Apple vs. Google – The big trade

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Replacing Google as default for search is a big trade off.

  • If Apple’s deal with Google for search is due for renewal next year, there is every chance that Apple will switch to another search provider.
  • In reality, there is only one choice as both Bing and Yahoo! are powered by the same search engine owned by Microsoft.
  • I have long been of the opinion that Apple would dearly love to remove Google from all of its ecosystem but it is a decision not to be taken lightly.
  • Google and Apple are the main ecosystem providers and their business models for monetisation are completely different.
  • Apple monetises its ecosystem through premium pricing of hardware while Google monetises through targeted advertising.
  • Access to Google services is a very important part of the iOS user experience and as a result, I think that Apple will consider its options very carefully before deciding whether or not to ditch Google.
  • This is because at the moment losing Google services would encourage a meaningful number of loyal Apple users to consider using Android.
  • Consequently, I think that no matter what happens users that really want to use Google for search will be able to, but the removal of Google as the default search provider has meaningful implications for Google.
  • This is due to the fact that the vast majority of users use whatever the default search provider is and never bother to change it.
  • RFM estimates that in 2015E, Google will generate $10.2bn in mobile advertising revenues from iOS alone.
  • With the vast majority never bothering to change their default search provider, the loss of this hallowed position is likely to put a meaningful dent in revenues due to a market share loss to the new provider.
  • This is not a decision that will be taken lightly as the Google search experience is still meaningfully better than those of its competitors and consequently the user experience on iOS risks not being as good as it was before.
  • In this case I think that the advantages of removing Google outweigh the risks, especially as users can still switch to Google should they choose to do so.
  • Furthermore, Sirs has already switched to Bing and it looks very likely that the other parts of Apple’s ecosystem will follow suit when they have the opportunity
  • This is a negative for Google, as it derives a lot of revenue from iOS and there is nothing that it can do should Apple decide to remove it entirely.
  • This is the single biggest risk to the upside in Google’s revenue and profit forecasts.
  • With Samsung on the ropes, Google has the upper end of Android nicely under its thumb and there is very little risk to those revenues now.
  • Microsoft and Yahoo! are the likely winners should this deal happen and of the two, Microsoft is by far the best bet over the next 12 months.

Micromax Yu – The Bollysystem.

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The first Indian ecosystem launches. It won’t be the last.

  • India’s second biggest handset vendor has launched a new line of devices resplendent with a new user experience, paving the way for the first Indian ecosystem.
  • The first device in the series will be available in December but as of yet there is no word on the device itself or its price.
  • Yu Televentures, a subsidiary of Micromax has been working with Cyanogen to produce a custom version of Android that replaces all of the Google Mobile Services (GMS) with those belonging to Micromax and deemed relevant to the Indian market.
  • Cyanogen has taken the Android Open Source Package (AOSP) and implemented a custom user experience as well as a few services aimed at the Indian user.
  • The devices are being launched under the “YU” brand and will be sold through online mechanisms not unlike Xiaomi.
  • The initial target is tech-savvy Indian users as the devices will also be provided with bootloader access making them easy for the users to upgrade with the software that they want rather than that which the operator decides to provide.
  • Upon this platform, Yu Televentures will eventually provide a full suite of Digital Life services targeted at the digital activities of Indian smartphone users.
  • Here I suspect that the Digital Life services required will be roughly the same as they are in developed markets, but they will need to be adapted for the local taste and focus primarily on Bollywood content.
  • This is essentially a replication of the Xiaomi business model in China and underlines how difficult Xiaomi is going to find life in India.
  • I think that Yu Televentures already has many of the media rights that it needs to populate the content part ecosystem with some music and movies whereas Xiaomi appears to have none.
  • Furthermore, licensing content in India is a painful and labyrinthine task and I suspect that Xiaomi will end up going with Google’s ecosystem in this market.
  • Google’s ecosystem is global and will have no real local customisation to appeal to Indian users.
  • This is a logical move from Micromax as the development of an ecosystem is the only way in which the company can hope to differentiate its products and earn anything more than a wafer thin margin in the long-term.
  • Indian ecosystems are likely to start with pure content (iTunes-like) and then move onto apps and services as they mature. (Just as they did in China and in developed markets).
  • However, developing an ecosystem that users love and will pay for is a massive and difficult task but if YU has the content already sown-up, it will have bought itself some time.
  • Micromax is the first of the Indian makers to jump into the ecosystem. It is very unlikely to be the last.
  • As in China, I think that the Indian players will have an advantage in their home market.
  • Hence, I continue to be very cautious regarding Xiaomi’s ability to gain meaningful share or make any money in this hyper-competitive market. 

