Google – Law of small numbers.

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Google must take control of software distribution.

  • The headlines are touting 80% growth in share for Android 5.0 (Lollipop) but that is only because it is coming from a tiny base.
  • The reality is that Android 5.0 (Lollipop) is still used on less than 10% of Google Android devices that are in the world today.
  • If all Android devices are included, then RFM estimates that the number is more like 4% as Google compliant Android makes up only 43% of the entire base of Android devices in the world.
  • In contrast iOS8 made it onto over 30% of devices within 2 days and over 70% of devices within 3 months.
  • Lollipop was launched with great fanfare almost a year ago at Google i/o 2014 and it represents a great improvement over KitKat.
  • However, as only 4% of all Android devices are using it after one year, in reality it has no impact on the overall user experience and makes Google a laughingstock.
  • This problem exists because Android distribution is controlled by the handset makers and operators who have declined to upgrade their devices.
  • Google’s inability to roll out its software onto its devices is now the biggest problem that Google has.
  • Fragmentation, malware and so on can be dealt with but getting its software onto the devices that run its services is the most basic and fundamental requirement to have a thriving ecosystem.
  • Without it, there is no point in upgrading the user experience and the ecosystem because the users will never experience it.
  • The worst part of it is that the software has been widely available and documented for a year which has allowed its competitors to copy its innovations and get them to market while Google’s software sits on the shelf.
  • While this state persists Google’s Digital Life services, upon which $8bn of its advertising revenue depends, will become less attractive and less engaging because almost all users will be running older code.
  • This gives Apple plenty of space to distance itself from Google in terms of the quality of the experience and Microsoft the opportunity to break in.
  • This is why Google’s priority must be to take control of software distribution.
  • The problem here is warranty liability as the distributor of the software has to be responsible should the distributed software brick the device.
  • Currently, it’s the handset makers and the mobile operators that take this liability but I think Google will have to take it over.
  • This means extra risk for Google but it will provide a further incentive to ensure that the software is much more consistent and of very high quality before distribution.
  • For me, this is the single most important issue that Google needs to address at its developer conference (Google i/o) which will be held on 28th and 29th of May in San Francisco.
  • Without addressing this issue, most of the conference will be irrelevant as great innovations that sit on the shelf rather in the hands of users benefit only competitors.
  • Lollipop is a great upgrade for Android and improves the user experience significantly, but while it sits on the shelf, only a sucker will think that it makes a difference to the Google ecosystem.
  • Microsoft remains my top choice for the ecosystem but there is still some upside in Google even if it fails to fix this thorny issue.

 

Facebook and Nokia – Value in patience.

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Facebook deal underlines that it is too early to sell Here.

  • It looks very likely that Facebook has already or is about to sign up to use Here as the source of location data for its services.
  • Here is a global mapping company owned by Nokia that is one of only two high quality maps that are available on the open market.
  • The other is Google and to date, Facebook has used a combination of Google or Apple maps for its location data.
  • RFM research has found that Here’s map is just as good as Google’s but where it is less good is on points of interest and searching for places.
  • However, Here’s great redeeming feature is its neutrality.
  • Since the sale of Devices and Services to Microsoft, Nokia has no skin in the digital ecosystem making it far more attractive as a supplier of mission critical data.
  • In many ways both Google and Apple are competitors of Facebook and clearly it feels uncomfortable relying on a competitor for such important data.
  • All of the old concerns of being suddenly switched off or treated unfairly will be at the forefront of Facebook’s mind.
  • Consequently, as long as the mapping data is of good enough quality (which it is), Here is the best option for Facebook as it knows that it will be treated fairly and that Nokia has no incentive to suddenly terminate its contract.
  • I think that this is a classic example of the opportunity that still lies ahead of Here.
  • When many of the contracts were struck with Google, its ecosystem ambitions were much less defined and consequently it was not seen as a threat by its customers.
  • A lot has changed in a few years and just as Google is losing the default search provider position with Firefox, and probably now Safari, the same is happening in maps.
  • Consequently, I think that Here is in pole position to gain a meaningful amount of market share over the next year or two as Google Maps contracts come up for renewal.
  • This is why it is much too early to sell Here.
  • If Here can meaningfully increase its market share before it comes to a sale, it will be able to command a much higher valuation.
  • The market chatter is looking for a price tag of around €2bn but I think that if Nokia is patient and grows market share, it could get €4bn or more.
  • This combined with a strategic sale of the patent portfolio at some point could allow investors to realise significantly more value than they do today.

