MWC Day 2 – iPhone 5se.

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The 5se needs to be something very different but it is unlikely to.

  • The fact the two companies that make almost all of the profit in the mobile handset industry continue to shun MWC has not stopped the endless rumours and questions.
  • Foremost of these is will the iPhone 5se push iOS further into the mass market eating into the traditional Android market.
  • This has been spurred by rumblings from the supply chain that Apple is gearing up to ship 50m units of this device.
  • It is important to bear in mind that these same rumblings also predicted that the Apple Watch would ship 100m units in its first 12 months.
  • Furthermore, this is exactly the same question that was asked about the iPhone 5c which had almost no impact at all.
  • The problem with the iPhone 5c is that it was not cheap enough to appeal to the mass market meaning that most users either paid up for the real thing or bought the much cheaper 4s.
  • The net result was that Apple’s iPhone ASPs barely moved and many operators ended up with far more stock of the 5c than they had bargained for.
  • The iPhone 5se looks set to take the same path unless Apple does something radically different and of this I see no sign.
  • Looking at the rumoured specification of the iPhone 5se, it is almost certainly not going to be a mid-range product and hence I think it will be a non-event when it comes to volumes.
  • There are two problems that prevent Apple from cracking this problem.
    • First. By its own admission, Apple does not do cheap well and almost every attempt (except iPod) it has made has failed.
    • Second. To make 40% gross margin on a much lower priced product, Apple will have to meaningfully reduce the specification of the device which risks breaking the ecosystem.
    • In RFM’s 7 Laws of Robotics which measure the quality of an ecosystem, Law 7 refers to software consistency.
    • Apple’s software consistency across its entire ecosystem is second to none and this is a major reason why the user experience is so good and why developers are able to earn excellent returns from iOS.
    • A lower end product would mean that apps would no longer run consistently across all iPhones adding complexity, cost and difficulty for developers.
    • The lack of software consistency in the Google ecosystem and all of the other ecosystems based on Android is a major reason why the user experience is second rate and why developers earn less money from targeting these devices.
    • Hence I think that gaining a few points of market share is simply not worth the risk of fragmenting the incredibly consistent ecosystem that is iOS today.
  • This why I think that the iPhone 5se will be a non-event as far as Android handset makers are concerned as I see nothing in this product that will make it perform any differently to the iPhone 5c.
  • Hence I see no change to the status quo where Samsung is the king of Android outselling every other handset maker by at least 2 to 1.
  • Samsung remains by top choice amount the Android handset makers although it needs to be extremely wary of Huawei which is showing that it is prepared to spend the big bucks to become number 1.

MWC Day 1 – CES wannabe.

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MWC wants to become CES but misses the importance of software.

  • From the fairground VR ride at Samsung to the Submarine at SK Telecom and the endless devices that have nothing to do with telephony, it is clear that MWC is becoming more like CES.
  • Samsung launched the Galaxy s7 / s7 EDGE but most of the excitement was around the Gear VR, championed by Facebook, and the Gear 360 which captures VR pictures and video.
  • Sony launched a series of products that aim to free the user’s eyes from the smartphone screen and define a new way of using Digital Life services.
  • LG launched its flagship G5 device that both looks good but also enabled a series of bolt-on modules that enhance media consumption (with Bang and Olufsen) and the imaging experience of the device.
  • HTC’s stand was split into two but while the phone area was very quiet, there was plenty of interest on its VR product the Vive.
  • Huawei launched the most interesting tablet with its Mate Book being the thinnest, lightest, fully functional tablet PC I have seen.
  • Huawei also takes the prize for spending the most money with a huge stand in Hall 3 and a customer area that takes up a third of Hall 1 that was also very busy.
  • At the end of the day, the show this year is all about devices that do not connect to the cellular network.
  • This is symptomatic of an industry that has realised that growth in smartphones has ground to a halt.
  • This combined with the fact that Apple and Google have siphoned off almost all of the profit, leaves device makers having to look for other markets to chase.
  • Consumer electronics is firmly targeted, but with everyone jumping on the same bandwagon at the same time could result in very aggressive price competition.
  • This is why differentiation is so important and as always, this is going to be achieved through software.
  • Software is the glue that will ensure that devices from the same company work optimally together and it is also what is needed to add the extra functionality needed to drive consumer purchase decisions.
  • Unfortunately, no one is talking about software where it seems that the hope is that the plethora of new devices is so dazzling that no one notices.
  • Furthermore, all of the companies grabbing the headlines are from Asia and software is something that Asian hardware vendors really struggle with.
  • This is critical because it is the vendor that really gets to grips with software that will offer the best experience, get the best reviews and drive consumer device preference even if it doesn’t have the best hardware.
  • Furthermore the added functionality that many (Sony in particular) are talking about requires a deep understanding of artificial intelligence and machine learning.
  • Again this is not an area that any of these companies excel at opening the possibility of an M&A frenzy once they have realised what is really required to make this work.
  • The net result is that growth is going to be very hard to come by this year as VR, AR, Wearables and IoT are still too small and too early stage to really plug the gap.
  • I think when these issues are solved, then other devices can begin to take up the slack of the slowing smartphone market as it is those great experiences that will encourage users to splash out.
  • Hence, what I am looking for at MWC is the seamless genius that allows the digital ecosystem to be delivered to users no matter which device they choose to use and of this, there is very little sign.
  • Until then, there is very likely to be little change in the non-Apple segment of the device market where it will be Google that reaps almost all the profits.
  • Microsoft, Samsung and Facebook remain my long term choices although Apple looks like a safe bet with little growth but a very low valuation to match.