 

Amazon – Suspension of disbelief.

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Freemium Instant Video looks likely to deepen losses.

  • The latest scheme to come from Amazon appears to be an idea to move its Instant Video service to a Freemium model.
  • The content would be made available in two ways:
    • First: a continuation of the existing service where Amazon Prime users get unlimited streaming as part of their $99 free shipping subscription.
    • Second: The same content would be available but instead of paying for it, it would be supported by advertising. This is very similar to the business model of Spotify and the hope is clearly that new users can be enticed to make the upgrade.
  • There are two problems with this idea:
    • First: Users primarily choose Amazon Prime because they buy a lot of stuff on the site and not for the video.
    • Hence a user that is using the free service is unlikely to make the upgrade as he will be paying for a free shipping option that is the main reason to subscribe in the first place.
    • Second: Amazon will be forced to pay for the content upfront meaning that there is a significant risk of incurring heavy losses should the idea not prove successful.
  • Consequently, I think that this will not work for Amazon as it is very unlikely to act as a draw for new Amazon prime users.
  • This is yet another sign of how disjointed Amazon’s strategy is.
  • Its hardware devices have been launched into an ecosystem vacuum and seem to be very little more than a series of expensive experiments. (see here)
  • Combine this, with an apparent continuing refusal to make anything more than the tiniest of net margins is unlikely to endear investors to the stock in the medium term.
  • The strategies of Google, Microsoft and Apple are clear and their valuations do not require a suspension of disbelief.
  • Further disappointments at Amazon look likely.

Google – Flavour of China.

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Getting back into China will be long, tough haul

  • Google has been effectively absent from the Chinese market since 2010.
  • With the growth of Internet use in China and ever increasing smartphone penetration, it is clear that this is a big revenue stream that is currently passing it by.
  • Looking at the ecosystem opportunity, RFM estimates that the Chinese market could account for 30% of all users by the end of 2016E.
  • With developed market growth slowing, this is an opportunity that Google cannot afford to ignore and this is why I suspect that it is looking to enter this market once again.
  • This time it looks like Google is going to make its Google Play or a version of it available in the Chinese market.
  • This also co-indices with a move to allow developers based in China to make money in 130 countries but with the unfortunate exception of China.
  • How this would work is very unclear but I think it very unlikely that this is the beginning of free availability of Google Play on all Android devices.
  • Google Play is Google’s most precious mobile asset as it is the availability of the apps that users most demand.
  • In most markets, in order to get Google Play a handset maker or and operator needs to sign an agreement with Google.
  • This ensures that all of Google’s Digital Life services are also present on the device and that certain criteria around placement and defaults are met.
  • This is how Google’s ensures that its ecosystem is present on around 40% of all Android devices in the market.
  • RFM estimates that Google’s ecosystem will generate around $6.9bn in mobile advertising revenues on Android devices in 2014E.
  • Consequently, I suspect that a Chinese store will be something very different to Google Play, probably with a totally different name.
  • I also suspect that it will be very Chinese in its nature and mostly feature apps and content that are tailored to the Chinese market.
  • Hence, this is not going to represent a backdoor way to getting Google Play on a device without deploying the rest of the Google Ecosystem.
  • The Chinese ecosystems are at an early stage of development and I am looking for three big ones to emerge owned by Baidu, Tencent, Alibaba and maybe Xiaomi.
  • I think that these players are intent on keeping Google out of their home market and are likely to keep their popular services and apps out of whatever Google launches in China.
  • Consequently, I see no change to the existing status quo and continue to expect Google to see no real increase in traction in China.
  • Despite that, the revenue outlook picture for Google still looks healthy and the stock is more than fairly priced despite the overspending and the shortcomings in corporate governance. 

