Google Auto – Greek gift pt. II.

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Tinkering with Android for cars is a dangerous game.

  • Ahead of its developer conference, Google i/o, Google has demonstrated another version of Android that will be able of running many more aspects of the car beyond infotainment.
  • While Android Auto is limited in terms of what it can do and the data that it can access, this version of Android for the car is much more deeply embedded.
  • As a result, I think it will have access to everything as the infotainment unit is the nerve centre of the vehicle where the 4 data networks in the car (CAN bus) meet.
  • This means that Google services such as Maps, Search and Assistant will be fully embedded in the car enabling these services to be far more contextual and relevant.
  • It also raises the possibility that Google will be able to suck all of the data out of the car, robbing the OEMs of one the most important pieces of exclusivity that they have.
  • Audi and Volvo have signed up to use this software which will be demonstrated on the Q8 and the V90 SUVs at Google i/o this week.
  • The two most important issues are:
    • First, Code control: Who is in control of this code is crucial to the outlook for the OEMs.
    • From the presentation, I get the impression that the manufacturers are nominally in control of the Android code going into their cars but I seriously doubt that they have done the implementation themselves.
    • This was most likely done by their tier 1 suppliers or even Google itself.
    • While this means that the OEMs will have control over software updates and feature releases, there are almost certainly going to be hooks in the code that Google can still use.
    • Second, Google agreements: If the OEMs have a similar relationship with Google that the handset makers do, it is important to understand what the OEMs have agreed to.
    • Google controls Android through its agreements with the handset makers and given that the OEMs are getting Google services deeply embedded in their systems, something similar is likely to be demanded by Google.
    • Parts of those agreements are likely to include aspects of user interface design as well as the sharing of data.
  • I view this software as a replacement for the OEM designed software that resides in the head unit of the vehicle.
  • Android Auto and Car Play run on top of the OEM software but have limited access to the rest of the system.
  • This is likely to be the same such that CarPlay will still run as before but Android Auto will obviously be obsolete.
  • Google has said that the new software will not be draining the vehicle of data but I suspect that Google is referring to how the software behaves as it leaves the factory.
  • Once it is in the hands of the user and he has agreed to a pop message requesting access to data to improve Google services, the reality could be very different.
  • Sharing this data will make Google services on other devices better for the user but critically, this is the data that the OEM needs to hang onto in order to differentiate itself in all things digital in the car.
  • This is the risk of deploying software that has not been written in-house as the reality is that the OEMs will have no real idea about what they are deploying on what is becoming the most strategically important part of the vehicle.
  • Tesla and BMW are the only ones that seem to understand the importance of this which is why they are the only OEMs I know of that write their own code.
  • Google has everything to gain and little to lose by helping OEMs use Android instead of their in-house software which is exactly why OEMs need to look in minute detail at this gift before letting it into their holy of holies.

 

Microsoft BUILD – The right choices.

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Enterprise remains the focus.