Samsung Q1 15A – Pointless gimmicks pay

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The pointless curved screen should generate some EBIT.

  • Samsung reported its full Q1 15A results that revealed a better performance in the handset business than many had anticipated.
  • Q1 15A revenues / EBIT were KRW47.2tn / KRW5.98tn in line with the guided range of KRW47tn / KRW5.9tn.
  • Samsung shipped 99m mobile devices of which 80% were smartphones (79.2m) at an average price of $200.
  • This was slightly ahead of RFM estimates where 96.2m (78.9m smartphones) were expected to sell for an average price of $194.
  • This is what underpinned IT and Mobile Coms revenues of KRW25.9tn which was nicely ahead of RFM estimates of KRW23.6tn.
  • The best news was margins where cuts in OPEX allowed Samsung to return IT and Mobile Coms EBIT margins to 10.6% up from 7.5% in Q4 14A.
  • Device Solutions (semiconductors and panels) continued to perform strongly but Consumer Electronics slipped into the red largely on the back of lower revenues from the seasonally weak Q1 revenues.
  • Optimism on the Galaxy s6 is running high as supply side surveys are revealing that the Galaxy s6 edge is genuinely out of stock as demand has been surprisingly high.
  • This fact has been corroborated by RFM’s own research which has revealed component shortages holding up supply as well as good demand for the s6 edge at retail.
  • Samsung would not be drawn on how well the device was selling other than to say that it is doing better than the s5.
  • The s6 edge is a good looking device with cool looking, but useless, curved edges to its screen.
  • However, the fact that the curves are pointless does not matter as it is quite possible to sell huge volumes at high prices if the useless gimmick is perceived to be cool and desirable.
  • It is looking like Samsung has won some desirability with this device and stands to reap the benefits in the next 2 quarters.
  • Consequently, it looks likely that IT and Mobile Coms margins should improve again in Q2 15E as ASPs and gross margins rise by more than OPEX.
  • Samsung is being very cautious on OPEX following the very difficult six months it suffered at the end of 2014A and I think that 12% margins should be achievable in Q2 15E.
  • Without a major renaissance of its product line, I estimate that this will be the limit of Samsung’s ability to raise its margins.
  • Form here, in order to sell more products it will either have to cut prices or raise its sales and marketing expense, either of which will keep a lid on margins.
  • Samsung has recovered well from the nadir of Q3 14A but I think returning to steady growth will still be difficult given its commoditising product line.
  • I would continue to prefer Microsoft or Google in this space.

Microsoft Build – The great trade off

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One thing at Build 2015 really stood out.

