Yahoo & Verizon – Final execution.

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Finally, Yahoo executes.

  • Yahoo may have badly failed to create any value for investors in mobile, but its execution on the sale of its core business is finally generating significant value for its long-suffering shareholders.
  • Verizon will now pay $4.48bn to acquire the core business of Yahoo a reduction of 7% of $350m and the two companies will share any legal and regulatory liabilities that arise from the two massive data breaches that Yahoo has suffered.
  • I think that this is a triumph for Yahoo which is capitalising on Verizon’s apparent desperation to build a digital ecosystem.
  • For the last 10 years Yahoo has neglected its Internet assets but it has still managed to enjoy high usage and engagement in the fixed Internet despite its failure in mobile.
  • It is this engagement that Verizon is paying $4.48bn for.
  • However, recent events have given users the perfect excuse to finally close their Yahoo email account and move to something else.
  • I have long believed that Yahoo Mail is the service that generates most of the usage and should users leave Yahoo, then the value that Verizon is attributing to Yahoo will have to be written off.
  • Top of the list of Yahoo’s many misfortunes are two massive hacks, one of which took Yahoo 4 years to detect.
  • Over the last 12 months, Yahoo has admitted that around 1.5bn user accounts have been compromised in two very large break ins.
  • This is more accounts than Yahoo actually has, implying that every account that Yahoo has been compromised with a good number of its users having suffered the indignity twice.
  • If this was not enough, Yahoo’s Q4 results showed improving margins solely due to cost cuts which deflected attention away from the fact that revenues are still falling, albeit more slowly than before.
  • On top of Yahoo, Verizon already owns AOL and is trying to rebuild its Go90 mobile video service using the team and assets acquired from Vessel in 2016.
  • The problem I have with Verizon’s strategy is that it is late to game meaning that it has ending up acquiring all of the assets that no one else wanted.
  • Furthermore, Yahoo and AOL have both badly failed to generate any traction on mobile but somehow Verizon seems to think that putting all of these together will create a thriving ecosystem.
  • This is of course possible, but if Yahoo was unable to hold onto the talent capable of executing this dream, I think that Verizon has very little chance.
  • Consequently, instead of a thriving ecosystem, I see a bunch of disparate assets from which users are likely to drift away from at the first opportunity.
  • The real winner here is Yahoo which is receiving far more value for this asset than I think that it is worth and has also managed to halve its exposure to liabilities that I think it should be fully on the hook for.
  • Combine this value with the continued strong performance of Alibaba and Yahoo Japan, and it is not difficult to still see upside in the Yahoo share price.
  • Marissa Mayer may have been terrible at executing on a digital ecosystem but she seems to be a great salesperson.

Alibaba – Five guns east

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Alibaba is going guns blazing for offline. 

  • Alibaba appears to be moving into offline retail much more quickly than I had anticipated as it is complimenting its $2.6bn bid for Intime Retail Group with a partnership with Shanghai Bailian Group which owns 4,700 stores in 200 cities in China.
  • This is a huge step forward from its bid to acquire Intime retail group which operates 29 department stores and 17 malls predominantly in the eastern province of Zhejiang where Alibaba’s home town of Hangzhou is to be found.
  • The idea of this partnership is to bring Alibaba much further into the physical world where $4.5tn of sales are still transacted every year as well as improve the offline experience that users have in Bailian stores.
  • Chinese retail is a fragmented and frustrating experience where decent service and information with regards to inventory, product lines and so on is routinely not available.
  • Consequently, when an online offering appears where this information is clear and one is able to easily purchase goods and know when they will be delivered, shoppers quickly adapt.
  • It is the terrible offline experience with regards to almost everything that has allowed so many other goods, services and activities in China to rapidly migrate from offline to mobile.
  • It these problems that Bailian hopes to fix via its partnership with Alibaba which will provide its technology, its understanding of logistics and its processing systems to modernise Bailian.
  • In return Alibaba will get a large physical presence, access to shopper data and the first big launch for Alipay into the physical world.
  • There are two large mobile payment systems in China.
  • One is Alipay which utterly dominates B2C e-commerce and the other is WeChat Pay which dominates peer to peer as well as payments to shops, restaurants and service providers.
  • This move will bring Alipay into direct competition with WeChat Pay for the first time.
  • I think this partnership will be similar to the potential deal with Intime but on a much larger scale.
  • I have previously viewed (see here) the potential deal with Intime as an experiment in retail which would then be rolled out more widely once it had been proven to work but it looks like Alibaba is going national regardless.
  • Fortunately, as this is a partnership, there will not be much downside risk if it goes wrong which leads me to believe that for Alibaba, this is really about data and pushing Alipay into a new domain.
  • If Alibaba can have a deeper understanding of, and relationship with Chinese shoppers then it will be able to more accurately predict their shopping patterns resulting in better purchasing rates and the ability to charge a higher percentage of GMV to its merchants.
  • This will translate into better revenue and profit growth as was the case in 2016 where increasing monetisation underpinned a large part of the company’s outperformance.
  • I think this expansion will be much slower in 2017, and so I remain cautious on Alibaba preferring Tencent or Baidu in China.