  • At Microsoft’s developer conference, it continued to emphasise its move away from being a platform for the consumption of content to one that is primarily for the creation of content.
  • At the same time it cemented its move away from mobile with the migration of its strategy from cloud first, mobile first to intelligent cloud, intelligent edge.
  • Effectively, Microsoft is signalling two main changes:
    • First, device agnostic: Microsoft no longer cares what device the user has, but instead is aiming to ensure that its services work seamlessly across everything that is available.
    • This was embedded in every presentation during the first two days of BUILD where cross device was emphasised time and again.
    • Cortana, Office 365, team collaboration and communication will be increasingly integrated across all the devices that the user has.
    • This was made very clear with the announcement of the cloud powered clipboard where text and pictures copied to the clipboard on the PC can be pasted into non-Microsoft apps on iOS or Android devices.
    • Microsoft employees no longer have to hide their iPhones and Galaxies or take off their Apple Watches when entering hallowed ground in Redmond.
    • I have long argued that cross device is a good way to differentiate an ecosystem that is vying for engagement with the two giants Apple and Google.
    • Microsoft has led in this space for a long time and, as long as this works as billed, it will take Microsoft further into the lead.
    • Second, processing at the edge: Microsoft discussed a future where all the processing does not happen in the cloud but part of it is redistributed to the edge for faster response times and greater efficiency.
    • Microsoft demonstrated how running diagnostics locally could cut an emergency shutdown time for a piece of industrial equipment from 2000 millisecond to just 100.
    • However, this is a problem that is supposed to be solved by 5G, which was not mentioned once, further cementing Microsoft’s move away from mobile as a standalone technology.
    • This goes directly against what Intel (and others) is aiming for as its most profitable and highest market share products are the processors that power the cloud meaning that it wants as much as possible to run there.
    • I see a number of schools of thought with regard to how intelligence and processing should be distributed throughout the network with each proponent obviously going for the option that benefits their business the most.
    • I think that the reality will be that different use cases require different scenarios.
    • For example simple monitoring that requires rapid response makes sense in the edge but object recognition and tracking and relating that to policies is a very intensive task that is best carried out on big servers in the cloud.
  • Microsoft also announced the fall creators update for Windows 10 to support all the cross-device capability as well as badly needed improvements to the Windows Store that is needed to give Windows 10 S a chance (see here).
  • Hololens was also upgraded with the addition of a controller to bring it into line with the other offerings but this remains very much a tool for the enterprise.
  • This was clear in the demos and examples which were focused around productivity with the idea of a virtual shoot out in the living room, thankfully not being repeated.
  • With every presentation that passes, Microsoft distances itself further and further away from content consumption and the consumer.
  • Consequently, while there is a strong rationale to keep Bing (data generation), I cannot say the same for Xbox, Minecraft and a number of other assets.
  • Hence, I would not be surprised to see them sold off should a good opportunity present itself.
  • The net result is that Microsoft is doing exactly what it should in playing to its strengths and differentiating where it has a chance rather than wasting money trying make a difference where it has no chance.
  • This sets it up for steady growth with its dominant position in the enterprise, still giving support to the valuation even though the shares have been strong.
  • I still like Microsoft alongside Baidu and Tencent.

Microsoft – An Office education.

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Office in education sets up the future.

  • While the education segment is still relatively small when it comes to computing, the opportunity to influence preferences of future content creators makes it a market worth putting considerable effort into.
  • Microsoft appears to be taking 2 more steps in that direction with the launch of Windows 10 Cloud expected on May 2 at an education related event and another try at Windows on ARM at the end of the year (see here).
  • I think that the May 2 event is likely to centre around a new SKU of Windows 10 called Windows 10 Cloud that is a stripped-down version of Windows not unlike Google’s Chromebook OS.
  • This brings back the bad memory of Windows RT but I suspect that this time, Microsoft will be sticking with Intel.
  • By stripping the product down and only running software from the Windows Store, Microsoft can really bring the price of the devices down significantly but this will also ensure that appeal will be limited.
  • For example, Windows 10 Cloud will be useless for every corporation that has its own software as well as being underpowered and limited for many power users.
  • However, for education this could work well as cheap yet reliable devices are required to distribute to students.
  • Furthermore, this would work well with Microsoft’s move to make full-fat Office free for education obviating the necessity to use the inferior Google Docs.
  • I suspect that this strategy is most likely to succeed outside the US where Microsoft already has a strong and growing position.
  • Windows 10 Cloud could do well in protecting and expanding that position keeping Chromebooks out.
  • Inside the US, Google with its Chromebooks has gone from 38% share in 2014 to 58% in 2016, mostly at the expense of Apple’s Mac OSX and iOS (Futuresource Consulting).
  • Here, Microsoft’s task will be much more difficult as many establishments have only recently moved to Chrome but critically, Office is available on Chrome giving it a fighting chance.
  • As far as Microsoft is concerned, I think that in the long-run the OS and chipset are almost irrelevant with Office being the only asset that really matters.
  • This is because I think that Office is the only reason why the majority of content creators and corporations choose use PCs and hence represents a large part of Microsoft’s differentiation.
  • If it can increase its penetration in education through Windows 10 Cloud as well as through Chrome, then there should be a strong preference for Office as students enter the workforce.
  • This is why I think the focus of Microsoft is to bring down the cost and increase the options for hardware that can be used to access Office rather than at the high end where it is already strong.
  • If Microsoft can win in education then the legacy of Office should be far more secure going forward.
  • I think it has a very good chance as its product is far superior, and used by more people globally than anything else.
  • Microsoft continues to offer steady value and hence I still like it alongside Tencent and Baidu.