Yahoo! and Mozilla – Face not wallet

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The loss of Firefox hurts image and more than revenues.

  • Yahoo! and Mozilla have announced that Yahoo! will replace Google as the default search engine within the Firefox Internet browser.
  • This change marks the end of the 10 year deal in which Google was the default search provider for Mozilla.
  • Mozilla and Yahoo! have signed a 5 year deal where no details were disclosed.
  • Through the Firefox browser Mozilla was acquiring traffic on Google’s behalf and its share of those revenues made up the vast majority of Mozilla’s revenues.
  • In 2012A (last available figures) Mozilla had $311 in revenues where I think Google was probably responsible for around 85%.
  • Google typically pays away 20% of its gross search revenues to those that source traffic on its behalf implying that something in the region of $1.3bn of its gross search revenues was coming from traffic sourced from Firefox.
  • In 2012A Google’s gross search revenues were $37.6bn meaning that being the default search provider to Firefox represented only 3.5% of revenues.
  • Consequently, I suspect that this means that the loss of Mozilla is unlikely to have much impact on Google’s ability to earn revenues from search.
  • This is especially the case as since 2012A, Firefox’s desktop browser share has declined from 22.5% to 14.2% while Chrome’s share has risen from 17.6% to 21.1% (see here).
  • Add this to the fact that Yahoo! is desperately trying to gain share in search, and it is not difficult to see how Yahoo! was willing to pay more to be the default search provider than Google was.
  • Furthermore, I suspect that Mozilla was keen to get away from Google given that it is actively trying to lure users away from Firefox to its own Chrome browser.  
  • As a result Yahoo! clearly makes a better match for Firefox than Google does and both parties had an incentive to see a deal done.
  • Hence, Yahoo! is probably paying much less than some commentators may think, but probably more than the 20% gross search revenue share that Google was paying.
  • Whether, this transaction meaningfully lifts Yahoo!’s search revenues has yet to be seen as one must not forget that Google is better at monetising traffic that comes in than Yahoo! is.
  • Net net this is a good deal for Yahoo! and it should have some top line impact but the loss to Google is probably more face than wallet.
  • I would still pick Google over Yahoo! in the short term, given Yahoo!’s inability to execute on the assets it has already acquired.

Samsung – No bottom with this line

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Cutting a few models does not address the problem.

