Google i/o 2017 – Brain game

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Superior brains being used to make its services the best.

  • Google held the first day of its annual developer conference and in its keynote, it highlighted the features and improvements that it is making to its ecosystem to keep users engaged while gathering and categorising as much data as it can.
  • Artificial Intelligence headlined the event with Google’s leading expertise now being implemented in everything that it does.
  • These included:
    • First, Google Lens. This is machine vision similar to what many others have also announced but in Google’s case I suspect it will work properly.
    • This can be used to identify items which combined with search to bring up relevant information about it.
    • This stretches from the history and background of a place to the ratings users have given to restaurants and shops.
    • Others fall short in the ability to identify items as well as in the digging up of relevant information about the item.
    • This is because the AI they are using to power the service is not nearly as advanced as Google’s.
    • This functionality is being rolled across all of Google’s properties to enhance everything Google does such as the Photos app, Maps, Daydream and so on.
    • Second, AutoML. This is a research project within the Google.ai initiative.
    • It is neural network that is capable selecting the best from a large group neural networks that are all being trained for a specific task
    • While few details were disclosed, Google said that the results achieved to date were encouraging.
    • This is a hugely important development as it marks a step forward in the quest to enable the machines to build their own AI models.
    • Building models today is still a massively time and processor intensive task which is mostly done manually and is very expensive.
    • If machines can build and train their own models, a whole new range of possibilities is opened-up in terms of speed of development as well as the scope tasks that AI can be asked to perform.
    • RFM has highlighted automated model building as one of the major challenges (see here) of AI and if Google is starting to make progress here, it represents a further distancing of Google from its competitors when it comes to AI.
  • Google also gave updates on all the current products and services including the next version of Android: Android O.
  • Most relevant updates included:
    • First, Android. There are now over 2bn active Android devices in the market but I suspect that there is meaningful multiple device ownership.
    • For example in Brazil there are more mobile phone connections than there are people, highlighting that multiple devices are owned by a large number of people.
    • This is a trend that is mirrored in many other emerging markets.
    • Every Google Android device has a Google sign-in and for the other Google services, the figures are closer to 1bn which also includes those that have iOS devices.
    • Hence, in terms of real unique users rather than devices, I think the numbers are much lower.
    • This is important because it is unique users that generate the revenue for Google and hence they are a better measure of the real penetration of Android across the globe.
    • Second, Android Go. This is the relaunch of the failed Android One project which aimed to put smartphones in the hands of more users which obviously, requires much lower cost.
    • Android Go is like a mini-mode of Android O which runs in an optimised way on devices with memory down to 512MB of RAM.
    • Google’s apps have also been optimised to run in this highly constrained environment.
    • Importantly, functionality has been added that focuses on saving data usage as well as offering complete control of data usage from the device.
    • For the lower income users, data has become almost like a currency and this gives them much better control of their “spending”.
    • This looks like a much better proposition than Android One which was highly restrictive to the handset makers.
    • However if they start tinkering with Android Go (as they always do), there is a good chance that all of these good improvement will vanish into thin air.
  • While this is not the most exciting i/o event in terms of new announcements, it is what is going on with AI that has the most implications for Google’s outlook.
  • AI is now embedded in everything and because Google is clearly the global leader it has the scope to make its services richer and more intuitive than anyone else’s.
  • This is critical because this is how Google will win over more users to its services, generate more traffic and therefore more revenue.
  • However, I think that much of this is already embedded in the share price and I continue to prefer Baidu, Tencent and Microsoft.

 

Android Project Treble – Yellow brick road

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Yellow brick road that leads to a fully proprietary Android OS.