 

Enterprise AI – IBM and Salesforce

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Microsoft to Facebook could be what IBM is to Salesforce.

  • Salesforce and IBM have announced a wide ranging partnership which will combine their two AI offerings but they will continue to sell the combined offering under two brands.
  • At the same time IBM has announced that it will move its CRM business to Salesforce, depriving Microsoft of a landmark customer.
  • IBM and Salesforce also stated that they already have about 5,000 clients common but virtually no overlap which means to me that the cross-selling opportunity is actually not that large.
  • Hence, I think that the main reason for the combination is that today AI requires both a lot of time and a lot of data and it is here where IBM and Salesforce can help each other out.
  • IBM’s Watson has been around for many years which makes it one of the most experienced.
  • Salesforce is a relative new comer to AI but I think that it is generating far more data than IBM is.
  • Consequently, it is not hard to see how using Watson’s brains and Einstein’s data could result in more effective AIs being trained in a much shorter period of time.
  • Compared to consumer, enterprise AI is much trickier as each corporation wants different things from AI and the data sets are quite specific to each company.
  • Hence, I can see more general algorithms being trained by the supplier which are then customised with the requirements and specific data set of specific customer companies.
  • The net result is that I can see a lot of sense in this tie up as both companies will be able to do what they are currently doing better without treading on each other’s two.
  • In the same vein, there may be some sense in Microsoft doing a similar deal with Facebook in consumer.
  • Facebook is sitting on the second largest data pool in the world but has no idea what do to with it while Microsoft has some history in AI, but its waning consumer ecosystem means that its data volumes in this area leave a lot to be desired.
  • Furthermore, Facebook and Microsoft do not really compete against each other anymore and are already co-operating on building an undersea cable (see here).
  • Consequently, a co-operation on AI could have significant benefits to both companies and would go quite some way to fixing the serious problem that Facebook has with AI (see here).
  • I continue to prefer Microsoft, Baidu and Tencent over Facebook.

Virtual Reality – Virtual standstill.

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VR seems only to be popular at trade shows.

  • After a very disappointing 2016, Virtual Reality looks set to have another disappointing year in 2017 while its proponents work out how to fix the issues that keep it from being a success.
  • The latest blow is the removal of 200 out of 500 of Oculus Rift demonstration stations as a result of poor performance within stores.
  • The idea has been that to get a user to buy VR, he has to try it but in some stores entire days have gone by without a single demo being given.
  • Best Buy will continue to range the Oculus Rift but the real estate given up will be re-used for products that produce better sales per square foot.
  • It appears that the only place where people queue for a demo is at trade shows with the regular user not really seeing the point of the technology.
  • This is a further indication that the limitations of VR continue to hamper its appeal.
  • These remain:
    • Price: Many of the devices cost several hundreds of dollars and also require a PC to run, further increasing the cost.
    • Clunky: VR and AR units are still large, clunky and uncomfortable to wear.
    • In many cases they also make the user feel foolish when wearing one.
    • Comfort and security: VR in cuts the user off from almost all sensory inputs from his immediate environment severely limiting the situations in which the user would feel comfortable using one.
    • Many units also cause feelings of nausea due to an imperfect replication of the real world compared to what the brain is expecting.
    • Cable: Many units require an HDMI cable which prevents the user from moving and also increases the risk of a fall should the user trip over the cable.
    • Content: Both games and content remain in short supply limiting the reasons for users to immediately adopt the platform.
    • The adult entertainment industry is a good yardstick for the adoption of new media types and even this has been slower than expected to jump in.
  • The net result is that I think 2017 will be a disappointing year for VR.
  • The one bright spot remains augmented reality (AR) to enterprise customers.
  • For the enterprise, it is productivity that really matters with the user experience being less important.
  • This is because in consumer, the users pay money for an experience but in the enterprise users are paid to use the technology.
  • Hence, enterprise users’ willingness to put up with a substandard user experience is much greater.
  • The AR user experience is still miles from where it needs to be but critically it does offer productivity improvements that have led to many companies trialling it particularly for employees in the field.
  • Hence, I think that AR in the enterprise should see both unit shipment growth as well as good growth in revenues from software and services in 2017.
  • Consequently, the companies to watch this year are those in this field like ODG, Microsoft HoloLens, Meta, Atheer Labs and of course Magic Leap.
  • Magic Leap is an exception is it has made incredibly bold promises around a consumer offering in AR, but it is questionable as to how close it really is in terms of having a working, commercial product (see here).
  • From an investment perspective, AR in the enterprise is the only place I would entertain putting money into this year unless it is something aimed at fixing the limitations I have listed above.