  • Samsung has confirmed that it will cut the number of smartphones that it launches in 2015E by 30% in an attempt to shore up profitability.
  • It will also aim to increase its re-use of parts across its portfolio and thereby gain greater scale advantages from volume purchases.
  • The hope is that these measures plus a good slug of cost control will bring margins back up to 10% on the lower revenue outlook that the company faces.
  • Unfortunately, this is a further sign that Samsung appears to have lost control of its handset business and I fear that these measures will do nothing to halt the margin decline of the last 2 quarters.
  • The graveyard of the mobile handset industry is littered with examples of companies who led the market and then lost their edge.
  • All of them were unable to control the loss of market share which unravelled so fast that substantial losses were incurred as management struggled to bring the businesses back under control.
  • Handsets are a business of scale.
  • A handset maker invests in R&D to develop a handset and then runs a marketing campaign at launch.
  • These are fixed costs meaning that the more devices of each model that ship, the higher the margins that are earned.
  • In recent years Samsung has gone from shipping less than 1m each of over 100 models to shipping tens of millions of single models such as the Galaxy S and Galaxy Note. .
  • I have long suspected that the profitability of these devices is at least as high as Apple’s and have almost single-handedly underpinned Samsung rise to prominence.
  • The problem is that these devices are no longer special and it is in the devices that have been expected to ship huge volumes where most of the weakness has been felt.
  • Simply cutting other devices that ship lower total volumes does nothing to address the fundamental weakness currently being exposed in the heart of its portfolio and I think margins are very likely to continue falling.
  • In Q3 14A Samsung only suffered competition from the iPhone 6 for a few weeks but in Q4 14E it will feel it for the full quarter.
  • Now that Apple is producing large screen devices, the one competitive edge that Samsung had has now been removed.
  • Hence it looks certain to lose further share in the critical high end, high margin devices where it has been making the bulk of its profits to date.  
  • Consequently, simply trimming models that are less popular and that have much lower margins is unlikely to have much of an impact as the critical problem remains the profitability of its flagships.
  • The market seems to have accepted that Q3 14A was the bottom for Samsung and that steady recovery is in the works.
  • I have seen nothing that would lead me to this conclusion.
  • Its erstwhile forbears all suffered huge losses before bringing their business to stability and I cannot see that Samsung is doing anything differently.
  • Hence, I am looking for margins to decline again in Q4 14E which I think will be badly received.
  • There is plenty of downside left in Samsung following its recent rally and I would immediately exit the shares before its inability to escape the fate of its peers becomes obvious.
  • Microsoft, Apple and Google all offer far better and far safer places to take a view on the digital mobile ecosystem. 

Yahoo! and Aol – Heaven and Hell

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A deal with Aol would be great for the stock but bad for the company.

  • The Aol and Yahoo! story is heating up again (see here) as Starboard has gone back into Aol and now has a reasonable stake in both companies.
  • There is substantial value to be released in both companies and while putting them together would give a one-time release of value, it would do nothing for the long term outlook for either company.
  • The main issues here are that Yahoo! is trading at a substantial discount to the sum of its assets and that its core business continues to underperform.
  • The activists want Yahoo! to realise the value in its Asian assets, cut costs and return cash to shareholders thereby releasing substantial value for shareholders.
  • Such a release of value would most likely result in a one-time substantial rally in the stock but little else.
  • They are also pushing Aol and Yahoo! to get together in the belief that they can solve each other’s problems.
  • Unfortunately this approach ignores the fact that Yahoo!’s only real chance of seeing real growth again lies in the development of its ecosystem.
  • Over the last 2 years it has accumulated a series of Digital Life assets that together give it over 70% coverage of the Digital Life Pie.
  • While it has been great at accumulating these assets it has done almost nothing with them.
  • These assets need to be integrated and rolled out on mobile in a fun and easy to use way where users can identify with Yahoo!
  • That way users would want to spend time with Yahoo! which Yahoo! can then use to sell valuable, targeted advertising.
  • Unfortunately, none of this has happened which is the main reason why the core business has been a bad underperformer this year.
  • Getting together with Aol does nothing to fix this problem and in every likelihood would make it worse.
  • This is due to the added complexity of adding in Aol’s assets on top of the jumble that is already there at Yahoo!.
  • Furthermore, other than the potential to release value for shareholders, this combination does nothing for Yahoo!’s ecosystem strategy and nothing to get growth going again.
  • This is why I suspect that the management of Yahoo! will resist this deal but the sale of its Asian assets would go a long way to mollifying investors.
  • I continue to be frustrated by Yahoo!’s lack of progress and think that until there an improvement in the company’s ability to execute, its core business will continue to underperform.
  • I am taking Alibaba-related profits on Yahoo! as there is no sign of a turnaround and I do not expect it to sell its Asian assets.
  • I could be looking for a re-entry point in 2015E but I need to see some signs of progress first.  