Research Update – Mobile Ecosystems – Money Talks – Update

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16 03 Mobile Ecosystems

 

 

 

 

 

 

February 21st 2016:  Radio Free Mobile updates its ecosystem monetisation model with a new slide deck.

RFM research subscribers will receive their copy directly by email. 

Thanks to price erosion, the value of the smartphone and tablet markets are likely to decline this year. This will place even more emphasis on monetising ecosystems through advertising and subscription as revenue growth using these methods is based on subscriber numbers which are still growing nicely. This means that the fundamentals of Google, Facebook, Yahoo, Twitter, Amazon and increasingly Microsoft, will perform better than those of Apple, HTC, Samsung, LG and so on. However to access that growth, execution in growing the scope of the ecosystem has to be first class and here there are huge differences between the different players.

  • Money Talks. Rapid growth in the past has been driven by ecosystems monetising their assets more and more efficiently. Once the existing assets are fully monetised, growth returns to baseline unless either coverage of the Digital Life Pie is expanded or more users are added. This is difficult to achieve and many ecosystems are likely to see growth fall before their new strategies are in place drive the next leg up. Twitter is a great example of this problem.
  • Google’s long-term ability to control Android looks increasingly doubtful. This is because Google Play is no longer heads and shoulders better than anything else at emulating what the Apple App Store has to offer. To counter this, and to fix the chronic fragmentation within its ecosystem, RFM thinks that Google will take complete control of Android and turn it into a vertically integrated proprietary OS like iOS or Windows 10.
  • Facebook has almost completely monetised the opportunity open to it with its current assets. This is why RFM sees Facebook engaged on expanding its coverage to include gaming, media consumption and search. With these in place Facebook has a chance to become by far the largest ecosystem with a revenue line to match. This will take some time to come to fruition and there is scope for a slowdown before this kicks in. Facebook is now Google’s biggest threat.
  • Twitter has no respite in sight. It is attempting to develop a live video offering in order to expand into the media consumption segment. Unfortunately, Facebook and Google are already there with their own offerings. Twitter continues to lack a bold strategy to return the company to growth which RFM thinks is exacerbated by having a part time CEO.
  • Yahoo has given a knee jerk response to its problems by cutting staff and assets. Yahoo Games and (RFM assumes) Maps are to be closed bringing Yahoo’s coverage down to 41%. Even with 41% coverage of Digital Life, Yahoo’s underperformance of its potential is startling with 88% of the opportunity being missed every quarter.
  • Apple and Microsoft serve as the do and do not of monetisation via hardware. Apple generates 5-10x the amount of “ecosystem revenue” via hardware than it could if it used advertising. By contrast Microsoft generates no “ecosystem revenue” raising questions about the viability of its consumer ecosystem.

Freedom 251 – Alarm bells.