Google Enterprise – No G man.

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G Suite and Chromebook upgrades are too little too late.

  • Functionality upgrades to the mobile version of G Suite (Office-like apps) and enhancements the Chromebook proposition are not likely to alter the downward trajectory that I see for Google in the enterprise.
  • Google has announced upgrades to the iOS and Android versions of Docs and Sheets that include more advanced editing and formatting.
  • It has also moved forward with its intention to enable Android apps on Chromebooks by stating that all Chromebooks launched in 2017 will be able to run Android apps (although not all of them will be able to do so right away).
  • In theory both of these moves could help to enhance the appeal of using Google for Digital Work as well as Digital Life but I see a number of problems.
    • First: Ever since Microsoft released free Office 365 apps for iOS and Android, I feel that Google has been losing the Digital Work game.
    • I think that this is because Office 365 with basic editing being free on iOS and Android obviates the reason to use G Suite at all.
    • I think that the same goes for the other Office alternatives such as Libra Office and so on.
    • Office is by far the leader when it comes to functionality and compatibility and now that it is free in simple user cases, it makes very little sense to use anything else.
    • Second: I do not think that adding Android apps to Chromebooks will do very much to enhance their appeal.
    • This is because the vast majority of Android apps are designed to be used with a device that uses touch as its input mechanism rather than a keyboard and mouse.
    • It is also worth noting that enabling Android apps on Chromebooks will have the side effect of bringing Office 365 onto the platform.
    • Consequently, I think that the user experience of Android apps on Chromebooks will be substandard, pushing users back to their smartphones and tablets to use them.
    • Furthermore, I think that the keyboard and mouse input system is increasingly the domain of the content creator with content consumers overwhelmingly finding touch based devices cheaper and easier to fulfil their requirements.
  • Consequently, I do not see either of these actions improving the appeal of Chromebooks nor increasing the use of Google Docs by content creator users.
  • I see content creators preferring Windows or Mac OSX with a keyboard and mouse and content consumers sticking to iOS and Android on a touch based device.
  • I think that the combination of Office 365’s superior functionality and the free basic functions have obviated the reason to use anything else which will lead to a long-term decline in G Suite.
  • One area where Google has a chance with the enterprise is in the cloud, but there it is already very far behind both Amazon and Microsoft and will also have to contend with Alibaba’s clear intention to take AliCloud international.
  • The net result is that I continue to see almost all of Google’s growth remaining in consumer where mobile and YouTube are still growing very nicely.
  • Finally, I think that this growth is already fully priced into the shares leaving me still preferring Microsoft, Baidu or Tencent over Alphabet.

GOOG, MSFT & INTC – Cloud party.

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Cloud and mobile drive 3 for 3.

 Alphabet Q4 16.