  • Microsoft launched its Build 2015 developer conference with a plethora of announcements but at its heart only one thing really stood out.
  • Microsoft has launched Software Development Kits (SDK) that allow developers to bring the code they have written for Android or iOS directly into Visual Studio and re-compile the code for Windows.
  • This is a crucial announcement because if it works, it could fix the problem which has kept many users away from Windows Phone: lack of decent apps.
  • Microsoft is on a mission to make of the most of the “post PC” opportunity focusing on mobile and cloud.
  • In terms of cloud, Microsoft is doing well.
  • However when it comes to mobile Microsoft is floundering.
  • Buried in the last set of results was another market share loss in smartphones to just 2.6% with gross margins in negative territory.
  • It is clear that there is far more to Microsoft’s mobile strategy than just devices but when one is creating an ecosystem, it is much more difficult to succeed if one does not control the platform.
  • There are four reasons for this:
    • First. Using the devices of others means that one is just one of many clamouring for the user’s attention and the owner of the platform can cut one out at any time.
    • Second. Without being able to marry the hardware and software to optimise performance, one’s ecosystem will always be at a disadvantage to the ecosystem of the platform’s owner.
    • Third. Monetisation of the ecosystem through hardware, which is the most effective method, is no longer possible.
    • Fourth. Ecosystems exist on multiple devices but still the smartphone is the device upon which the user spends most of his time and it is on the basis of this device that the choice of ecosystem tends to be made.
    • Hence it is much more difficult to be the ecosystem that user choses if there is not a successful mobile platform available.
  • Consequently, I believe that it is very important for Microsoft to have a mobile device portfolio that is capable of offering Microsoft’s Digital Life and Digital Work services in their best light.
  • Hence, it cannot allow this business to quietly die in the background.
  • Although the financial analysts won’t notice, it will substantially undermine a huge part of what Microsoft is trying to achieve.
  • Microsoft is losing share in smartphones because the availability of apps is poor and because the offering is badly marketed to users.
  • There are two ways to fix the apps problem.
  • Microsoft can either create software in its platform that emulates iOS or Android or make it as easy as possible for developers to get their apps onto Microsoft.
  • The first route is the easiest as it requires no involvement from the developer, but history has shown that the apps in emulators never run at their best.
  • The second route gives the best performance of the apps but it requires some input on the part of the developer as recompiled apps have to be debugged and tweaked before they will run properly.
  • This is where there great trade-off is to be found.
  • Microsoft has chosen to optimise the performance of the app but requiring developers to have some input is very risky.
  • This is because the credibility of Microsoft in mobile is now so bad that many developers simply can’t be bothered to develop for Windows no matter how easy it is.
  • This is why Microsoft must fix its market share problem in mobile devices because if share continues to decline, the developers will increasingly think that they were right not to bother.
  • Windows 10 offers a unified code base between PC, console, tablet and mobile phone and it also represents Microsoft’s last chance to get mobile right.
  • Failure in mobile will mean that a large part of the opportunity that it sees will pass it by and long term profit growth will be much lower.
  • Fortunately, everyone expects Microsoft to fail in this space and so success is not built into its valuation.
  • I remain happy that it is safe to live in hope.

Twitter Q1 15A – 90 minute slip

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The core business of Twitter is looking mature.

  • Twitter suffered a double blow as its investor relations website accidently disclosed weak Q1 15A results 90 minutes before the close of US trading.
  • The shares were halted while Twitter formally released its results after which the shares fell by 18%.
  • Q1 15A revenues / EPS were $436m / $0.07 compared to consensus at $456m / $0.04 and guidance at $440m-$450m.
  • Monthly Active Users (MaU) came in at 302m which was exactly as the company had guided adding 14m during Q1 15A.
  • MaUs are a bit of a grey area with many companies counting them differently.
  • This, combined with Twitter’s abrupt adding of those that access Twitter via SMS in emerging markets and the weakening revenue picture raises uncomfortable questions.
  • Twitter blamed the revenue shortfall on its direct response products where Twitter has increased the bar of what constitutes a click-through.
  • The result is lower click through rates for Twitter but a higher value for advertisers as they are no longer paying for low quality clicks.
  • In the long run this should allow Twitter to increase its pricing but for now the result is lower revenue.
  • Twitter expects this value to come back to Twitter at the beginning of H2 2015E but I can’t help wondering if revenue is finally beginning to top out.
  • The biggest problem Twitter has is its narrow focus as its services only cover a small part of Digital Life.
  • This means that its monetisation opportunity is fundamentally limited unless it can spread its wings wider and encourage users to spend more time with Twitter.
  • I have previously forecast, (see here), based on RFM’s estimates and its narrow focus, that Twitter’s revenues will flatten out at around $2bn annually.
  • With Q2 guidance coming in at $470m-$485m rather than the $536m consensus estimate it looks as if Twitter is beginning to run out of growth.
  • This makes me think that the new annual revenue forecast of $2.17-$2.27bn estimates may have further fall.
  • Twitter is doing the right sort of things to expand its appeal beyond microblogging but these things take time.
  • Consequently, I can see 2015E being a difficult year as Twitter ramps up new offerings to expand its reach while the core business stabilises.
  • Hence, Q2 15E estimates look achievable but I suspect that the guidance for Q3 15E will reveal that the promised return to growth requires much more than a tweaking of the existing business.
  • Consequently, with a high valuation and downside to H2 15E estimates, I think the shares will go further south.
  • I would begin to be looking at Twitter with real interest in the mid $30s.