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Someone is losing a lot of money on this device.

  • The latest sensation to hit the mobile device industry is the launch of the Freedom 251 smartphone that is retailing online for INR251 or ($3.70).
  • The device is “made” by an Indian handset maker called Ringing Bells which is part of the Make in India initiative launched by Prime Minister Modi in September 2014.
  • The Freedom 251 runs Android Lollipop and sports a 4inch 540×960 display, a MediaTek 1.3Ghz processor, 1GB RAM, 8GB of internal storage and a dual-SIM 3G baseband.
  • The problem with this device is that the economics make no sense.
  • The device is being sold at INR251 with no strings attached meaning that any entrepreneur could buy up as many of the devices as he can get his hands on, break them up and sell the components at a profit.
  • On my calculations this device is being sold at gross margins of at least minus 650% with $26 of losses with every device sold.
  • This is before expenses for sales and marketing and warranty costs.
  • I do not think that there have been any development costs because in reality this device appears to have been sourced from Indian electronics importer Adcom. (see here).
  • The closest matching product is the Adcom Ikon 4 which currently sells for INR3,599 ($53).
  • Adcom is not a manufacturer and therefore it is extremely likely that this device was actually manufactured in China.
  • The big question remains who is underwriting this product? There are a few possibilities.
    • First. The Indian government. Although the company strongly denies that this device is state subsidised, there are many ways that this could still happen.
    • For example, the government could be a shareholder of Ringing Bells and thereby contributing cash to support the company without officially subsidising it.
    • Second. The Chinese company that actually made the phone.
    • Chinese companies are very keen to break into the Indian market as their home market is brutally competitive and showing every sign of maturing.
    • Consequently, it may have been willing to virtually give the phone away in order to get a toehold in the Indian market.
    • Third. The Freedom 251 could be sourced from old inventory that has already been written down to a very low level or even zero.
    • This is possible as the device has not been certified as safe by the Bureau of Indian Standards (BIS).
    • Consequently if the device batch failed the BIS safety tests it would become unsellable in the Indian market providing the manufacturer with little choice other than to write it down.
    • This could have enabled Ringing Bells to buy the device for almost nothing and thereby not lose money in selling it at such a low price.
  • The company’s line is that by making the phone in India it can reduce costs by INR400 per device with scale providing another INR500 of savings.
  • The long term hope is that the company will obtain enough scale with its devices to be able to make money by selling services to millions of users in a similar manner to Cyanogen.
  • Unfortunately with the likelihood that the device was actually made in China and with only 30,000 devices sold before the website crashed, these aspirations look highly questionable.
  • This launch has generated a lot of waves and I suspect that either after the first batch has been sold, the price goes up to $53 per device or that the company quietly disappears.
  • There is no way that these economics add up in the long term meaning that the alarm bells must already be ringing at the company.
  • I doubt that other handset makers will lose much sleep over this device or its pricing as it is clearly unsustainable.
  • RFM would like to acknowledge Aamir Siddiqui from xdadevelopers which was the source for many of the facts in this post. (see here).

Flexible displays – University challenge

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Flexible displays are hard to make and mostly useless.

  • The latest innovation around flexible screens has been announced by the Queen’s University Human Media Lab in Canada which uses the flexing of the screen as a method of command input.
  • A flexible LG OLED display has been combined with sensors and can detect to what the degree the screen is being flexed.
  • The headline example is using the flexing of the screen to flick through the pages of an ebook which is very similar to what a user would do with a paperback.
  • The paperback has the obvious advantage being readable in bright sunlight and infinite battery life.
  • The researchers also demonstrate using the device as a regular touch screen smartphone.
  • This is all well and good but I suspect that we are still very far from seeing flexible panels hitting the mainstream.
  • Samsung and LG have had fully flexible, virtually indestructible panels for years but to date, only the most basic curved and flexible panels have made it to the market.
  • There are two main reasons for this.
    • First. These devices are quite difficult to make meaning that a meaningful number of the panels fail quality tests and have to be thrown away.
    • This makes mass production prohibitively expensive and the premium that the maker would have to charge for the panel is so high that the user won’t pay for it.
    • RFM research indicates that Samsung and LG are continuing to wrestle with this problem but that little progress has been made.
    • The fact that there is no demand in the market for these devices (see below) has also not enticed them to expedite solving the mass manufacturing problems.
    • Second. No one has really come up with a decent use case for a flexible screen to date.
    • This problem is so acute that I understand that even Samsung had problems in rustling up interest for its curved and flexible displays from device manufacturers.
    • I have long been of the opinion that a major use case for this technology is a display carried on a phone form factor that can be unfolded or unrolled to give a display of 10-14 inches.
    • This would obviate the need to ever have a tablet and I think could kill the market overnight.
    • Unfortunately, the technology to make screens to this specification is still not ready and while simpler versions languish, I suspect that this will remain on the shelf.
  • The net result is that flexible displays are cool to see for the first time but do very little to improve the use case of the device.
  • Consequently, I suspect that flexible displays will not be making any impact on the device or ecosystem economics anytime soon.