  • Alphabet reported excellent results driven once again by mobile advertising but was somewhat marred by a one-off tax payment.
  • Q4 16A revenue-ex TAC / Adj-EPS was $21.2bn / $9.36 compared to consensus at $20.6bn / $9.63.
  • If the one off tax payment is removed, Q4 16 Adj-EPS was $10.13, comfortably ahead of expectations.
  • Alphabet stressed on the call that it was focusing on cloud and the enterprise but I think that this strategy will not work.
  • This is because both Amazon and Microsoft are already far ahead and with a simple version of Office 365 now being free on phones and tablets, there is very little incentive to use Google’s office apps.
  • Furthermore, Alibaba is aggressively expanding its AliCloud offering and has a very strong base in China upon which to base its international investments.
  • Hence, I see Alphabet being driven by its consumer offerings which I do expect to slow somewhat in 2017.
  • I continue to see all the growth as being already priced into Alphabet’s share price.

Microsoft FQ2 17.

  • Microsoft reported good results as the legacy PC-based businesses held steady allowing very rapid cloud growth to show through in the numbers.
  • FQ2 17 revenues / Adj-EPS were $25.8bn / $0.84 compared to consensus at $25.3bn and $0.79.
  • Azure was once again the star of the show with revenues more than doubling YoY together with the prospect of much better gross margins as Azure begins to hit real scale.
  • While Microsoft is going from strength to strength with regard to offering services for enterprise customers and prosumers, its consumer ecosystem continues to whither on the vine.
  • As these businesses continue to be neglected, I can see a growing case for divesting Xbox, Mojang and even Internet Explorer as they could be worth more to someone prepared to really make something of them rather than just let them chug along.
  • I still like Microsoft as these results show that there is still upside to be had from the perspective of offering services to enterprises and prosumers.

Intel Q4 16

  • Intel reported reasonable results as the PC market declined by less than expected allowing chip sales in the data centre to boost revenues.
  • Q4 16 revenues / EPS were $16.4bn / $0.73 compared to consensus at $15.8bn / $0.75.
  • Lower profitability was largely driven by gross margins which have declines to 63.1% from 64.8% a year ago.
  • Intel is under assault on all fronts as chip makers who are willing to accept much lower gross margins are working on creating data centre processors as well having another go at running Windows.
  • Furthermore, almost everybody that is working on Artificial Intelligence is using NVIDIA processors to train their algorithms rather than Intel.
  • In the data centre I still think that Intel is safe as using other processors requires all legacy software to be rewritten but I see risk in both AI and PCs.
  • I think Intel has some time to address those threats but the time to step up is now.

Microsoft – Back to front

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Back to front strategy of Surface Phone looks sure to fail. 

