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.

Microsoft – Close call

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Microsoft needs 200m corporate upgrades to make its 1bn target 

  • Microsoft is just over 1/3rd of the way to its goal of 1bn Windows 10 users 3 years after its launch, but with the end of the free upgrade looming, it is going to be tight.
  • Windows 10 was launched on July 29th 2015 and one year after launch there are 350m devices running Windows 10.
  • This is by far the best performance yet of any of Microsoft’s operating systems but it is also the first time that the upgrade has been both relatively painless and above all: free.
  • However, that free period is ending at the end of this month and consequently, I expect upgrades from Windows 8.1 and Windows 7 to grind to a halt.
  • In the last 12 months roughly 250m new PCs have shipped of which 225m will have had Windows 10 installed.
  • This means that around 125m existing users have upgraded their devices to Windows 10.
  • However this already includes 48m Xbox One consoles that were upgraded at the end of 2015 to run the Windows 10 core.
  • This means that 77m PCs have been upgraded to the new OS.
  • I suspect that almost everyone who has Windows 8.1 will have upgraded but for users still using the excellent Windows 7 there is very little incentive to pay up after the end of July.
  • Consequently, I think that from here almost all additions will come from new PCs being shipped.
  • If I assume that in the next 2 years 500m new PCs will ship of which 450m will be running Windows, this leaves Microsoft at a total of 800m Windows 10 devices in July 2018.
  • This is why I have long been of the opinion that Microsoft would extend the free upgrade period but that has been proved to be incorrect.
  • Consequently, Microsoft will have to see 200m existing corporate PCs upgraded to Windows 10 in order to make its 1bn target.
  • RFM estimates that there are around 1bn PCs that are currently being used in a corporate context, meaning that 20% of them need to be upgraded rather than replaced in the next 2 years.
  • Given that PCs these days last between 5 to 7 years, this is not a huge stretch.
  • Furthermore, as many large corporations have a subscription deal with Microsoft for their software, the upgrade is unlikely to involve further expense.
  • Hence, I think that Microsoft will make its target quite comfortably but I think that this has very little to do with the consumer and is all about professional use.
  • When it comes to Digital Work, Microsoft is doing very well but I have concerns with regards to the Digital Life assets such as Xbox, Bing and so on.
  • In the context of an increasingly enterprise focused company, the Digital Life assets look out of place and I can’t help thinking that they might be worth more to someone other than Microsoft.
  • The good news is that Microsoft’s valuation does not demand any traction from Digital Life as Digital Work is enough to see upside in the valuation.
  • Consequently, I still like Microsoft in addition to Samsung and Baidu.

Microsoft & LinkedIn – Stolen Thunder

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Microsoft and LinkedIn steal Apple’s thunder. 