Apple Q2 15A– The mighty cycle

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iPhone replacement drives big Q2 15A results.

  • Apple reported excellent Q2 15A results as the iPhone replacement cycle has remained strong.
  • Apple increased its cash return program by more than 50% to $200bn.
  • Q2 15A Revenues / EPS of $58.0bn / $2.33 comfortably beating consensus at $55.7bn / $2.13 despite the currency headwind that crimped the results of all its peers.
  • 61.2m iPhones shipped compared to consensus at 58m, 4.6m Macs shipped compared to consensus at 4.7m and 12.6m iPads shipped compared to consensus of 13m.
  • Once again the iPhone carried the day and more than offset the small miss in Macs and the ongoing weakness in iPads.
  • This underpinned gross margins which came it at 40.8% nicely above the guided range of 38.5%-39.5%
  • This allowed another $15.6bn of cash to be added to the pile, bringing it to $193.5bn.
  • The problem is that 88% of the cash is held overseas and is unavailable for dividends or buybacks without paying the hefty repatriation tax of around 30% when bringing it back into the US.
  • Guidance for Q3 15E was in line with forecasts with revenues / gross margin of $46bn-$48bn / 38.5%-39.5% expected compared to consensus of $47bn / 38.9%.
  • Apple remains in the grip of a very strong replacement cycle which I suspect could continue until calendar Q3 15E.
  • The larger screen has allowed Apple to address the single biggest shortcoming of owning previous devices.
  • This combined with a nice design, superb radio and good enough battery life has encouraged existing iPhone users to upgrade sooner than they normally would as well as meaningful switching from Android.
  • It popularity is also allowing Apple to hold pricing steady meaning that it continues to monetise ecosystem extremely effectively.
  • Although Apple does not really have Digital Life services of its own, it distributes third party apps in an easy and fun to use way that remains unrivalled.
  • The other ecosystems are catching up but still have a long way to go giving me confidence that Apple has time to plot its next move before the iPhone becomes commoditised.
  • That being said, this is all pretty much in the share price of Apple already leaving me preferring the ecosystems with more growth (Google) or those mounting a credible challenge (Microsoft).

 

Amazon Q1 15A– Silver lining

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Amazon Web Services outshines a dull earnings report

  • Amazon Web Services (AWS) was the bright spot in a set of results that came pretty much in line with expectations.
  • Revenues / EPS were $22.74bn / LOSS $0.12 compared to forecasts of $22.4bn / LOSS $0.11.
  • Guidance was weak with revenues / EBIT expected at $20.6bn-$22.8bn ($21.7bn) / LOSS $500m – $50m (LOSS $225m) compared to estimates of $22.1bn / LOSS $15m.
  • However, Amazon revealed that its Cloud business, Amazon Web Services (AWS) is much bigger and more profitable than many had expected.
  • In Q1 15A AWS grew revenues 49% YoY to $1.6bn and reported operating margins of 16.9% which is far ahead of what most commentators had assumed.
  • By contrast Microsoft’s Azure business is currently at $1.1bn in sales but is growing at 114% and I estimate that gross margins are around 40%.
  • I think that most commentators had assumed that AWS was roughly the same size as Azure and very unprofitable.
  • This surprise has caused many to meaningfully increase their valuations of this part of Amazon.
  • This report shows that Amazon is comfortably the leader in the public cloud but it also shows that outside of AWS nothing else has changed.
  • Amazon is still investing heavily in growing its empire but there is no sign that these investments are being made with any particular strategy in mind.
  • Instead they continue to feel like a random series of experiments with Amazon throwing mud at the wall to see what sticks.
  • Unfortunately, nothing is sticking and this is because Amazon still seems to have no real understanding of the ecosystem.
  • It has a range of assets such as Amazon Prime, Kindle, Twitch, Maps and so on but all of them are independent from one another.
  • In order to be a coherent, easy to use and fun ecosystem, Amazon needs to integrate these offerings together into something where users are going to want to spend their Digital Lives.
  • Furthermore, Amazon needs to split its free shipping off from its ecosystem as this creates a $99 per year barrier to joining the ecosystem.
  • To me the fact that it has not done this is evidence that still has no understanding of it is trying to achieve and until it does it is likely to continue wasting money on experiments that yield no results.
  • Amazon remains very far from the top of my list of places to be in the digital mobile ecosystem.