  • Mobile phones are a bit of a blank spot for Microsoft but 2017 is likely to see it give it another go despite the fact that Office 365’s success in iOS and Android have made this feat almost impossible.
  • It has been a very long time since Microsoft has done anything meaningful in the mobile phone and with the massive write down of the Nokia acquisition and the lay-off of the vast majority of the staff, it would almost seem that it has given up.
  • However, there is still a device in the works which will be part of the Surface portfolio to add to the excellent Surface Pro, Surface Book and Surface Studio.
  • This device will be called the Surface Phone and very much like its big brothers it will aim to be the ultimate mobile device and appeal to a certain set of users.
  • Unfortunately, I suspect that no matter how good this Surface Phone is, it will not appeal to even Microsoft’s hardest core fans.
  • This is because the mobile phone is a device that is predominantly used for Digital Life whereas the Surface products excel at Digital Work.
  • In Digital Work the Surface products are aimed at content creators and in that instance they are best in class.
  • However, every content creator is also a content consumer who predominantly uses an Android or iOS device for his Digital Life.
  • Therefore, Microsoft will have to make its Digital Life offering utterly compelling to convince even these users to move their Digital Lives to Microsoft and in that regard I see nothing but neglect and malaise.
  • This is why the Surface Phone will fail because no matter how good the hardware is, the ecosystem has deteriorated to a point where most of the apps that the user would want are not available.
  • Microsoft’s coverage of the Digital Life pie has deteriorated from 71% to 57%, developers are rapidly deserting the platform and user numbers are in free-fall.
  • This is how Microsoft has it back to front as users tend to being their digital lives with them into Digital Work and not the other way around.
  • Furthermore, the fact that Microsoft has made good quality versions of Office 365 available for iOS and Android devices substantially reduces any reason to buy a Surface Phone.
  • I have long believed that Microsoft’s most valuable asset is Office 365 meaning that it is in Microsoft’s interest to ensure that it works as well as possible on as many devices as possible.
  • Therefore, using Office 365 as a differentiator for the Surface Phone could actually do more damage than good to Microsoft as it could dent Microsoft’s reputation on the other, far more important platforms.
  • Hence, the only option would be for these users to have two devices, one for Digital Work and one for Digital Life.
  • However, because iOS and Android offer Microsoft’s Digital Work services to an acceptable level of quality and because the Surface Pro and Surface Book are so good at Digital Work and so portable, there is no reason whatsoever to buy the Surface Phone.
  • Hence, I think Microsoft would be best served in quietly dropping this idea and focusing its resources on the things that it does best and where it can succeed.
  • I think the mobile phone ship has already sailed.
  • Despite the inevitable disappointment, Microsoft’s share price does still not fully reflect the opportunity available in Digital Work which is why I still like it alongside Tencent and Baidu.

 

 

Microsoft – Wood for the trees.

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Microsoft is so focused on the future that it misses the opportunity in the present. 

  • Microsoft has moved even further away from the consumer with its Creators Update for Windows 10 and the launch of the Surface Studio complete with the Surface Dial accessory.
  • At the same time, Microsoft continues to ignore the huge opportunity presented to it by the obsolescence of the laptop form factor which I find strange as it claims to be all about creating new product categories.
  • Microsoft unveiled two new innovations as well as an incremental update to the Surface Book.
    • First: Windows 10 Creators update
    • In addition to a host of other incremental improvements, the Creators Update focuses on enabling 3D objects on the PC as well as in both AR (HoloLens) and VR, gaming and easier connections and sharing with close contacts.
    • None of this is desperately new except that the degree to which content now works across different devices is far superior to anything else that has been launched to date.
    • Microsoft hopes to include the mobile phone in this range of devices but how well it can do that on Android and iOS remains to be seen.
    • These platforms are now critical as Windows Phone is rapidly losing all of its remaining users.
    • Also key to this update is the focus on content creation as the upgrades in this update are aimed at improving functionality for those that draw, write, broadcast and so on rather than those that consume.
    • This is a tacit admission that the battle with iOS and Android for content consumers has long been lost.
    • However, it also shows Microsoft aggressively acting in both software and hardware to keep the content creator users and corporates on its platform.
    • Second: Surface Studio.
    • This is very high specification all-in-one PC with a 28” monitor that can transform to become a work surface exactly like the drafting table used by anyone that draws or designs for a living.
    • Surface Studio comes with the Surface Dial which is designed to go in the non-pen hand to alter characteristics such as ink colour, brush size, opacity and so on.
    • The Surface Dial works both on and off the screen and is backwards compatible with all Surface products.
    • This device is clearly aimed at professionals and it is priced accordingly at $2,999.
    • Third: Surface Book.
    • The top end i7 model has been upgraded to offer double the graphics capacity than its predecessor as well as 30% more battery life.
    • Microsoft now claims that the device can provide 16 hours of battery life.
    • However, the single biggest failing if this product has been carried through into the next version as the keyboard stops working as soon as the screen is detached.
  • The net result is an update to the Microsoft Windows proposition that is aimed at keeping content creators and corporates on its platform.
  • In that vein, this is a good update with nice looking and relevant products but I still think that Microsoft is missing the wood for the trees.
  • I have long argued that the laptop form factor is obsolete as having the keyboard, mouse and screen permanently locked together offers a substandard user experience that is both uncomfortable and unhealthy (see here).
  • This is why the Surface Pro line of products is a game changer as it enables a desktop like user experience to be enjoyed from anywhere.
  • This works by allowing the screen to be at the correct height and distance from the eyes with a wirelessly connected mouse and keyboard to be in the most comfortable and ergonomic position.
  • However, this does not work with the Surface Book as the minute the screen is detached from the keyboard, the keyboard ceases to function.
  • I think it would cost Microsoft less than $1 per unit to put this right and it would enable it to really push a whole new use case for content creators out of the office.
  • I have long believed that this could lead to a huge replacement cycle where ageing laptops are replaced with PCs in the tablet form factor which could even kick the PC market back to growth for a few years.
  • However, this failing indicates that Microsoft has still not realised the opportunity that lies before it.
  • Intel and the PC makers are equally guilty of this oversight but these companies have not taken it upon themselves to re-imagine computing.
  • I suspect that the main issue here is that these companies have been selling laptops for over 30 years and it is very difficult to break out of that mindset.
  • It would also require a big marketing campaign as laptop users are also so ingrained with this form factor that they have not realised that there is something much better on offer.
  • The net result of this event is a software and hardware update that goes a long way to keeping content creators faithful to Windows but continues to ignore the possibility to create a large replacement cycle in its core product.
  • Fortunately, Microsoft’s valuation does not demand this vision to come true in order to be attractive which is why I continue to like it alongside Tencent and Baidu.