Google vs. Amazon – Homefront.

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This could be a repeat of VHS vs. Betamax. 

  • Google is adding functionality to allow Google Assistant to compete more directly with Amazon’s Alexa, but what it really needs is to offer love and support to developers of smart home products.
  • Google’s failure to do this was visible on every stand at CES where a smart home product was to be found as they all will work with Amazon Alexa
  • Only a very tiny fraction will work with Google Assistant.
  • Google’s shopping functionality has involved singing a up a series of retailers such as Costco, PetSmart and Target to link their online ordering systems with Google Home such that a similar (to Amazon) shopping experience can be offered through the device.
  • Measuring up to Amazon in this category is going to be tough because Amazon has one system through which millions of products are available globally, whereas Google will have to sign up lots of retailers in every locality where it aims to have this service available.
  • However, when it comes to almost all of the other features, Google Assistant is capable of offering a vastly superior user performance than Amazon Alexa.
  • This is because the AI that powers Google Assistant is top of the class while Alexa’s is second rate at best.
  • Furthermore, the Google Home speaker is $50 cheaper than the Amazon Echo and in my opinion, a nicer looking product.
  • However, where Google falls over is home automation and here Amazon is currently ruling the roost.
  • RFM research has found that device developers receive plenty of love and support from Amazon which combined with the fact that there are now 8m devices in the hands of users drives them to make their products work with Alexa right from launch.
  • This is despite the fact that using many of these products with Amazon Alexa is a frustrating and fragmented experience.
  • A good example of this is Plex, which recently enabled an Alexa skill so that the user could control the Plex player using Alexa.
  • However, because Alexa lacks the brains to make service intuitive, the user experience is so bad that one tries to control Plex with Alexa once and quickly returns to the remote control.
  • In contrast to Amazon, many developers find that Google is difficult to work with and some did not even know who to at Google to call to enable Google Home with their product.
  • This is the opportunity for Google Home even though it only has around 0.5m devices in the market today.
  • I think Google needs to ramp up its love and support for developers immediately and thinking that they will just turn up at Google i/o is not nearly good enough.
  • There is a whole segment (home) of the digital ecosystem up for grabs right now and I still maintain that this is Google’s to lose.
  • However, at the moment it is Amazon that is blazing the trail and if Alexa makes it into the majority of households before Google pulls its finger out then the game will, in all probability, already be lost.
  • This will not be the first time that an inferior product will have won the day and I think there are valuable lessons that Google can learn from studying this history.
  • From an investment perspective, I continue to not really like either Alphabet or Amazon preferring Baidu, Tencent and Microsoft.

Facebook – Brainless video.

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Focusing on video first makes complete sense.