Microsoft & Google– 2 for 2

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Strong US$ masks good fundamental developments.

  • Microsoft and Google produced good results that were marred by the problems caused by the strong US$.
  • Both saw good developments in the core businesses, justifying their position as my top choices in the digital mobile ecosystem.

Microsoft

  • Microsoft reported strong numbers as adoption of its cloud offering and Office 365 continued to outpace expectations.
  • Q31 15A revenues / adj-EPS were $21.7bn / $0.64 compared to consensus at $21.1bn / $0.53.
  • Although the PC market has continued to be weak during the quarter, growth in Office 365 users and enterprise adoption of Azure has more than offset that weakness.
  • Furthermore, revenues from Windows being sold to corporates has stabilised after the bump caused by the end of support of Windows XP.
  • This is good news as with this revenue stream stable, Microsoft can concentrate on delivering growth from its new businesses.
  • Unfortunately there are danger signs when it comes to smartphones.
  • With 8.6m units shipped during Q1, RFM estimates that Microsoft has lost share again to just 2.6% globally.
  • Some of this is due to its tighter geographic focus when compared to its peers, but Microsoft cannot afford to continue losing share.
  • RFM research indicates that the smartphone is at the heart of the ecosystem and it is upon this device that most users make their choice.
  • Whatever the circumstances, the problem is that falling market share damages the credibility of the platform and will dissuade third parties from supporting it and consumers from buying it.
  • Financially, this is an insignificant blot on a good set of results from Microsoft, but without a credible smartphone platform, winning users over to its ecosystem will much more difficult than it already is.

Google

  • Google reported a fair set of Q1 15A results as revenues were just shy of expectations but stripping out the FX effect reveals a strong underlying performance.
  • Q1 15A revenues-exTAC / EPS were $12.9bn / $6.57 compared to estimates of $14.0bn / $6.63.
  • During Q1 15A Google suffered as many of its peers have suffered from the strong US$ which it estimates held back revenues by about 5%.
  • Without the impact of the US$ growth would have been 17% which would have put both revenues and profits nicely ahead of expectations.
  • Mobile continued to be the engine of growth where RFM sees most of the growth coming from Android devices.
  • The market was expecting a harder hit from the strong US$ which combined with some progress on OPEX was met with a relief rally.
  • Google has been more efficient on its marketing spend but at 8.1% of revenues its General and Administrative expenses remain way too high.
  • That combined with the poor corporate governance continue to spoil what it is an excellent story.
  • Fortunately, investors continue to be well compensated for these shortcomings and I still see some upside in Google in the medium term.

Facebook & Sony– Irrelevant variance

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Variances from expectations have little to do with fundamentals.

  • Facebook reported results and Sony pre-announced results that differed from expectations but neither were very relevant to the underlying story of either company.

Facebook

  • Facebook reported Q1 15A results that were weaker than expected but this looks to have been almost entirely due to the strong US$.
  • Revenues / EPS were $3.54bn / $0.42 compared to consensus at $3.56bn / $0.40.
  • Advertising revenues were 72% derived from mobile and grew by 46% YoY to $3.32bn.
  • Given that Facebook is now a global company, a substantial portion of its revenues are no longer in US$ and the 6% strengthening of the US$ during Q1 15A did some damage.
  • Removing the effect of the US$, advertising revenues would have grown by 55% rather than 46% which more than accounts for the weakness seen on the top line when compared to consensus.
  • The impact of currency is expected to be greater in Q2 but Facebook has brought down its OPEX growth estimate slightly from 55%-70% for 2015E to 55%-65%.
  • The net result is a set of figures that were hurt by currency but the fundamentals remained strong.
  • Facebook still needs to cover more of Digital Life in order to secure long term growth but its excellent execution when it comes to mobile is buying it time to get its house in order.