Android – 1984.

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An Orwellian future beckons for Android.

  • The news that Samsung is finally upgrading the Galaxy s6 and s6 EDGE to Marshmallow (Android 6.0) will come as little comfort to Google which continues to unable to distribute its innovations.
  • Marshmallow and iOS9 became available at roughly the same time but Marshmallow is present on just 1.2% of Google’s devices while iOS9 is on 87% of Apple devices.
  • To make matters worse the previous version of Android (Lollipop 5.0) is present on just 34% of Google’s devices despite having been available for nearly 18 months.
  • 60% of Google’s devices currently run Android 4.x meaning that most of Google’s users do not have access to any of the innovations that Google has made in Android for the last 3 years.
  • To date this has not been a real issue, as Google has still been able to update and distribute its services through Google Play, but as services need to become more sophisticated problems begin to arise.
  • Now on Tap is a great example of this.
  • Now on Tap is context based search from anywhere on the device.
  • This can be quite useful for users but also has upside for Google as it will understand what users are doing regardless of whether or not it owns the service.
  • I have long believed that this will enable Google to monetise data collected from services is does not own for the first time.
  • Consequently, this represents meaningful upside in revenues.
  • Unfortunately this requires Marshmallow to work which renders this innovation effectively useless for several years to come.
  • This is why I think Google will end up taking complete control of Android by moving the entire OS into its services layer known as Google Mobile Services (GMS).
  • This is the only way that Google can end the endemic fragmentation that continues to plague its devices as well as take back control of software distribution.
  • The net result is that a Google device will become much like an iOS or a Windows 10 device with absolutely no options for handset makers to make any changes.
  • I suspect that this could also go hand in hand with Google becoming far more prescriptive in terms of hardware to ensure that its software runs properly.
  • While this would be good for Google in terms of improving its user experience and its ability to monetise, it will be yet another nail in the coffin of the long suffering handset makers.
  • Android handset makers have already been reduced to virtual commodities with only Samsung being able to earn more than 2-4% margins on a sustainable basis.
  • I suspect that a number of the Android ecosystems like Xiaomi, Baidu, Tencent, Alibaba, Cyanogen and so on will react to this by creating their own version of Android following in Amazon’s footsteps.
  • The result will be rising costs as the alternatives to Google will end-up having to write more and more of the code themselves.
  • The result will be a series of ecosystems based on a proprietary version of Android making the attainment of scale more important than ever.
  • With life getting harder for those involved in hardware, I would still consider only being involved with either an ecosystem or a value added technology supplier.

Tidal – The foot vote.

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An example of how to make customers unhappy.