  • I think that Facebook is making the right choice in targeting video first as it already has traction and video-based services tend to have the lowest requirements for artificial intelligence to make them easy, fun and useful.
  • With the launch of a TV app being just the latest move Facebook has made in video, it is increasingly clear that Media Consumption is Facebook’s number 1 priority for 2017.
  • The TV app that is being launched is very simple in that it makes it easy for a user that does not have time to watch videos on Facebook during the day to easily to so at night on a larger screen.
  • This should enable a better video experience and begin to spread engagement across other devices but it will come with the added complication of multiple resolutions and bit rates.
  • On a mobile device the screen is small which means that lower resolution videos and bit rates are acceptable, but once these are played on a larger screen, their shortcomings quickly become obvious.
  • This move into TV comes hot on the heels of the addition of a tab at the bottom of the Facebook app which links to the top trending videos as well as videos that Facebook thinks that the user might like.
  • The TV app will initially be available on Amazon TV and Apple TV but I expect that it will quickly spread to Xbox, PlayStation and the other streaming TV devices that are available.
  • The one place I don’t expect to find it is Chromecast as Facebook’s video aspirations are clearly a challenge to YouTube.
  • Of the three new areas of Digital Life (Gaming, Media Consumption and Search) that I see Facebook targeting (see here), going for video first makes complete sense.
  • This is because Facebook already has a lot of traction in this space and also because it is the least demanding in terms of requiring intelligent automation.
  • The total number of video items that are present is very low compared to other things like music or searches and knowing who posted the video is a good indicator of its content and who will like it.
  • I continue to see Facebook as the laggard in AI (see here) and targeting video is sensible as it gives it more time to improve its AI before having to apply it to more difficult tasks.
  • Furthermore, the fact that video is a fast growing, but likely soon to mature, medium for digital advertising also means that the time to really address it is now.
  • I see the app on the TV as just the beginning and would not be surprised to see this being followed up with premium content taking it into the realm of Netflix, Hulu, YouTube and Amazon Prime.
  • That being said, I don’t think that Facebook’s offering in Media Consumption is anything like mature and so I think it will be some time yet before it becomes a real destination like YouTube.
  • Consequently, I still see a slow period of revenue expansion while its new strategies mature before revenues take off again.
  • As this reality sinks in, I think the valuation could unwind somewhat providing a better opportunity than now to invest for the long-term.

Baidu – One trick pony?

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Baidu may be giving up on its ecosystem.

  • There is little doubt that Baidu’s investments outside of its core search offering have proven expensive, but it appears that Baidu may be losing the stomach to endure the heavy losses required to build an ecosystem.
  • The three assets in particular are Nuomi, its e-commerce offering, iQiyi, its video streaming service and its on-demand food delivery service.
  • Nuomi and iQiyi have been the real areas of investment and in recent quarters have between them consumed over 50% of the operating profit generated by the core businesses.
  • This combined with its problems with low quality advertising and its higher tax rate, have put it under much greater pressure to deliver better profitability.
  • This has been further exacerbated by the fact that of the three BATmen, Baidu is by far the weakest both in terms of cash flow generated each quarter and cash reserves on the balance sheet.
  • This is why I suspect that Baidu has been forced to look at these investments to find ways of reducing their drain on the financial performance of the Baidu Group.
  • I understand that outside investment as well as trade sales have been considered but it looks like the most likely outcome will be heavy cost cuts.
  • This will limit both Nuomi and iQiyi’s ability to compete against Alibaba’s T-Mall, JD.com and Alibaba’s Youku Tudou leaving them as niche services rather than national leaders.
  • On the Chinese Digital Life pie (see here) Media Consumption and Shopping make up 29% of the total meaning that if Baidu was to abandon or sell these activities its coverage would drop to 24% (Search, Browsing and Mapping).
  • Consequently, I think that it would spell the end of Baidu’s ambitions to become a leading ecosystem in the Chinese market leaving it as a dominant player in just a few segments.
  • Search, Mapping and Artificial Intelligence are extremely important segments and I think that Baidu will be able to make a good living from them, but its real long-term upside will have been curtailed by this retrenchment.
  • The net result in the short-term will be a substantial improvement in its financials making the current valuation look cheap and so I suspect that news of this move will have a quite positive, but short-term, impact on the shares.
  • This is why I am happy to keep Baidu on my preferred list along with Tencent and Microsoft despite the possibility that its long-term upside may now evaporate.

Magic Leap – Creations great but not small

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Technology is there but size is miles off.