  • Microsoft has announced that it will acquire LinkedIn for $196 per share or $26.3bn which represents a premium of nearly 50% on Friday’s closing price.
  • This is an all cash transaction that Microsoft will finance with the issuance of debt which makes sense as almost all of Microsoft’s cash is trapped overseas.
  • This is by far the biggest acquisition that Microsoft has made since Satya Nadella took over as CEO but represents further evidence that Microsoft is increasingly becoming a company focused on the enterprise.
  • Linked in has 433m members of which 105m are active each month and where 60% of usage is on mobile devices.
  • At $255 per monthly active user, this is a very expensive transaction but given the position that LinkedIn has, this does not concern me greatly.
  • This is because, LinkedIn users are predominantly professionals and the monetisation opportunity of a professional is many times greater than that of the average consumer.
  • I also view LinkedIn as a true unicorn rather than a donkey (see here) as it remains effectively unopposed in its space and is single-handedly disrupting almost the entire recruitment industry.
  • Consequently, if this acquisition is executed correctly, it could deliver value to Microsoft that goes way beyond the $26.3bn price paid.
  • The synergies are obvious and include:
    • First. Office can use LinkedIn’s profiles, identities and connections to make its productivity and experience far better.
    • Second. Dynamics (CRM) should be enhanced with LinkedIn’s data and should help fill the gap left after Microsoft’s advances to Salesforce.com came to nothing.
    • Third. A big improvement for collaboration, communication and enterprise social networking which is somewhere where I think Microsoft is having difficulty.
    • Fourth, Cortana can become smarter and more pervasive by having access to LinkedIn’s data and by also being present while users are working with LinkedIn’s services.
  • However, it is with the realisation of these synergies that my concerns begin.
  • Microsoft does not have a good history at making the most of its acquisitions and making the most of LinkedIn represents a real challenge.
  • This is because LinkedIn will continue to operate independently of Microsoft and so how closely the companies will work together is a real question.
  • I think that the key to this acquisition will be using LinkedIn’s network, data and its assets to make Office, Dynamics and Cortana more compelling for its subscribers.
  • If LinkedIn and Microsoft can make improve the productivity and ease of use of LinkedIn then that could really help with converting millions of free users of Office 365 to becoming subscribers as well as making Dynamics much more sticky.
  • It also positions Microsoft very nicely for the emerging social networking activity that goes on both inside corporations and between professional users in an enterprise context.
  • However, for all of this to work, LinkedIn’s systems and data has to become deeply integrated with those of Microsoft which with the companies remaining independent, will be orders of magnitude more difficult.
  • The critical measures here are Radio Free Mobile’s Laws of Robotics No. 5 (Data Sharing) and No. 6 (Data Integration).
  • These laws state that apps on devices must be able to share data (5) and that an ecosystem must understand its users as a complete profile of all his activities (6).
  • This means that LinkedIn’s data that it keeps on its user base has to be integrated with Microsoft’s.
  • This is where the problems begin because Microsoft itself scores very badly against Law No. 6 as most of its own services have user databases that are completely separate from all of its other services.
  • If LinkedIn is going to be integrated, which one of Microsoft’s databases should it be integrated with?
  • The correct answer is all of them but in reality, until Microsoft can sort out its own failings against this test, it is unlikely to be able to do much with LinkedIn’s.
  • Furthermore, I think that this has to be done properly as a sticking plaster approach with something like single sign on will simply not deliver the promised synergies.
  • Hence, while I do not have a problem with the high price paid or with the rationale of the transaction, it has to be flawlessly executed for Microsoft to see a good return on this substantial investment.
  • With Microsoft back at $50 per share, there is still room for upside and I continue to prefer it to Google, Twitter, Alibaba and Amazon.

PC Industry – Twiddled thumbs.

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The PC industry continues to ignore the solution to its woes.

  • The Computex show passed virtually unnoticed last week as exhibitors on many stands spent a lot of time twiddling their thumbs.
  • Only stands which demonstrated virtual reality or were related to smartphones saw any real interest.
  • Most commentators have used this as another sign of an industry in the grip of terminal decline but I think a lot of this is self-inflicted.
  • I have long argued (in vain so far) that if the PC industry would address the 2 in 1 segment properly, it could trigger a product cycle that would kick the PC market back to growth at least for a few years.
  • This opportunity is rooted in my belief that the laptop form factor is obsolete and can be replaced with something that offers a more productive and ergonomic experience that is better for your health.
  • There is no longer any reason for the keyboard to be physically attached to the screen but the industry is so used to this form factor that seems incapable of moving on.
  • With the keyboard separate from the screen and a portable mouse, a tablet PC has the capability to become a portable desktop giving the user a desktop quality experience wherever he is.
  • The one caveat is when the user has no surface upon which to position the device and is forced to use it on his lap.
  • In this orientation, the tablet PC offers a poor experience but I believe that this use case is a minority of the time spent using a portable computer.
  • I think that the average computer buyer these days is a content creator as most of the email / web browsing crowd have long since migrated to smartphones and tablets.
  • This means that a keyboard, mouse and probably Office are important to that user which I think creates an opportunity for the PC industry to offer something better than a laptop.
  • A good example of how badly the PC industry misunderstands this issue is the specification of most laptops where the screen can be detached.
  • In almost every single product (Surface Book included) the keyboard stops working the minute the screen is detached.
  • This makes no sense whatsoever as it obviates the one use case (portable desktop) that the product really excels at.
  • This is a very simple and cheap problem to correct and the fact that no one has done it clearly points to how short-sighted the industry has become.
  • I think the biggest problem with this proposition is marketing.
  • Users have been using laptops for 40 years and they are so ingrained into their psyche that it is almost impossible for them to contemplate that there could be a better solution.
  • Consequently, users need to educated that there is something better on offer and how it would benefit them.
  • Unfortunately, I don’t think that much of the PC industry has realised that there is an opportunity and even Intel and Microsoft are struggling to send a clear message.
  • If they can get it right, then there is a big product cycle to be had as laptops are replaced with tablet PCs which would push the industry back to growth albeit for a few years only.
  • In the absence of this cycle, the PC market is likely to continue drifting downwards until all the content consumers have left the platform and at that point it should stabilise.
  • I don’t think that the PC is dead as iOS and Android are awful platforms for content creation, but the PC industry has to start moving with the times.
  • Microsoft, Samsung and Lenovo are the ones I would look at for an upswing in the PC segment although I suspect that a rising tide would lift all boats.