  • The launch of Project Treble sees Google finally moving to address the Android updating problem but it also quietly paves the way for Google to take full control of the Android software.
  • It could also cost the handset makers more of the precious little differentiation they have left.
  • I have long believed that the inability to update Android OS is one of the biggest problems that Google faces with its ecosystem on Android (see here).
  • This has meant that whenever Google makes an innovation that requires any changes to be made to the OS, it takes around 4 years to arrive on the majority of Google ecosystem Android devices.
  • In contrast iOS takes a matter of weeks to update almost everybody.
  • For example, as of today, despite being available for over 6 months, less than 7% of all Google ecosystem Android devices are running the latest version (7.0 Nougat).
  • This is because Google has no control over the updating process for all of its devices (except Pixel and Nexis) and must rely on handset makers and operators to do it.
  • The problem here is that handset makers have little incentive to make their devices updatable and most of the time are quite content just to sell a new handset instead.
  • Project Treble aims to fix this by abstracting the hardware vendor’s modifications from the underlying OS such that the OS can be updated independently.
  • The way it works today is that Google passes the code to semiconductor companies who modify the code to ensure it works with their chips and release it to the handset makers in the form of a board support package (BSP).
  • The handset makers take the BSP and then modify it to meet their own requirements such as functionality or new hardware.
  • It is at this point that their modifications must pass the compatibility test suite (CTS) in order to able to deploy Google’s App store: Google Play.
  • Problems begin when Google updates Android OS as the manufacturer has to ensure that all of the modifications it has made will work before distributing the new Android code to its devices in the hands of users.
  • This process can be so arduous that many handset makers simply do not have the resources or the incentive to redo their modifications meaning that the update stays on the shelf.
  • Project Treble aims to fix this by adding in an abstraction layer between the Android OS and the vendor modifications such that the underlying Android OS can be updated without the manufacturer losing compatibility.
  • This is being referred to at the Vendor Test Suite (VTS) and while it looks like a great idea, it will have a number of problems.
    • First, differentiation: Most Android handset makers differentiate themselves through hardware innovation.
    • For example, Samsung’s iris scanner and HTC’s edge sensors on the U11.
    • This sort of differentiation may require the handset maker to put changes into the Android OS that go beyond the VTS interface that Google has defined.
    • Modifications beyond the interface obviate the whole point of the VTS and so Google updates would be back to square 1.
    • Second, control: The VTS will be like the computability test suite (CTS) which is a series of tests that the software must pass in order to ensure that apps from Google Play will run properly.
    • Modifications made beyond the interface are likely to result in a failure to pass the VTS test.
    • Hence, in effect, the VTS is another level of control as I suspect that handset makers that don’t pass the VTS will not be able to use Google Play or Google services.
  • Hence, the VTS could further limit the small amount of differentiation that the handset makers have left, further increasing their commoditisation.
  • However, for Google its all good as handset makers will no longer have any excuse not to update the Android OS, thereby ensuring that Google’s innovations in the OS come to market much more quickly.
  • However, this does nothing to address the fact that a large number of handsets are not updateable which has been discussed here.
  • This also paves the way for Google to:
    • First: take control of updating the Android OS separately from any modifications that the handset makers have made.
    • Second: move the remaining parts of Android OS out of open source and into Google Mobile Services (GMS).
  • It has long been my opinion (see here) that this is what Google must do to fix the inherent problems of fragmentation and software updating that continue to plague the platform to this day.
  • An easier to use and more consistent platform would most likely increase traffic generation and therefore Google’s revenues which on Android remain half of that generated on iOS.
  • I continue to think that Alphabet remains fair value and I would continue to steer clear of the handset makers whose differentiation looks like it may take yet another hit.

 

Amazon – Show and tell.

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Screens help to alleviate digital assistants’ stupidity.