 

BlackBerry – Commodities trader

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BlackBerry now looks stable but commoditising fast

  • Blackberry held an event in San Francisco where it unveiled the new version of its server product (BES12) and launched a partnership with Samsung for regulated industries.
  • The new version of the server makes a number of meaningful improvements over BES10 that include:
    • First: Seamless support for all platforms.
    • The platform supports iOS, Android, Windows Phone, BlackBerry 10 and BlackBerry OS.
    • The ability to run both versions of Blackberry in the same place is a meaningful improvement as until now the two different versions had to be managed separately.
    • Second: The platform supports all ownership structures including: BYOD (bring your own device), COBO (company owned business only) and COPE (company owned personal enabled).
    • Third: the platform has designed to be saleable with up to 25,000 devices per server and 150,000 devices per domain.
    • Fourth: BlackBerry has placed its development emphasis on user experience, extensibility into Internet of Things (IoT) and total cost of ownership.
    • Fifth: A number of advanced features such as VPN authentication, simple and secure authentication among other features were also launched but only for BlackBerry devices.
  • At the same time, Samsung and BlackBerry have jointly announced that BES12 will support Samsung Knox and that the two companies will work together to address the regulated and government sectors.
  • These are two sectors where security is incredibly important and where Android’s lack of security has hampered its adoption.
  • Samsung Knox is also thought to be not that secure and teaming up with BlackBerry will help Samsung penetrate this industry more deeply.
  • I suspect that this relationship will be along the lines of offering a complete device and service offering for these industries.
  • Here, I think that BlackBerry devices will address the COBO and COPE segments of the user base and Samsung devices the BYOD piece.
  • John Chen is doing the right things to keep BlackBerry solvent but what is emerging is a vendor of MDM services.
  • This is a tough and competitive landscape with Airwatch, MobileIron, Good Technology, Microsoft and a host of others all vying to manage an enterprise’s mobile devices.
  • BlackBerry still has an advantage here as it has around 50m subscribers which is far more than any of its competitors and its solution is still the most comprehensive.
  • However, BlackBerry is having to offer heavy concessions (EZ Pass) to keep customers happy and I fear that this segment is rapidly becoming a commodity.
  • Consequently, I suspect that BlackBerry should now stabilise but the days of high margins, high growth and a high multiple are long gone leaving the shares with a difficult and uncertain future.
  • I would prefer Microsoft as an investment in the Digital Work ecosystem.

Twitter – Hopes and dreams

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Far more changes are required to meet the long term goals.

  • Twitter made some bold promises at its analyst day giving investors some confidence and sending the shares up 7%.
  • Firstly, a series of product announcements aimed at increasing engagement for logged-on users and casual visitors that include:
    • Instant timeline. Gives new users and casual visitors an idea of what is going on without having to follow anybody right away.
    • “What you missed”. Curates a list of tweets that were posted since the user logged in.
    • Homepage. A new design to make the homepage more engaging for both logged in and casual visitors.
    • New apps. New apps for mobile beyond Twitter and Vine will be released although what function they will serve is unclear.
    • Localised and event content. Content will be location aware and also curated by events that occurring around the user.
  • Secondly: Twitter provided some numbers that gave some context around the size of its audience and its long term targets:
    • Audience: Twitter estimates that its total audience is roughly twice the size of its user base at around 500m.
    • Long term audience: Twitter thinks that by 2020 it will have a reach of 2bn people, 4x where it is today.
    • Long term revenues: Twitter thinks that it can reach around $14bn in revenues within around 10 years, up from about $1.4bn in 2014E.
  • Thirdly: The company tried to play down the recent executive turmoil and turnover but in reality it explained very little.
  • Twitter is rapidly approaching saturation with its existing business and there has obviously been large differences in opinion in terms of where the company should go from here.
  • The fact that the head of product role has changed numerous times recently is a bad sign which only adds to the issues created by the departure of the head of analytics and VP of engineering at the end of October.
  • The medium term path has now been laid out and I hope that Costolo now has his ship under control and that turnover will now cease.
  • It will be a very bad sign if departures continue.
  • From the long-term goals it is clear that Twitter has no chance of meeting them unless there are fundamental changes.
  • I estimate that in its current form Twitter revenues will normalise at around $2bn.
  • This is because users only spend a very small portion of their Digital Lives engaging in microblogging.
  • Consequently, the information that Twitter receives about its users is more limited and the opportunity it has to advertise to them is also much shorter than for other activities like social networking.
  • Furthermore, Twitter knows nothing about at least half of the users that are viewing the tweets making targeting more difficult.
  • Some targeting will be possible based on the nature of the tweets being viewed, but the quality of these adverts and the revenues earned will be much lower.
  • In order to get to $14bn in revenues Twitter needs to address far more of the Digital Life pie and it must do so effectively.
  • Assuming it is a good instant messaging platform, Twitter currently addresses 9% of the Digital Life pie (see here).
  • If it can increase its reach to 2bn viewers on a monthly basis, I would estimate that Twitter needs to cover at least one third of the Digital Life pie to reach $14bn in revenues.
  • This means it will have to have a stab at competing in social networking, gaming or media consumption.
  • Of this, there is no sign and until there is I think it very unlikely that Twitter will ever come close to this target.
  • If it increases its reach to 2bn viewers with no changes to its current activity, revenues might just make $4bn in 2020E.
  • Either way it is clear that Twitter is not the next Facebook (see here) and while investors continue to pin their hopes on this dream, they are in for disappointments.
  • Twitter is a great company but I think the stock will remain bad for now.