  • While I do believe that Magic Leap is capable of producing an augmented reality experience (AR) that far outstrips anything its peers are offering, I think it is years away from fitting that technology into anything that a consumer will tolerate.
  • The latest leak (see here) from Magic Leap shows a unit that is clearly a development board in a clear plastic box powered with an external battery pack and a fairly large head unit.
  • This has been reported to be the latest prototype called PEQ (product equivalent) that the company will be presenting to its board and investors this week.
  • This group are all looking for results from the $1.39bn raised so far.
  • Magic Leap CEO, Rony Abovitz, has been quick to identify the device as a R&D test rig used for data collection that helps with the creation of surfaces and textures in AR.
  • This follows a number of data points that RFM research has collected over the last month that include:
    • There appear to be problems with the core fibre optic technology that has led to the company having to redesign elements of its offering (see here) to make it smaller.
    • Suppliers have described conversations with Magic Leap engineers that strongly imply that some parts of the system are not even past the concept stage.
    • Silicon Valley chatter also highlights the possibility of infighting between the Silicon Valley operations and the mothership in Florida as well as some high-level departures and very short senior tenures.
  • I think that the key to understanding what is happening at Magic Leap comes from Rony Abovitz himself who describes his prototypes (see here) as being in “agile build cycles”.
  • To me this means that the hardware and software design and specification of the PEQ product, that Magic Leap intends to launch, are far from being locked down.
  • Consequently, there is no point whatsoever is spending a fortune in trying to miniaturise the hardware as all that investment would be wasted if something has to be changed.
  • I also suspect that Magic Leap has been forced by the pressure to start generating revenues into producing a compromised product.
  • RFM research indicates that the older, far bulkier prototype uses all of the Magic Leap technology and produces a great user experience but remains far too bulky to wear.
  • Consequently, it appears that to make it wearable, Magic Leap has been forced to make compromises in the user experience.
  • These would include features like field of view, resolution and refresh rate.
  • This would explain why the feedback generated by the few who have experienced the technology appears to have gone from “wow!” to “ho-hum”.
  • Hence, I think that Magic Leap is very far away from producing the kind of product with which it could take the AR market by storm.
  • I don’t think that this is a problem as almost all of its competitors are looking to sell their units to enterprises where the user experience is much less important (see here).
  • Magic Leap is aiming for the consumer and given how poor the general AR experience is today, I can’t see anyone producing a successful consumer device for 2-3 years at least.
  • This gives Magic Leap time in terms of the market it is aiming at but the real question is what time frame did it promise its investors and will they be willing to pour a lot more money into this company?
  • One thing I am pretty sure of is that Magic Leap is going to need it.

 

Twitter Q4 16 – No Trump card

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Trump card fails to win the trick.

  • Despite becoming a major channel for the White House to communicate with voters, the realities of Twitter’s situation have continued to dominate its financial performance.
  • Q4 16A revenues / Adj-EPS was $717m / $0.12 badly missing consensus at $740 / $0.23.
  • Monthly active users (MaU) also remained stagnant coming in at 319m up 4% YoY which reflected the anaemic revenue growth which was just 1% YoY.
  • Daily active users did manage to grow 11% indicating some increase in engagement with the service, but it was not nearly enough to convince advertisers to spend more money on the platform.
  • This reality was reflected in Q1 17 guidance where Adj-EBITDA will be $75m – $85m well below consensus at $188m which I think reflects stagnant revenues as well as higher investments in media consumption.
  • I continue to believe that the lack of growth is caused by the fact that Twitter has already fully monetised its segment and in order to grow revenue further it has to address the other segments of the Digital Life pie.
  • In this regard, Twitter has opted to go for Media Consumption which would add another 10% points to its coverage, bringing it to 28%.
  • This is why its progress with its streaming of NFL games and partnership with Bloomberg, Buzzfeed News and PBS is so important.
  • If Twitter can develop this offering into a fully-fledged Media Consumption service with real engagement, then I could see Twitter increasing its revenues to over $1bn per quarter giving annualised revenues of $4-5bn.
  • However, it is still very far from challenging YouTube or Facebook Video which is why I need to see far more than just NFL streaming and a bit of news in order to become confident that Twitter has a media consumption offering that it can monetise.
  • With $196m in cash flow from operations in Q4 16 and $763m for FY2016, Twitter is very far from any existential danger but I see the fair value of the company with no growth being way below where it is today.
  • Consequently, I see nothing in 2017 that is going to drive Twitter back to growth which will put further pressure on the share price.
  • I continue to see Twitter as a potential acquisition target but would expect to see the shares touch $10 before real interest is triggered.
  • I see no reason whatsoever to go bargain hunting as there is no bargain to be had.