  • I think that the Echo Show is more about addressing the shortcomings of voice interaction with machines than it is about launching a series of new and exciting Digital Life services.
  • Amazon has launched an ugly looking device called Echo Show that is effectively Alexa with a 7 inch screen attached to the front.
  • The form factor is disappointing as even Baidu with no hardware experience managed to come up with a far more appealing looking product (see here).
  • Amazon has also upgraded the speakers to give a louder and richer sound profile but I see this being about giving Alexa another medium with which to communicate with the user given the limitations of voice.
  • The problem is simply that Alexa (and all other others) are far too stupid to be able to hold a meaningful conversation with a user.
  • Google Assistant is currently the best but remains woefully short of what one would consider to be a useful assistant.
  • Digital assistants were designed to replace the human variety but because their intelligence is so limited, they are unable to hold a coherent conversation with the user.
  • Human assistants do not need to use screens to understand requests, relay information and carry out tasks meaning that the perfect digital assistant should not either.
  • Hence, I think that the Echo Show has been created to make up for the huge shortfall in Alexa’s cognitive ability
  • This type of interaction is what RFM refers to as one-way voice where the user asks a question and the results are displayed on a screen.
  • RFM research has found (see here) that the vast majority of all man to machine interactions are one-way voice and with this device, Amazon makes these interactions easier.
  • Furthermore, for those that depend on advertising having a screen also helps to maintain the business model of lacing a Digital Life service such as Search or Social Networking with advertising.
  • Consequently, I think that Google is likely to follow up with a similar product which will take advantage of the fact that the necessary communication apps that the device will use are already installed and ready to use on all new GMS Android compliant devices.
  • In Alexa’s case, it looks like the user will have install another app on his phone in order to communicate with the Echo Show.
  • The Echo Show will come with all of 12,000 Alexa’s skills but these skills have been designed for a device with no screen and so I do not see the screen improving the already very poor user experience that these skills currently offer.
  • At $230 or two for $350, the Echo Show is priced to sell but I think that volumes will be small given that the vast majority of Echo’s shipments are made up by the cheapest member of the family, the $50 Echo Dot.
  • Hence, I do not see a sudden rush by developers to upgrade their existing skills or develop new ones to make use of the screen.
  • This is where Google Assistant has a huge advantage as it has already been designed to run with a screen (smartphones) meaning that adapting to having a screen on the Google Home product should be much easier and much better.
  • I still think that Google Home has the advantage here as it has a much better assistant than Alexa, but its lack of developer support for the smart home is starting to be a real problem.
  • Google really needs to pull its finger out and show developers love, especially as Microsoft looks set launch something similar to Echo Show but using Cortana.
  • I continue to struggle with Amazon’s share price whose valuation I think demands that investors pay for profits that never seem to materialise.

Google vs Amazon – Battle of the home.

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The time for Google to move is now.

  • Amazon is far from standing still in its battle to win the smart home meaning that Google really needs to pull its finger out before it suffers a defeat not unlike that suffered by Betamax at the hands of VHS.
  • Amazon is already miles ahead of Google when it comes to devices, with over 10m in the hands of users (compared to Google Home at I estimate, 1m), but it is not stopping there.
  • Last week, Amazon and Conexant announced the availability of the AudioSmart 4-mic development kit.
  • This is a piece of hardware that allows third parties to integrate both the far-field microphone technology that the Echo products use to hear the user as well as the assistant itself.
  • In essence it is an Amazon Echo Dot without the case, being roughly the same size and shape.
  • The idea is that third parties take the kit and integrate it into their own products to provide voice control as well as the ability to control everything else in the house.
  • Ecobee has already taken the plunge by integrating it into its own thermostat and I would not be surprised to see many others follow suit.
  • Amazon has been extremely welcoming to third party developers giving a lot of support as well as meaningful discounts for running their services on AWS.
  • The same cannot be said of Google as almost every developer I have spoken to has not been complimentary when describing the experience of trying to develop for Google Home.
  • I find this to be a big surprise because Google’s Android developer program has been huge and thriving for years.
  • This is why Google suffered such a resounding defeat at CES in January where Amazon Echo was everywhere and Google Home was barely to be seen or talked about.
  • Google must act very quickly as even though it has vastly superior product, it is at risk if being swamped unless it starts to materially improve the number of third party products which can be used with Google Home.
  • Google has its developer conference (Google i/o) on May 17th to May 20th where I will be looking for three things:
    • First, Developer love: Google needs to show creators of smart devices plenty of love and support when it comes to making their products work with Google Home.
    • Second, Google Assistant: Google needs to make the assistant available such that anyone who wants to deploy it on their device can do so easily.
    • Third, hardware: Google should make its microphone array available to anyone that wants to use it.
    • This is more important than one would think as the system needs to able to hear the user from far away even with background noise.
    • This requires some specialised microphones and is important when it comes to delivering a good user experience to ensure engagement and traffic generation.
  • I still think that smart home is Google’s to lose but unless there is real movement in this direction at Google i/o, I fear that by next year, the game will already be over.
  • Google’s outlook for 2017 remains pretty good but the shares still look fairly priced leaving me preferring Microsoft, Tencent and Baidu.