  • The release of Kanye West’s latest album, Life of Pablo has rocketed Tidal up the Apple App. Store charts but I suspect that Tidal’s awful handling of its new customers has done more harm than good.
  • At the time of release, Life of Pablo was made exclusive to Tidal and available to buy as a digital download or as part of the streaming option.
  • This exclusive rocketed Tidal from 237th in the US Apple App Store to No.1 but interestingly there has been no corresponding impact in the Google Play charts as measured by App Annie.
  • Clearly, the aim of the exclusive was encourage users to sign up for Tidal’s music service which to date has continued to languish as a result of poor management and a lack of differentiation.
  • However, sometime after the album’s release, Kanye West decided to pull the album for further tweaking leaving only the streaming option open to users.
  • The album is expected to be available again next week.
  • The result is that thousands of users have paid for the album but have not received the download as promised.
  • The resulting storm of complaints and Tidal’s slowness to respond to has done further damage to Tidal’s reputation and raises questions about its ability to scale and the way it handles its artists.
  • To be fair to Tidal, the mess caused by the album only being temporarily available is not its fault, but the way it has dealt with the fall-out indicates that there are real problems.
    • First. The mess over payments and refunds combined with its slowness to act raises questions as to whether Tidal is capable of running a service with tens of millions of subscribers without the quality of service taking a nosedive.
    • Second. This incident also shows that a music service needs to be able to exercise some control over the content that it is selling.
    • A far better response to this incident would have been to keep selling the album and then promise to send those that purchased it a new and improved version when it is available next week.
    • I suspect that in this case, Tidal had no control over the availability of this album and is now paying the price for it.
  • The net result is likely to be that incensed fans will resort to other methods to get the album which is already easily available for download on peer to peer networks and Usenet.
  • This is another example of how important it is to put the user first especially when he has paid for something as in Digital Life it is easier than ever to vote with one’s feet and there are almost always “free” options available.
  • Hence, I suspect that the impact on Tidal’s subscriber base could well be negative as users realise that there are better, more reliable services elsewhere at the same price.
  • Apple and Spotify are likely to be the main beneficiaries of Tidal’s woes but I think that Tidal’s numbers are so small that it is unlikely to make a visible difference to either company.
  • Apple and Spotify remain the two leaders in music streaming and the only two (excluding YouTube) that are likely to be around long term.

Baidu – Videodrome

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Short term gain is likely to mean long term pain.

  • Baidu has received an offer to purchase its 80.5% stake online video asset Qiyi at a valuation of $2.8bn from its own CEO and chairman, Yanhong Li, and the CEO of Qiyi.
  • Qiyi is an advertising supported online TV and movie portal in which Baidu bought its first investment in 2010 along with US based Providence Equity Partners.
  • Baidu bought out Providence Equity Partners in 2012 and added the assets of a video transmission technology company called PPS in 2013 for $370m.
  • Qiyi has risen to become one the leading video platforms in China, with 40 new shows planned for 2016, and a constantly strong position in the top 10 app chart in the Chinese Apple App Store.
  • Despite this strong position, Baidu has been unable to really make a return from Qiyi as in Q2 2015, Baidu admitted that Qiyi had dented its margins by 5.1%, losing $134m which widened to $150m in Q3 15A.
  • Although Qiyi is clearly a drag on Baidu, this could prove to be a YouTube moment for Baidu as the strategic importance of video in the Chinese market is clear.
  • Alibaba has recently agreed to by YouKu (Chinese YouTube) for $4.8bn and Xiaomi’s ecosystem usage is primarily driven by content consumption.
  • Consequently, while getting rid of Qiyi would make its short term financial statements look a lot better, the loss of this crucial Digital Life segment could deal a meaningful blow to Baidu’s ecosystem aspirations.
  • I think that the parallel with YouTube is clear.
  • I very much doubt that YouTube in its own right makes Google any money, but if it were removed, I am certain the group revenues and profits would fall.
  • This is because Google can gather data from what users watch and monetise that through better targeting on search.
  • Consequently, YouTube is a core asset for Google and one that pulls its weight despite not being profitable in its own right.
  • The reason why Qiyi loses money is mainly because of the content costs that it incurs but as the US example is showing, content is becoming more and more important.
  • The fact that Baidu is pondering selling this asset implies makes me concerned that it has been unable to execute on this acquisition and really integrate it into Baidu.
  • This is a key step in moving from being a jumble of random assets like Yahoo or Amazon and becoming a fully-fledged ecosystem like Google or Apple.
  • It is clear that this is where all of the Chinese contenders want to end up but the fact that Baidu may sell this assets raises doubts in my mind as to whether it knows how to get there.
  • Baidu and Qiyi are likely to continue some form of co-operation if it goes private but history has shown that these sorts of arrangements rarely work out.
  • Hence, this would be a meaningful loss for Baidu and would dent its aspirations handing the initiative to Alibaba and Tencent.
  • I still think that there are three slots open in the race to become a successful Chinese ecosystem but there are many contenders including: Baidu, Tencent, Alibaba, Xiaomi, China Mobile, LeTV and several others.
  • Alibaba and Tencent look to be moving ahead leaving everyone else to scramble for number 3.

