraw from the market in 2016 focusing instead on software.
  • Here, it has a credible proposition which is more than I can say for HTC which is in a very similar situation to BlackBerry but has no plan B.
  • I can still see downside in both of these companies but HTC most of all.

Jolla – Rogue wave.

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The sailors at Jolla may be better off selling their boat.

  • Jolla, the creator of the Sailfish OS for mobile devices has filed to restructure its debts as it has been unable to close its latest $10.6m financing round.
  • This has resulted in 50% of its staff being temporarily laid off effectively suspending development of the OS until another solution can be found.
  • Jolla has been engaged in trying to licence the Sailfish OS as an alternative to Android, but has only met with limited success.
  • Indian handset maker Intex signed up in July with the intention to release devices this year, but of these there is no sign.
  • I suspect that Intex has found it more difficult and more expensive than expected to get a device to market, which combined with the debt restructuring, casts serious question marks over this relationship.
  • The irony is that although Google’s growth has made it very difficult to convince anyone to buy an alternative, the time has never been better.
  • Google’s ecosystem is under siege on all fronts (see here) and its inability to distribute updates to its software severely hampers its ability to improve its user experience.
  • Furthermore, the Amazon App Store is getting better and better at replicating what Google Play has to offer and so there is less reason for a device maker to be forced down the Google ecosystem route.
  • Despite this, it is increasingly difficult to convince anyone that Google’s position is more vulnerable than it was 12 months ago.
  • What Jolla needs is a partner that needs an alternative to Google and one that is willing to commit its ecosystem to the Sailfish OS.
  • Consequently, I think that Baidu and Tencent must be its best chance of salvation but I suspect that they will want to acquire the company.
  • Alibaba is increasingly committed to its own in-house version of Android (Yun OS) but Baidu and Tencent appear yet to have made a commitment one way or the other.
  • Both Baidu and Tencent are large enough to have the scale to warrant an in-house development which is why I suspect that they would prefer to buy rather than licence.
  • This would also give them the ability to ensure that the software is developed exactly to their specifications which is becoming an increasingly important factor in differentiating and delivering a good user experience.
  • Jolla’s difficulties also raises questions around the viability of Cyanogen which is in a very similar line of business.
  • The one difference is that Cyanogen is based on Android making it an easier sell and the company also has the benefit of having raised $85m in March 2015.
  • However, Cyanogen’s business model is to take a revenue share of the services that it enables with its software which I think could very easily come unstuck.
  • Despite this, the latest funding gives Cyanogen time to work out where it fits in the mobile ecosystem which is something that Jolla does not have.
  • Consequently, I suspect that Jolla well end up being acquired because despite its issues, the Sailfish OS provides an excellent starting point for the creation of an ecosystem.

Yahoo! – Purple rain

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Yahoo!’s assets and its few remaining loyal employees are bleeding purple.

  • Yahoo! is still profitable but it seems to be slowly bleeding to death as the falling appeal of its assets has caused traffic to fall which can only mean further revenue declines.
  • This comes on top of some of the worst disharmony inside Yahoo! that I have ever seen, explaining why there is no plan to fix the current problems and return this company to growth.
  • On top of a large number of executive exits, I understand that both morale and belief in the company have plummeted
  • These problems are so acute that RFM calculates that Yahoo!’s lack of a mobile strategy is costing the company $2.5bn per quarter in lost revenues. (see here).
  • This means that Yahoo! is failing to monetise 90% of the opportunity it has and that the entire company’s revenues are only 31% of what they should be.
  • The biggest problem remains execution.
  • When Marissa Mayer joined Yahoo! in 2012 she knew exactly what she had to do and in the next 18 months she built a good series of assets that could have been welded together into and ecosystem.
  • However, in true Yahoo! style (remember Flickr) very little has been done with these assets to make them onto something that is unique and enticing to users.
  • It is the ecosystem that lies behind the growth and profitability of Apple and Google and it is Yahoo!’s failure to properly enter this space that has put it in its current predicament.
  • An ecosystem requires an integrated series of services that are easy and fun to use and with a user identifies as being a unique place to live his digital life.
  • Instead what Yahoo! has is a jumble of assets and online brands that have been left virtually untouched since their acquisition.
  • A quick look at comScore and the Apple App. Store reveals the extent of some of the damage.
  • Traffic to its fashion segment and to Yahoo! Screen is down around 50% YoY while its top app., Yahoo Mail, languishes at No. 84 and is the only app. in the top 100.
  • I understand that traffic to many of its other properties is also in negative territory.
  • The net result of this can only be further declines in revenue as traffic is the life blood of any internet business based on advertising.
  • Yahoo! is currently valued at $30bn with $5.5bn in net cash giving an enterprise valuation of $24.5bn.
  • Its stakes in Alibaba and Yahoo Japan are worth $38bn alone which if I spin-off and tax at 30% (an unlikely outcome) still gives me value of $26.6bn.
  • This means that the market is assuming that Yahoo! itself has negative value of at least $2.1bn.
  • The way that things are going, it looks very much as if plenty more value destruction is to come before shareholders really take matters into their own hands and force a shake-up.
  • I see the value in the shares but this has all the hallmarks of a classic value trap.

 

IPO Window – Unicorns and donkeys Pt II

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The best thing for Square would be to pull its IPO.