Microsoft – S for school.

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Windows 10 S great for schools but not for the Surface Laptop.  

  • For the education of children, Windows 10 S makes perfect sense but for college and everything else, I can’t see why anyone would want it.
  • Microsoft held an education event this week where it launched a new version of Windows 10 called Windows 10 S and a stunningly beautiful laptop called Surface Laptop.

Windows 10 S

  • The main feature of Windows 10 S is that it is locked to running apps that are available in the Windows store.
  • This allows a greater degree of security as each app will have been checked by Microsoft but also will run in its own container.
  • This has the effect of not bogging down the operating system as often happens as devices age and ensures that performance will always be crisp and quick.
  • This is ideal for the classroom where all devices should offer exactly the same performance and teachers can’t waste time waiting for the older laptops to boot or load.
  • Windows 10 S also allows the school to take complete control of the device just as enterprises do with the laptops within their organisations.
  • I see this as highly appealing to schools whose aim is educate the students rather than to offer them a good and fun user experience on the device of their choice.
  • Microsoft has also added a handy feature enabling the creation of a USB drive that can install all of the required apps, settings and permissions on a Windows 10 S device in one go.
  • This makes the set up and management of devices within a school much easier and faster.
  • The app limitations mean that Windows 10 S can run effectively on devices that compete with Chromebooks which is clearly what Microsoft is intending with this version of Windows.
  • However, outside the controlled environment of a school, I can’t see anyone willingly running this version of Windows.
  • This is because what is available in the Windows Store is a sad reflection of the wealth of software that is available for the PC.
  • If take the example of a student at university then this reality is put into sharp focus.
  • Students tend not to have a lot of spare cash and therefore will rely heavily on free software which is they are using Windows 10 S needs to be on the store.
  • Taking the top free PC software as recommended by TechRadar, I found that 3 apps were available compared to 10 that were not but of which, 2 or 3 had something similar in the store.
  • The Windows Store does not offer Google Chrome, iTunes, Google Drive or any BitTorrent clients, all which I suspect are pretty important for cash strapped students.
  • Microsoft refers to its refusal to install the software that the user wants as a “friendly popup” that directs you to something similar in the store but I suspect that almost all users who have paid for their own devices will find this utterly infuriating.
  • Hence, I think that to make Windows 10 S gain any traction outside of schools, Microsoft needs to dramatically improve the Windows Store.
  • This will take some time and hence I see virtually no traction for Windows 10 S outside of the controlled education environment for which it has mainly been designed.
  • The good news is that users can unlock the device by upgrading to Windows 10 Pro for $49.99 (free for students) but how well Windows 10 Pro will run on a $170 PC remains to be seen.