Xiaomi and Microsoft – The Office

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This deal is really about Office in China.

  • Microsoft and Xiaomi have struck a deal where Xiaomi will take ownership of 1,500 of Microsoft’s patents and Xiaomi will pre-install Office on all of its handsets.
  • I suspect that these patents are almost exclusively wireless patents which, with Microsoft’s precipitous decline in smartphones and the sale of its feature phone business to Foxconn, are now worth very little to Microsoft.
  • Historically, it has been important for a handset maker to have a patent portfolio so that it has something to negotiate with when other patent holders assert their patents against its phones.
  • I think that this is less of an issue these days, as recent interventions by the White House (see here) have weakened the threat of patent infringement, but it is still important to have something.
  • Xiaomi is stagnant in its home market and so has been looking overseas to try and find desperately needed growth.
  • It has already opened up India and Brazil and I suspect that this deal heralds its attempt to get into the developed markets of Europe and North America.
  • This is not a new development for Xiaomi and I still fear that revenues may fall by as much as 10% this year (see here).
  • However, for Microsoft this represents an opportunity to do something about the rampant piracy that blights its products in China.
  • I have long been of the opinion that Office is by far the most valuable asset that Microsoft owns and, because of that, I suspect that Microsoft virtually gave the patents away in return for this pre-installation deal.
  • This arrangement would also suit Xiaomi very well as has very little cash to spend on investments (see here).
  • Usage of Office in China is high but not many pay for it and with the rise of mobile, there is an opportunity to convert a portion of this usage over to Office 365.
  • On devices with a screen size of less than 10”, the basic version of Office 365, which offers simple editing, is free and being pre-installed on Xiaomi handsets will ensure that it is at least present in the Chinese market.
  • China is predominantly a mobile first market where users do far more with their phones than in developed markets meaning that there is a good chance that those that use Office illegally today will begin to use the free version of Office 365.
  • This will create a funnel of free users that may eventually decide that that there is value in paying $9.99 per user per month to use Office 365 rather than a pirated, older version of Office.
  • RFM calculates that there are 94m Xiaomi device users in China which should hit 150m by mid-2018 meaning that Office will be present on a meaningful number of devices in China fairly quickly.
  • This is all upside for Microsoft and even a very low conversion rate will improve revenue and profitability which has come in exchange for a portfolio of patents that Microsoft does not really need anymore.
  • This is unlikely to help Xiaomi to recover its fortunes in 2016 and I still think that Xiaomi is worth closer to $5bn rather than $45bn.
  • I still see upside in Microsoft and this deal is yet another sign of how much things have changed for the better in Redmond.

Microsoft – Mission Impossible pt. II.

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The digital consumer ecosystem is looking increasingly impossible.

  • Microsoft is taking the knife to phones again which casts further doubts over its commitment to the digital consumer ecosystem.
  • Another 1,850 positions are to go of which 1,350 are in Finland which will result in a $950m charge of which $200m is severance payments.
  • This reduces the existing headcount by another 40% which will leave 2,820 people in the smartphone business which is just 11% of what it was when Microsoft acquired it.
  • With the sale of the feature phone business to Foxconn, another 4,500 positions go as these will transfer to Foxconn and HMD Global Oy.
  • Microsoft’s market share in smartphones is now 0.9% putting it behind HTC which I have long believed has no sustainable business in smartphones (see here).
  • It is clear to me that the remaining 2,820 positions in phones will be focused on creating devices that dovetail into the successful and profitable Surface business.
  • With the Surface Pro, Microsoft has opened up a segment that has the potential to replace every laptop in the market with a device that offers a far superior experience that is both more ergonomic and much better for user’s health (see here).
  • The idea here is to offer such a good Digital Work experience that the user chooses to live his Digital Life with Microsoft as well via a Surface phone.
  • The problem is that this is not the way the market works.
  • Users bring their Digital Lives with them into the workplace not the other way around.
  • Consequently, while the Surface phone might be a great product, it is unlikely to appeal to the market beyond a small professionally oriented niche.
  • The big issue here is not the mobile phone business but what this signals for the Microsoft consumer ecosystem assets.
  • Microsoft has a range of consumer assets such as Xbox, Bing, MSN, Skype and Minecraft whose relevance becomes highly questionable within a company solely focused on the Digital Work ecosystem.
  • The problem here is that users make the choice about where to live their Digital Lives based on their experience on a smartphone or a tablet.
  • With no device, the route to market suddenly becomes much more difficult.
  • Microsoft will now have to compete with its Digital Life services on iOS and Android where it will severely hampered because those platforms are controlled by Apple and Google.
  • Competing services will be installed on the majority of devices by default meaning that Microsoft will have to market its wares more intensely and more effectively than it has in the past.
  • Marketing is not one of Microsoft’s strengths and I can see the outlook for these assets deteriorating as a result of being less and less relevant on the key consumer devices.
  • Consequently, the question as to whether Microsoft should be in the Digital Life services at all needs to be asked.
  • Xbox is a valuable asset but with its lack of traction in mobile at Microsoft, Xbox could more valuable to someone else than it is to Microsoft.
  • I think that the same could easily be true for the other digital consumer businesses meaning that unless something changes, further divestments are on the cards.
  • Fortunately, the investment case for Microsoft is predicated solely upon its continued dominance of the Digital Work ecosystem and in this instance, Microsoft is going from strength to strength (see here).
  • However, the optionality of a turnaround in the consumer is looking less and less likely which puts a crimp into any blue sky hopes.
  • Consumer is increasingly looking like one mission too far.