  • The news that Square has again cut the price of its IPO serves as a severe warning that the IPO window is about to slam shut.
  • Square, the US payments company and competitor to iZettle, is looking now to price its IPO at $9 per share giving a valuation of $4.1bn.
  • This is 25% lower than was expected last week ($11-$13 per share) and 32% below the last round that was struck at $6bn.
  • However, the investors in this last round are protected by a device called a ratchet.
  • This means that if the IPO price is below that which was promised, these investors are issued extra shares to make up the difference.
  • In this case an extra 10.3m shares costing other shareholders $93m will be issued to these investors who invested $150m and are guaranteed a 20% return.
  • In my opinion this creates a conflict of interest as it is becoming clear that the best interests of the company would be served by pulling the IPO.
  • This is for a number of reasons:
    • First. Sentiment is starting to turn against hugely valued start-up companies making it a bad time to sell shares. (see here)
    • Second: Square’s growth is slowing and it is not making money nor is it generating cash. Public companies tend to do better when they are profitable unless they are very fast growing.
    • Third: Square’s CEO is also the CEO of Twitter which is a far from ideal situation for either company (see here).
  • Consequently, I think that the embarrassment of delaying the IPO is far outweighed by the benefit of waiting for a better time and getting the company into better shape before going public.
  • The problem is that the investors in the latest round have no incentive to call off the IPO because as long as the shares don’t fall below $7.2 per share they will make money when the lock-up expires.
  • With a bad IPO, Square will require a spectacular return to form in order to shift the stigma of its bad start and of this there is no sign.
  • Unfortunately, I think that the IPO will be going ahead and hence, I am not optimistic with regards to its post-listing performance.
  • This is likely to have a knock-on effect on private company valuations and expose a number of so-called unicorns for the donkeys they really are (see here).
  • In the long-term a reset of valuations to realistic levels is a good idea but the journey to get there is always very painful.

Google – Google minus.

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Reddit and Twitter look like more realistic targets than Facebook.

  • Google has announced a significant restructuring of Google + removing the focus on social networking and instead targeting interests (collections) and communities.
  • There is no doubt that Google + has been a huge disappointment and despite substantial investment it has failed to gain any meaningful traction.
  • Google can claim hundreds of millions of users thanks to the integrated nature of its services but when one looks at usage of Google +, there is only empty desert.
  • The restructuring of Google + is an admission that Facebook, Twitter, Snapchat and so on have won the social networking space meaning that it needs to become something different.
  • The new aim of Google + is to focus on two areas collections and communities.
    • Collections groups users’ posts around different types of interests which other users can choose to follow.
    • Communities is similar to collections except that it encourages more active discussion of the various topics and interests that the community is based around. Users belong to a community rather than follow it.
  • With this change it is clear that Google is moving out from social networking and instead focusing on the much softer target of content discovery and online discussions.
  • Hence, instead of competition with Facebook, Google is now going after Reddit, Medium, Pinterest, Tumblr, Twitter and so on.
  • These companies are not without their own problems and Reddit and Twitter at the moment look like particularly soft targets.
  • However, this means that Google’s position in Digital Life now looks substantially weaker as it is no longer competing in the very important social networking space.
  • Combine this with Google’s absence in gaming and suddenly its ecosystem looks much weaker in the long-term.
  • I do not think that this is going to cause a dent in Google’s advertising revenues today but it raises question marks about Google’s ability to grow its revenues in the long-term.
  • Currently, Google monetises the data that it collects from its Digital Life services through search but this is likely to change.
  • As monetisation mechanisms become more sophisticated, I see monetisation occurring more directly within the Digital Life services themselves.
  • This means that what the ecosystem understands about the user will be monetised more directly through maps, video, games and so on.
  • An ecosystem without the services to both understand the user and monetise the traffic, will have real problems in securing long-term growth.
  • Hence, I am concerned that Google’s weakness in both gaming and social networking will cause long-term growth problems.
  • Add this to all of the other problems that Google currently faces (see here) and I can’t see any reason to remain involved with the shares.
  • I would prefer Microsoft, Samsung or even Apple to Google.

Facebook & Google – Fair weather friends.

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I think the new found friendship will be short lived.

  • Facebook has been allowing Google to index some of its data for some time but a new agreement struck last week will improve the experience for mobile users.
  • Google has been able to search some of Facebook’s user data since 2007 which was expanded to Facebook comments in 2011.
  • The latest evolution will allow searches effected on mobile devices to launch the link directly in the Facebook native app rather than its inferior website within a mobile browser.
  • This should improve the user experience and drive engagement for Facebook as well as searches on Google.
  • This data sharing is a two way street where Facebook gets better content discovery and more traffic driven to its site while Google gets to learn about some of things that Facebook user’s get up to on the site.
  • Right now this is a win-win as Facebook and Google’s Digital Life pies do not really have any areas of overlap.
  • Google has offerings for both social networking and instant messaging but usage of them is so low that it is almost as if they do not exist.
  • However, RFM research sees Facebook expanding way beyond its current niche and moving into gaming, search, digital assistants and media consumption.
  • This will bring it into direct competition with many of Google’s core assets and this is where I see the relationship beginning to break down.
  • I see Facebook’s long-term ambitions being to increase its revenue 3 or 4 fold from where it is today and this will not be achievable without building a fully-fledged ecosystem and taking market share away from Google.
  • It is as this ambition becomes clear that I suspect that the sharing of data between the two companies will cease and full completion will begin.
  • Facebook’s valuation is already very high and I think there will be a correction before the long-term strategy delivers results.
  • Hence, I think that then is the right time to take a large position for a 3-5 year investment.
  • However, I am becoming increasingly concerned about Google.
  • It is under assault on all fronts from Apple, the EU, Microsoft in the enterprise and now Facebook in the long-term.
  • Furthermore, the valuation of the shares assumes that nothing goes wrong with the current outlook which is increasingly looking like the best case scenario.
  • Consequently, I see no real upside but plenty of scope for downside and think the time has come to take the money off the table.
  • It is too early to buy Facebook as I think it will have a correction when the current leg of growth slows down and instead would prefer Microsoft or Samsung for the immediate term.