Surface Laptop

  • Microsoft also launched a beautifully designed laptop that has looks and power but with the price tag to match starting at $999.
  • Every detail has been attended and it is refreshing to see a device maker show such care and passion for a product that it has created.
  • For high end users, who are not fans of the tablet form factor, this is a great option but in that regard, it has no business whatsoever being launched with Windows 10 S.
  • This product has clearly been designed to appeal to users and hence I suspect that almost every device will be shipped to users who have paid for it themselves.
  • Furthermore, the vast majority of schools, will not be buying this product for their students but rather something much cheaper.
  • Hence, I think that to create the best possible demand for this product Microsoft should offer the option for the device to ship with a regular version of Windows at no extra charge.
  • This is because I suspect that almost everyone who buys this service will not want to be bound by the limitations of Windows 10 S.
  • I think that after paying up to $2,200 for this device being forced to pay another $50 just to run the apps that the user wants will really stick in the craw.
  • Microsoft have launched the Surface Laptop as a hero device to encourage the adoption of Windows 10 S on much cheaper devices but it makes absolutely no sense for the device itself to run this version.

Take Home Message.

  • The end result is that I like Windows 10 S for school as it will take the fight to Chromebooks which dominate the education landscape in the US.
  • This is especially the case because Office is a far better option for content creation than Google Docs but where Google has an edge is in text books.
  • Google has spent a lot of time building up a huge library of e-text books for schools and this is something that Microsoft will have to quickly replicate in the store if it wants schools to switch.
  • Furthermore, if Microsoft can win students over to Office when they are young it sets Microsoft up nicely to continue its dominance with Office as these students enter the workforce.
  • Microsoft looks better positioned in education with this release which to me looks like a very long term, but worthy investment.
  • I continue to like Microsoft which is doing very well in the enterprise and fortunately the valuation does not demand excellence in consumer, where I continue to see indecision and slow decline.

 

Apple FQ2 17– New normal

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These days, Apple looks like an industrial. 

  • Apple reported reasonable results and in increasing both the dividend and the share buy-back program, ushered itself squarely into a new normal of pedestrian growth.
  • FQ2 17A revenues / EPS were $52.9bn / $2.10 broadly in line with consensus at $52.9bn / $2.02.
  • Gross margins were 38.9% at the high end of the guided range and slightly above consensus at 38.7% as the iPhone 7+ was a stronger contributor to the mix than anticipated, lifting profitability.
  • Unit shipments were:
    • 50.8m iPhones vs 51.4m expected with an ASP of $655 compared to $666 expected.
    • Note that a higher than expected inventory adjustment (1.2m units) more than accounts for the difference.
    • 8.9m iPads and 4.2m Macs also shipped with Macs faring a little better than expected.
  • Services continued to be very strong with $7bn in revenue growing by 18% YoY with Apple stating that it now has a total of 165m paid subscriptions.
  • This includes Apple Music, iCloud and the subscription services of others that it offers on the Apple App Store.
  • There is obviously a degree of double counting going on here where for example, Spotify subscribers who pay through the App Store are also included here.
  • In my opinion, this renders this number virtually meaningless as Apple is counting subscriptions of its competitors as its own although it will still be making some money from these subscribers.
  • This combined with both an increase in dividend and the share buyback program, indicate very clearly that there is no growth in this company unless it can conquer a new segment.
  • Having (rightly, in my opinion) given up on making a car (see here), there is no new segment in sight, and so I see Apple, by and large, growing in line with the world economy.
  • I suspect that it will swing above and below that average as new products drive replacement cycles but the long-term outlook is industrial in its nature.
  • The next swing is likely to come from the iPhone 8 for which speculation and anticipation is already at fever pitch.
  • This means that Apple has to come up with something pretty special to see another cycle that will push its revenue growth above its new long term average, albeit temporarily.
  • Fortunately, the valuation of the company is not too demanding with a PER of 13.0x but the buy case based on valuation has now evaporated.
  • I see very little upside other than income coming from the shareholder return programs.
  • I would prefer Microsoft, Baidu and Tencent for those looking for capital appreciation.

 

Wearables – Holding pattern

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Wearables are sitting in a holding pattern. 