Apple vs. MCX part II – Crash course

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MCX is likely to fail unless something changes.

  • The combined power of Apple and the major credit card companies is likely to exert so much pressure on MCX that something will have to change.
  • Retailers have problems with credit cards. The credit card companies charge them a fee every time a card is used which eats into their wafer thin operating margins.
  • As a result the Merchant Customer Exchange (MCX) was created by a consortium of US retailers to try and create an alternative payment system where the fees would no longer be charged.
  • This involves the use of store cards or direct debit on the customer’s bank account.
  • To date the payment experience has been the same for everybody with the customer presenting a card and signing a slip of paper or entering a PIN.
  • This has meant that MCX was offering a payment experience that was equivalent to everyone else giving a level playing field.
  • However, Apple has thrown a huge spanner in the works by creating a payment system that is much easier for users and that can be used any NFC enabled point of sale device.
  • This is a huge problem for MCX because it threatens to completely undermine all its efforts to move transactions in its members’ stores onto its systems.
  • MCX is developing its own mobile-based payment system called CurrentC but this has two huge disadvantages compared to Apple Pay.
    • First. It is a cumbersome QR Code based system that is more effort than making the payment with a piece of plastic.
    • Second. The merchant has to pay a higher fee to use CurrentC than either Apple Pay or a normal credit card.
    • This is because payment via CurrentC is classified as a “card not present” transaction which attracts a higher fee due to the increased risk of fraud.
    • With the creation of its very secure system, Apple was able to have Apple Pay transactions classified as “card present” transactions which are cheaper.
    • All other forms of in-App purchase also attract the higher fee giving merchants a strong incentive to adopt Apple Pay.
  • These two disadvantages alone are almost guaranteed to ensure that CurrentC fails.
  • The biggest problem with MCX’s strategy is that it is focused on the welfare of the merchants and does not seem to care about the customer experience.
  • This is exactly the kind of thinking that has hobbled the take-off of mobile based payments for the last 10 years.
  • This is where the huge risk lies. If customers start going to stores that accept Apple Pay instead of MCX member stores then there is a huge problem.
  • In the meantime, something has to change as MCX’s current course is almost certain to lead to failure.
  • If MCX is smart, it will quickly move its payment processing infrastructure to support Apple Pay because then it can achieve its own aims while keeping the consumers happy.
  • This would have the benefit of circumventing the fees charged by the credit companies as well as giving consumers and excellent user experience.
  • The consumer is king and there will always be alternatives where he can use whatever payment system he desires.
  • The sooner MCX realises that the financial well-being of its members depends on happy consumers, the better its chance of breaking Visa and MasterCard’s stranglehold on payments processing.