Pandora – Engaging asset?

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Pandora’s only real asset is its 81.1m very engaged users.

  • Pandora reported difficult Q4 15A results where bullish commentary by management was undermined by speculation that, behind closed doors, the company is up for sale.
  • Q4 15A revenue / adj-EBITDA was $336.2m / $24.8m behind forecasts of $341.6m / $29.0m.
  • The increase in content acquisition costs was mostly absorbed by the increase in revenues driven by Pandora’s ability to increasingly monetise its static user base.
  • However, despite revenue increasing by 22% (excluding acquisitions), adj-EBITDA fell by 43% mostly as a result of increasing investments in product development and sales and marketing.
  • Q1 16E guidance was soft with revenues / adj-EBITDA of $280m-$290m / LOSS $75m – LOSS $65m compared to expectations of $292m / LOSS $30m.
  • Despite the weak guidance for Q1 16E, management is bullish for the long term targeting $2.4bn in revenues with $480m in EBIT or 20% margins by 2020E.
  • Assuming success and that this becomes a steady state (no growth) with cost of capital of 8%, this would value the company at $6bn, way above its current valuation of $1.9bn.
  • Unfortunately, the news that management may be considering a sale of the company leads one to think that in its heart of hearts, management knows that this goal is unachievable.
  • I think that this is because there are a few fundamental weaknesses in Pandora that will make this goal very difficult to achieve.
    • First. Competitive pressure is intense and is likely to get worse.
    • Management pointed out that the free, ad supported part of iTunes Radio has been discontinued, but I think this is Apple rearranging its offering and simply putting all of its weight behind Beats.
    • RFM research indicates that radio stations Beats 2,3,4 and 5 are in development and the plan there is have them all advertising funded.
    • This indicates that in fact, the real thrust of Apple’s music strategy is to go after the much larger and softer plum of radio for which the US market alone is worth $45bn, 3 times the size of the global market for recorded music. (see here)
    • In this strategy, Pandora is likely to be collateral damage where its margins come under withering pressure from Apple’s scale and balance sheet.
    • Second. Pandora’s catalog is limited compared to that of Spotify, Apple, Deezer, Tidal and so on.
    • That means that in the streaming market, it does not have a competitive offering.
    • Third. Pandora’s is still predominantly selecting its music manually, meaning that it cannot effectively scale and still compete.
    • For example, Spotify sends every premium subscriber 30 tracks a week that it thinks that he or she might like.
    • This service has a pretty good hit rate and is completely algorithmic thanks to its heavy investments and acquisitions it has made in this area.
    • There is no way that Pandora can match this which also means that its ability to understand what its users like is also far weaker than its competitors.
    • I believe that this understanding and the ability to leverage it, is absolutely critical to the success of any digital music venture in the long term.
  • This leaves the real asset of Pandora being its large number of users each of whom rack up around 2 hours of listening per day.
  • This represents substantial engagement and represents a big opportunity for someone who can address the weaknesses inside Pandora.
  • It is for these reasons that Pandora may be seeking a buyer as there is a good fit to be had between Pandora and a company with good machine learning and a non-overlapping user base.
  • Top of this list is Spotify but I am not convinced that it has the financial clout to absorb Pandora even after the hefty falls in its share price. (Same goes for Deezer and Tidal).
  • I see no reason for Apple to buy it, as I believe that it is quite capable of crushing Pandora organically.
  • Google remains a possibility as YouTube is already a major source for free streaming music for millions of listeners.
  • Pandora could provide a place to consolidate and crystalize a proper push into the content consumption segment of Digital Life as well as provide a good head start when it comes to engagement.
  • Amazon is another possibility but its model of subscription only with Amazon Prime does not fit well with what Pandora has developed.
  • Consequently, I see Google as the most likely acquirer but the likely lack of hot competition for this asset and the volatility in both the public and private markets may well allow Google to beat the price down.
  • Therefore, I would not be looking to own Pandora on the back of any potential acquisition.