Microsoft FQ4 16A – Finnish with a flourish

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Good results restore optimism in strategy 

  • Microsoft reported good FQ4 16A results supported by signs of stabilisation in PCs and excellent performance in the cloud.
  • FQ4 16A revenues / adj-EPS were $22.6bn / $0.69 compared to consensus estimates of $22.1bn / $0.58 and RFM on $21.9bn / $0.59.
  • Microsoft’s strong results were driven by a very good performance by Azure which continued to grow by over 100% and some signs of stabilisation in the PC market.
  • This was slightly offset by gross margin pressure triggered by the increasing mix of revenues coming from cloud and Office 365.
  • This is completely normal as cloud revenues have lower gross margins than perpetual software sales but they are longer lasting meaning that they deliver more profit in the long term.
  • I would continue to expect to see gross margin decline steadily over the next year or two as this transition continues.
  • Stabilisation in PCs has been echoed by a number of other companies in the supply chain which have also seen some signs of stabilisation in the PC market this quarter.
  • I have long been believer that the PC is very far from dead but it is in fact suffering from a portion of its users continuing to defect to other platforms.
  • These users are the ones that I refer to as content consumers who have historically used a PC to do nothing more than browse the internet, email, shopping and so on.
  • These users have very little reason to own a PC as a smartphone or tablet running iOS or Android can do the job just as well and much more conveniently.
  • I think that other users such as content creators and companies will long have need of the PC and while I don’t think it is going to grow, I don’t see a precipitous decline either.
  • This is why I think that Microsoft’s legacy OS revenues are likely to stabilise as the OS tends to be sold as part of the PCs overall and therefore is likely flatten in line with the market.
  • The same cannot be said for Office but Microsoft is doing an excellent job at converting traditional Office sales into Office 365 subscriptions and there is every sign that this will continue.
  • Consequently, the outlook for the next fiscal year is good with steady revenue growth and tight control of the cost base.
  • However, the issue around the consumer assets remains unanswered.
  • Microsoft is increasingly becoming focused on prosumers and the enterprise and where assets like Bing, Xbox fit and Skype fit into that remains very unclear.
  • The good news is that Microsoft’s valuation does not demand any real action around integrating these assets to create a fully-fledged enterprise and consumer ecosystem.
  • Hence, I can still see these assets being sold off at some point which still gives me a valuation for the shares of around $62.
  • This is still nicely above current levels ($55) leading me to remain positive on the outlook.
  • I would also add Baidu and Samsung into this group of stocks to look at for the balance of 2016.