  • Amazon, eBay and Google (Maps) have ceased supporting their apps on the Apple Watch, confirming my suspicions that while it may be novel to shop and navigate from the wrist, it is neither useful nor fun.
  • I see this as yet another sign that smartwatches and wearables remain in limbo as they are a solution looking for a problem explaining why most users tire of them so quickly.
  • That being said, I think that wearables and smart watches have found a niche in the recreational fitness market which looks to have bottomed out after a very difficult period in the middle of 2016.
  • The market returned to growth in Q4 16 with 25% increase in volumes YoY but it was the cheap and cheerful providers that made all of the running with Xiaomi, Samsung and the others accounting for the vast majority of the increase.
  • To make matters worse, these are already commodity products with most priced well below $100 where no one is making a sustainable return.
  • The market leader Fitbit saw a 23% decline while Apple Watch grew by 13%.
  • I think that the reason why there is so little differentiation remains that no one has really figured out how to make a wearable product a must have.
  • Even Apple, which has a legendary ability to come up with compelling use cases, has struggled and the main question asked by potential users is: “Why would I buy it?” rather than: “How much is it?”
  • Outside of fitness tracking, wearables are little more than remote controls for a smartphone providing no reason to shop or navigate from these devices.
  • This is why I suspect that Amazon, Ebay and Google Maps have dropped support although Google has said that it “intends” to support Apple Watch once again in future releases.
  • I would be not surprised to see other third parties drop support for the Apple Watch as there are costs involved with development which don’t seem to have shown any tangible benefit to the developer.
  • I think that one of two things need to happen to make this segment blossom:
    • First: Devices become capable of delivering medical grade health measurements.
    • For blood pressure and blood glucose alone this would open up a market of 1.4bn users.
    • There are some signs of this among the start-up community but there is still some way to go.
    • Second: A must have use for these devices has to be found.
    • I am not confident as this has been Apple’s great strength to date but even it has failed when it comes to the Apple Watch.
  • Hence, I think that Wearables will bumble along the bottom with very low profitability until one of these criteria is met.
  • I can’t say that I would be keen to invest in anyone with exposure to this difficult and non-profitable segment.

Apple vs. Qualcomm – Proxy war

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Apple’s intransigence plays into Qualcomm’s hands. 