Sony

  • Sony effectively preannounced its fiscal 2015A (ended March) results (Due April 30th) by updating its guidance.
  • Revenues will now be JPY8,210bn compared to its previous estimate of JPY8,000bn (+2.6%) given in February and EBIT will now be JPY68bn compared to the previous guidance of JPY20bn.
  • Although this represents a tripling of the operating profit forecast, profitability is currently still very low meaning that a little change goes a long way.
  • The main reason for the upgrade in revenues is due to Financial Services, Imaging Products and Game and Network.
  • Given that the strength in Imaging products and Game and Network is already fairly well known (see here), I suspect this upgrade is almost all due to Financial Services.
  • Furthermore the improvement in profitability is almost all due to a write back of provisions taken at the Sony Life Insurance division due to good performance of its securities portfolio.
  • Consequently, this pre-announcement has very little do to with the key issues that Sony needs to address to return itself to profitable growth.
  • All eyes will be focused on the FY16E guidance given on April 30th but the bigger issue remains the developments of its ecosystem.
  • I expect Sony to continue with its strategy of developing its own ecosystem and hope these improving results will give doubters in the company a little more faith that it can be done.
  • Sony remains the only Japanese company that I think has a real potential to have a future in consumer electronics although it will be a long hard road.

Yahoo! Q1 15A– The last rabbit

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Yahoo! Japan will be the last rabbit to distract the market.

  • Yahoo! pulled its last rabbit out of the hat and in doing so successfully diverted the market’s attention from another disappointing set of results.
  • Q1 15A revenues-ex TAC / adjusted EPS were $1.04bn / $0.15 missing consensus of $1.06bn / $0.18.
  • The headline figures which are gross revenues before the deduction of traffic acquisition costs showed some improvement but this appears to be almost entirely due to the deal that has been signed with Mozilla.
  • Yahoo! is now the default search provider for Firefox and the first effects of that were seen during Q1 15A.
  • Mozilla clearly struck a good deal with Yahoo! as headline revenue growth of 8% became a decline of 4% YoY once TAC had been deducted.
  • Mobile, Video, Native and Social (Mavens) which make up the growth part of Yahoo! saw 58% revenue growth to $363m but are still not big enough to offset the poor performance of the underlying business.
  • Yahoo! made much of generating $234m in revenues from 600m mobile users, but I would argue that this is underperformance on a grand scale.
  • RFM estimates that in Q1 15 Google generated $2.3bn in revenue from its 684m Google ecosystem users on Android.
  • Yahoo! actually has better coverage of Digital Life than Google does (Google is missing gaming) and hence the opportunity for it to generate revenues on mobile is actually greater than Google’s.
  • If its claim to have 600m mobile users is accurate and its house was in order, it should have generated $1.98bn in revenues in Q1 15A using Google as a benchmark.
  • The missed opportunity of $1.75bn is due to the company’s failure to develop its acquisitions into an ecosystem of integrated Digital Life services that are easy and fun to use.
  • On this front there has been no progress and until Yahoo! executes on creating its mobile ecosystem, it is likely to continue vastly underperforming its potential.
  • This fact was evident in Q2 15E guidance where revenues are expected to be $1.01bn-$1.05bn below consensus of $1.054bn.
  • Yahoo! attempted to cover up this failing by announcing that it is now exploring strategic opportunities for Yahoo! Japan.
  • After this has been sold and the proceeds returned to investors, the hutch will be empty of rabbits with which to distract investors from the underperformance of the core business.
  • A quick glance at its competitors Google, Facebook, Twitter and so on show just how badly Yahoo! is underperforming when it comes to exploiting the opportunity it has before it.
  • Until Yahoo! begins to execute on its vision rather than just accumulating assets nothing is going to change.
  • Of this there is no sign and I see no reason to go near Yahoo! for some time to come.