Facebook vs. Alphabet – Worlds apart

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Facebook and Alphabet are worlds apart when it comes to AI.

  • While Google is pushing the boundaries of artificial intelligence forward, Facebook is making excuses for its inability to control hate speech highlighting once again who is the leader and who the laggard in the field of AI.
  • Google has demonstrated a system that it has built that allows very poor digital photos to be enhanced to reveal details of the photograph that have been completely obliterated.
  • In a similar fashion to the way that Deep Mind built AlphaGo, Google has combined two neural networks to produce the algorithm capable of enhancing low resolution images.
  • One of these networks uses its knowledge of certain images to add details while the other effectively reverse engineers the process by which the image was compressed into its current form.
  • The result is quite startling but it is worth remembering that the machine knew what the original image was a face or a bedroom but no more than that.
  • Despite Google’s claim that this was an experiment only with no plans to put it to use, I think that the uses for this are endless.
  • This technology would be useful in upscaling video to high resolution screens as well as being highly applicable to law enforcement, security, military, medical and so and so forth.
  • Hence, I think that this technology or an off shoot of it is likely to find its way into Google’s products and services in the medium term.
  • To me this is another demonstration of how well Google leads the field of artificial intelligence and is the closest to using it to enhance the richness and quality of its Digital Life services.
  • This will be a huge benefit to Google as better services will drive more usage through its networks giving it a greater opportunity to monetise.
  • However, this is also the opportunity that Facebook is chasing but when it comes to making its Digital Life services deeper and richer with intelligence, I see it being miles behind.
  • The problems that it has had with fake news, idiotic bots and Facebook M, all support my view that when Facebook tries to automate its systems, things always go wrong.
  • The problem is not that Facebook does not have the right people but simply that it has not been working on artificial intelligence for nearly long enough.
  • RFM research has found that time is the single most important element when it comes to having a solid foundation of intelligent algorithms upon which to build intelligent services (see here).
  • In contrast, Google has been working on this for over 20 years and is still innovating as fast as it can.
  • Facebook’s most recent pronouncement by one of its lawyers that it is unable to control hate speech on its platform due to the scale of data that is posted every day, is just another data point highlighting the problem.
  • Facebook has to get this under control otherwise I fear that it will fail to really expand beyond social networking and instant messaging as the offerings from its rivals will be more useful and more fun.
  • Facebook has some time to get to grips with this problem but I still think it will have to resort to making a series of acquisitions in order to catch up with its rivals.
  • I remain uninterested in both Alphabet and Facebook at this time preferring Microsoft, Tencent and Baidu with Apple for income based investors.

Xiaomi & Huawei – Different strokes

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Xiaomi and Huawei go in different directions.

  • While commentators are absorbed with Apple’s (almost certainly temporary) No. 1 position in the smartphone market and Oppo’s ascendency in China, no-one seems to have noticed a good recovery at Huawei and that things are looking increasingly dicey at Xiaomi.
  • IDC has released its figures for the smartphone market in Q4 16 both globally and in China.
  • The market has shown some growth with 7% growth YoY globally and 9% YoY in China with the Chinese makers increasingly dominating the market both at home and overseas.
  • Apple has gained the No. 1 slot but is almost certain to lose this back to Samsung in Q1 17, due to the heavy seasonality of its handset business.
  • Both Oppo and Vivo make an entrance in the global top 5 with 7.3% and 5.8% share respectively, but I think that the real winner of the quarter was Huawei.
  • By the same token all does not appear to be well at Xiaomi which has fallen to No. 5 at home and is well out of the global top 5.
  • I have discussed these two in a bit more detail below.

Huawei

  • Huawei has had a torrid 2016 after spending big at Mobile World Congress and failing to make the market share gains that it badly needed to begin to fulfil its ambition to become the global No. 1.
  • I am pretty certain that the increase in spending in 2016 has pushed the handset business into loss making territory for the year.
  • Furthermore, I suspect that the business will be on a much tighter leash in 2017 which will mean that investments have to be very carefully targeted.
  • The good news is that it had a much better Q4 2016 gaining 1.8% points of global share to reach 10.6%, giving it a platform upon which to build in 2017.
  • I remain convinced that to really become No. 1, Huawei must become an adept of software and the user experience which is something with which it continues to struggle (see here).
  • I see 2017 as a year of focusing on profitability and steady gains rather than all-out assault upon the market.