  • Qualcomm has been forced to adjust its guidance for the coming quarter after being informed by Apple that it would not be receiving any royalties for the foreseeable future.
  • According to Qualcomm (as Apple has made no statement), Apple has ceased payment as it finds the contract terms unacceptable even though it does acknowledge that some payment is warranted.
  • Qualcomm’s new FQ3 16 guidance is for revenues / EPS that will be $500m – $800m (midpoint $650m) and $0.15 – $0.30 lower than the guidance given at the recent FQ2 16 results.
  • Although the issues that Apple has with Qualcomm’s business model are very similar, if not the same as the issues that Nokia had back in 2006, the circumstances are completely different.
  • These are:
    • First Contract validity: The dispute that arose between Nokia and Qualcomm in 2006 occurred because Nokia’s contract had come to an end and the companies were unable to reach agreement on terms for the renewal.
    • Nokia stopped paying Qualcomm as it had no idea how much to pay and instead accrued an estimate of the cost in its balance sheet.
    • The contracts upon which Apple has ceased payments have not expired and I can’t see any real contractual grounds upon which to cease making payments.
    • As a result, I do not think that it will not be difficult to show to a court that Apple is acting in bad faith and to win an enforcement order.
    • Second: Third party suppliers. Apple does not pay Qualcomm directly as the payment is made by its manufacturing partners who make its products.
    • This means that Apple is getting involved in contracts that are in place between entities that have nothing to do with Apple other than it is the end buyer.
    • I do not think it will be difficult to argue that Apple has no real grounds to be involved in these contracts and is acting in bad faith.
  • Apple’s intentions are clear in that wants a lower rate from Qualcomm and unlike Nokia, is not prepared to wait until current contracts expire before launching its proxy war via its suppliers.
  • Apple’s royalties are calculated on the wholesale price of the device which in this case will be the price at which the supplier sells the finished device to Apple.
  • I calculate that the supplier is paying Qualcomm 2.8% of the price of the device from making the below assumptions:
    • Qualcomm’s FQ3 17 royalty revenues from Apple would have been from calendar Q1 17 as royalties tend to paid one quarter in arrears.
    • Apple shipped 52m units in calendar Q1 with an ASP of $650 giving iPhone revenues of $33.8bn upon which it made gross margins of 45%.
    • This means that suppliers sold the devices to Apple with an ASP of $448 for a total revenue of $23.3bn
  • There are a number of caveats to this assumption:
    • First price cap: There is a price cap above which no royalties are paid.
    • This cap was originally meant for products like laptops with modems, but premium smartphones are now so expensive that they often hit this cap.
    • I have estimated that this cap is somewhere around $500 but if it is as low as $400, then the rate I calculate paid by Apple goes up to 3.1%.
    • Second pay up front: There is a pay-up-front option (which Nokia took advantage of) which allows the vendor to pay a lower rate going forward.
    • It is not clear whether contracts with the iPhone suppliers have made use of this option or not.
  • The net result is that I calculate that Apple is paying somewhere around 3% to Qualcomm which I think is at least on par with many other vendors.
  • The problem with patents as there is no real way to determine what should be paid to for them.
  • I have long believed that patents are worth either:
    • First: what an entity is prepared to pay for them or
    • Second: the present value of the cash flows that the patent generates.
  • This is why historical precedent is so important when it comes to patent licencing and here Qualcomm has a huge advantage.
  • Qualcomm has hundreds of agreements and more than 20 years of history as evidence that its agreements have not damaged the mobile industry, in fact, quite the reverse.
  • Furthermore, I think Apple’s intransigence on this issue and ceasing payments that it has already agreed to in writing, plays enormously to Qualcomm’s advantage.
  • Courts look poorly upon a refusal negotiate and acting in bad faith and I think that Apple has done more harm than good to its case here.
  • Hence, I think Qualcomm’s chances of prevailing against Apple are better than they were against Nokia which is all the more reason why it should fight tooth and nail to preserve its business model.

Samsung Q1 17 – Roaring 40s

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Semis is a powerhouse with growth and margins in the 40s.  

  • Samsung reported a superb set of results driven largely by semiconductors but announced that it would not be re-organising into a holding company much to the dismay of some activists.
  • Q1 17 revenues / EBIT were KRW50.6tn / KRW9.9tn compared to consensus forecasts at KRW49.5tn / KRW9.18tn.
  • At the same time Samsung announced its first ever dividend of KRW28,000 (annualised) giving a yield of around 1.4%.
  • It also announced that it would keep its promise to cancel all of the treasury shares that it has bought resulting in a further return to shareholders of KRW40tn.
  • This is a promise that many US and European companies implicitly make when they ask s for permission to buy back shares but in practice, rarely keep.
  • For me, this is far more important to shareholder value than re-organising into a holding company.
  • I view holding companies as conglomerates where good intentions are, more often than not, ground down into inefficiency, bureaucracy and slowness.
  • Consequently, I do not see Samsung’s reticence to become a holding company as a bad thing for shareholders.
  • Semiconductors was the powerhouse of these results posting 40% YoY growth with EBIT margins of 40% making up 63% of total profits.
  • The handset business was much less exciting with a 17% YoY decline in revenues and EBIT margins of 9.2%.
  • Even if I reverse out the KRW1.0bn hit that was taken during Q1 17 in the handset business for the Note 7 disaster, I still have only 14% EBIT margins.
  • While Samsung’s margins in Android are exemplary compared to its Android competitors, its semiconductor margins are industry leading, handsomely beating even Intel at the operating level.
  • Consequently, I think that it is this business that will be the main driver of performance for the balance of 2017.
  • In that regard, the outlook remains good with steady demand coming from servers and handsets and no imminent threat to its domination of the memory industry.
  • The implosion of Toshiba and potential change in ownership can only continue to benefit Samsung Semi in 2017.
  • This could be further enhanced should Apple decide to move to OLED in its next iPhone generation for which Samsung is the most likely supplier.
  • This should help provide some stability to the display business which is notorious for its wild swings between profit and loss.
  • The net result is that the outlook for Samsung this year remains very healthy with only one uncertainty on the horizon.
  • This is the unquantified damage that has been done to the brand following the Note 7 disaster raising questions with regard to shipments of the Galaxy s8.
  • Despite this, the initial signs are good as the reviews of the device are overwhelmingly positive despite the software shortcomings (see here) and pre-orders are pointing to no lasting damage having been done.
  • Admittedly, I put the brakes on this one too early by deciding to call time in Q4 16 when the scale of the Note 7 disaster became apparent.
  • Now with the share price above KRW2m, the opportunity for further upside is less obvious leaving me to continue preferring Microsoft, Tencent and Baidu.