 

Palantir – Success victim.

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Palantir’s silence will only make matters worse.

  • Palantir is a very secretive company but the recent negative press raises valid points that need to be addressed if the gadflies are to be swatted into silence.
  • A recent article on Buzzfeed took a look at Palantir coming to the conclusion that all is not well with the company which was valued at $20bn when it last raised money late in 2015.
  • Buzzfeed’s research found the following:
    • Palantir has lost 3 of its top clients (Coca Cola, American Express and Nasdaq) in the last 13 months
    • Staff turnover has doubled to be in line with the Silicon Valley average at 20% in the last 12 months.
    • Palantir’s attempt to create a cybersecurity product and a data sharing consortium among its clients have failed and the teams have been disbanded.
    • Much greater attention is being paid to cost with reorganisations enacted to ensure maximum efficiency.
    • Serious issues around cash conversion with collections being just $420m in 2015 despite $1.7bn in bookings.
  • The article prompted a vigorous defence of the company from one the founders who no longer works at the company (see here) but this has does nothing to address the problem.
  • I suspect that there is nothing wrong with the company other than that things have not gone as well as the company expected and promised.
  • Furthermore, the little that the company has said raises more questions than answers.
  • The problem is simply that Palantir’s performance has not met the expectations that the company set with its investors and hinted at with the media when it raised money.
  • Cost cutting and an increase in staff turnover are key indications that something has not gone to plan.
  • This does not mean that Palantir is a bad company or that it is badly managed in any way, just that it has not been able to meet the lofty targets it set.
  • The biggest issue for me is cash conversion as this is the life blood of any company and critical to valuation once pie in the sky moves onto execution of strategy.
  • I think the increase in staff turnover is irrelevant and completely normal as Palantir transitions from being a start-up into a big company.
  • Also irrelevant are the failures of two projects as much of building a business involves throwing mud at the walls and seeing what sticks.
  • In fact, it’s a sign of good management that losing strategies have been cut fairly quickly.
  • Many founders become emotionally attached to their strategies and let losers run for far longer than they should.
  • However, I think Palantir needs to defuse the bad press which in a vacuum will only swirl and grow in strength.
  • It needs to do two things:
    • First. It needs to explain how cash conversion works.
    • This is to make up for the mistake of allowing the market to wrongly assume that bookings would translate into revenues and cash within 12 months.
    • Second. It needs to explain how its technology is better than anyone else’s making it impossible to take this kind of analysis in house as News Corp appears to have done.
  • In many ways, Palantir is a victim of its own success because with a $20bn valuation and no profits, one has to perform to an excruciatingly high standard especially in this environment.
  • This means that expectations have to be met at every level and on every occasion.
  • At this price there is no margin whatsoever for error.
  • On the surface, Palantir is very like Autonomy in that they both mine huge troves of corporate data to arrive at meaningful conclusions that can then be used to allow the business to perform better.
  • Furthermore, many of the issues raised by Buzzfeed were also issues at Autonomy when it was independent which a big reason why Palantir needs to nip this in the bud.
  • Failure to address that could result in Palantir being labelled alongside Autonomy which would be truly awful outcome for the company.