Xiaomi

  • Everything seems to have gone wrong at Xiaomi during Q4 16 with a heavy market share loss and the departure of its international captain and tireless cheerleader, Hugo Barra.
  • Following its explosion into the market with a cool user experience and innovative sales channel in 2015, during Q4 16, Xiaomi fell to an ignominious No. 5 in the Chinese market with just 7.4% share down from the 15% it managed during 2015.
  • I suspect that overseas it has also struggled as RFM estimates that its global share has fallen to 3.1% down from 4.1% in Q3 16 and its peak of 5.1% in Q2 15.
  • The departure of Hugo Barra is a sign that all is not well with its international business where its Chinese ecosystem has no relevance leaving it stuck selling Google.
  • I think that this leaves Xiaomi struggling for relevance both at home at overseas, putting its ecosystem strategy at great risk.
  • Xiaomi has comfortably more than the 100m it needs for critical mass, but I am becoming increasing concerned that the engagement that it is able to generate is not nearly enough.
  • This is because on the Chinese Digital Life pie, not one of its services is the dominant offering in any segment, leaving it playing catch up with the much stronger and more aggressive BATmen. (see here).
  • I am sticking with my $5.0bn valuation for now but unless Xiaomi shows a new lease of life in 2017, this will be going south again.

GoPro vs. Shenzhen – Forlorn hope

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GoPro needs something special to fend off Shenzhen.

  • GoPro released another set of awful results highlighting how much damage its failure in execution and software has done to its long-term prospects.
  • The problem essentially is Shenzhen, which makes much cheaper cameras that are just as good and drones that are better.
  • Q4 16 revenues / Adj-EPS were $540m / $0.29 compared to consensus at $573m / $0.22 but guidance for Q1 17 was very disappointing.
  • Q1 17 revenues are expected to be in the range of $190m – $210m some 25% adrift of consensus at $268m.
  • The company tried to explain this away citing inventory overhangs and seasonality but I think underneath lies a weak market and vicious competition.
  • Competition is really hurting in two areas:
    • First: Cameras.
    • GoPro has by the strongest brand when it comes to small high quality cameras but competitors like Yi Technology make great, well rated products at half the price.
    • This is why it has been imperative for GoPro to develop software around its products that users love to prevent them moving away to cheaper, just as good alternatives.
    • It has made some progress here but user numbers of its Quik App and its Capture App are not nearly big enough to hit critical mass.
    • The fact that the numbers are growing very quickly but GoPro declined to the actual figures indicates that the numbers remain very small.
    • This means that the vast majority of GoPro owners are not really engaging with its software making them prime targets for cheaper alternatives.
    • This has to be GoPro’s number one priority this year as failure will leave it commoditised and fighting a losing battle with companies with a much lower cost base.
    • Second: Drones.
    • Here GoPro is already on the back foot and there is only one way that I can see it making an impact.
    • Its competitor DJI is based in Shenzhen, giving it a lower cost base for manufacturing and it is also making the best product.
    • The holy grail of drones is autonomy necessitating good software, something with which almost all Chinese companies have struggled with.
    • DJI is unique in that is a Chinese company that produces drones that have the best operating software available.
    • Consequently, in a head to head comparison of the Karma drone against the DJI Mavic Pro, I think there is no contest.
    • The Mavic Pro has some simple, fun and useful autonomous features that the Karma lacks, making it a better overall product although it is a little more expensive.
    • Combine this with the embarrassing recall due to a faulty battery compartment, leaves GoPro fighting for relevance in this space.
    • Its’ one hope is its modularity where the Karma Grip and the Hero 5 work together with the drone to produce a compete video capture package.
    • Consequently, anyone who already owns the Hero 5, has a strong incentive to purchase the Karma as opposed to anything else.
  • The net result is that GoPro really has its work cut out for it and I remain unconvinced that it is going to survive on its own.
  • I still think that both GoPro and Fitbit (see here) will make reasonable tuck in acquisitions (see here) for the larger ecosystems looking to extend their services or market position into new digital devices.
  • Hence, I think that there is further to fall before acquirers are flushed out into the open and I am not tempted to go bargain hunting.