Juicero – Cautionary tale.

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A cautionary tale for budding entrepreneurs.

  • While Juicero is no Theranos, it has got itself into a life-threatening mess that I suspect has come about solely because it got its business model wrong.
  • Juicero is a Silicon Valley company that claims to offer the kind of juice purchased in a store but prepared freshly at home and is totally mess-free.
  • This works through a cold press that can deliver up to 4 tons of force to squeeze the liquid from pre-prepared pouches of fruits and vegetables that the company also sells.
  • The press can only make juice from the pouches which combined with an app and a database, is able to keep track of the produce the user has, when it will expire and send alerts and so on.
  • The juicer is priced at a pretty punchy $400 (reduced from an eyewatering $700) with each pouch selling for $5-$8 meaning that each glass of juice is going to cost somewhere in the region of $7-$8 depending on how long the machine lasts.
  • With each pouch delivering about 9oz of juice, this adds up to $0.83 per ounce which is broadly in line with the top-of-the-line juice companies in Silicon Valley (see here) which charge around $0.86 per oz.
  • I think that the business model is based around breaking even on the pouches and the service with most of the margin coming from the machine.
  • This explains why the company will only sell the pouches to owners of the machine as without it, the business model would collapse.
  • This is where the problems really begin because it turns out that it is possible to produce a perfectly good glass of juice using nothing but bare hands (see here).
  • A female reporter was able to extract 8.5oz of juice from one of the pouches faster than the machine could produce 9.0oz
  • NASA has measured that the human hands of the average male are capable of producing around 90Kg of force (see here).
  • This means that the other 3.5 tons of force that the machine can produce only increases production by 6% demonstrating that Juicero is massively over specified for the task for which it has been designed.
  • Furthermore, if there is a power cut or the Internet is down, no juice is produced whereas hands work all the time and can even offer juicing on the move with limitless battery life.
  • This is where I think the company has gotten its business model wrong.
  • I think it should have followed the tried and tested printer and cartridge model where the printer is sold at break even or a loss and the money is made on the cartridges.
  • I suspect Juicero could have designed the press to deliver 200Kg of force rather than 4 tons with no perceptible difference in performance other than a much cheaper price.
  • If the company had then sold the device for $50 rather than its starting price of $700, I doubt whether anyone would have even bothered to try and squeeze the pouches by hand.
  • This way the company could have hoped to have achieved much greater volume and in doing so it would have been able to get better prices from its suppliers and make good margins on the pouches.
  • The problem now is that everybody knows that the Juicero machine is surplus to requirements for everyone who can read an expiry date.
  • Hence, a change in strategy is urgently required.
  • Juicero offers convenience and in that regard it may have a future as a subscription service for very high quality juice that one prepares at home.
  • However, it will have to confess its shortcomings, ditch the expensive machine and reorient itself around the printer / cartridge model with something much cheaper.
  • On its current trajectory, it is likely to be squeezed out of existence.