LINE Q4 16 – Game off.

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Gaming could save LINE but the focus appears to be elsewhere. 

  • LINE reported a difficult set of results which laid bare how difficult it will be to return to growth without expanding either its coverage of Digital Life or its user base.
  • With the shares trading on 5.7x 2016A EV / Sales, I think that a return to rapid growth is required just for the shares to stand still.
  • Q4 16A revenues / EBIT were JPY37.5bn ($332m) / JPY1.6bn ($14m) substantially missing consensus estimates of JPY38.7bn / JPY5.3bn.
  • Even with a one-off charge against EBIT removed from the figures, LINE still missed consensus EBIT by 50%
  • The lower profitability was primarily caused by marketing expenses, general and admin expenses all of which grew substantially more than sales.
  • The main issue is that LINE is trying to change its business model from one based on stickers and games sold through its IM platform to one based on advertising.
  • This is because revenues from stickers and games is beginning to decline in the face of competing services (like Facebook Messenger and WhatsApp) which offer similar content for free.
  • Furthermore, RFM calculates that LINE’s current offering is not broad enough to return the company to real growth.
  • However, it should be able to replace existing revenues should they decline to zero.
  • When I look at LINE, I think it is capable of driving monetisation through the Digital Life services of Instant Messaging, Shopping and Telephony giving it total Digital Life coverage of 18%.
  • I do not think that its Smart Portal is mature enough to give it credit for Social Networking or any other Digital Life segment that it is trying to address.
  • Furthermore, its user base is pretty stagnant at 217m leading RFM to calculate that LINE could generate around $1.5bn in advertising revenues on an annual basis or $373m per quarter.
  • During Q4 16 LINE generated $139m in advertising with content generating $193m giving $332m in total.
  • This clearly shows that replacing content with advertising will only allow revenues to expand to $373m per quarter, some 12% above where the company is now.
  • To return to growth LINE will have to successfully expand its coverage of Digital Life or start growing its user base once again.
  • Growing the user base will be a major challenge as LINE has consolidated its focus onto the four countries of Japan, Thailand, Taiwan and Indonesia which considerably limits its scope.
  • Hence, I think it will have to improve its Digital Life coverage which will be difficult given that the other segments of Digital Life are pretty well covered already.
  • The one exception I see is Gaming and here there is an opportunity for LINE given its heritage in selling games through its platform.
  • This is a big segment and if LINE can generate a thriving multiplayer gaming community, then I can see its revenues expanding once again.
  • Unfortunately, of this there is no sign with much of the effort being places on other areas which to date have resulted in increased investments but no real revenues.
  • To justify its valuation, LINE must start to grow again as 5.7x EV / Sales is way to high for a company with low growth and heavy investments hitting profits.
  • I can see the valuation making a major adjustment downward from here.

Tencent Q3 16A – Work in progress.

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Still a lot of work needed to realise its full potential. 

  • Tencent reported another excellent set of results but the fact that expectations are already so high meant that the numnbers felt more like a damp squib.
  • Q3 16A revenues / EPS were RMB40.4bn / RMB 1.12 compared to consensus at RMB39.0bn / RMB 1.17 and RFM at RMB35.3bn / RMB 1.15.
  • The combination of greater investments being made in sales and marketing and a higher tax rate was responsible for the lower profitability that the company experienced.
  • When one looks at gaming, the importance of the transition that Tencent is going through becomes apparent.
  • Although Tencent did manage to grow revenues from PC gaming, the daily active user count was down by 9% YoY and the number of concurrently active users for casual PC-based games was down 18% YoY.
  • This is an indication that usage is shifting to mobile and that PC users are spending more time playing each other rather than on their own against the AI.
  • Tencent has responded to this by offering more game related activities such as tournaments, video streams of popular gamers and so on.
  • This shift is also nudging Tencent closer and closer to becoming a fully-fledged ecosystem but in that regard, there is still a lot of work to do.
  • Its biggest assets here are Weixin / WeChat, its social network Qzone and its mobile gaming offering.
  • All together Tencent has 77% coverage of the Chinese Digital Life pie but its assets remain quite disparate and fragmented and it is this that needs to change.
  • Tencent needs to become the place where Chinese users go to spend 77% of their digital lives perhaps with the occasional outing to Alibaba to shop and Baidu to search.
  • To achieve this, Tencent needs to fully integrate its offering and make it as consistent, easy to use and as fun as possible.
  • Tencent shows little sign of doing this on the surface but the investments that it is making in data centres and in sales and marketing are some indication of what is taking place behind closed doors.
  • This is encouraging because on its current trajectory, Tencent is heading for a big slowdown in 2017 and beyond as the Chinese market matures.
  • However, RFM calculates that Tencent is very far away from fully monetising the ecosystem that it is creating, meaning that there is an opportunity for another leg of growth in the medium-term.
  • To achieve this, Tencent needs to really integrate all of its assets into a single experience for users rather than a series of different services.
  • It is at this point that further growth is possible both in terms of profits and the share price.
  • However, I don’t see Tencent being ready to grab this opportunity in 2017, and so in the short-term a slowdown looks inevitable.
  • The good news is that even without the ecosystem there is still some headroom in Tencent’s valuation.
  • Hence, I am happy to keep it on my list alongside Microsoft and Baidu.

Facebook – Gamification.

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Facebook does not intend to play second fiddle to Tencent for long. 

  • Facebook is increasing its position in gaming aiming to come at this critical Digital Life service from all angles to ensure that it ends up dominating the segment in developed markets.
  • Facebook has launched a new app for the desktop called Gameroom which is a client, much like Steam, which allows games that are developed in Unity to be easily published and accessed via Facebook’s platform.
  • Steam is a PC gaming platform that serves as a distribution channel for digital games, supports multiplayer and has a thriving community of PC gamers.
  • Gameroom aims to be very similar with the added kicker that it will provide game developers with much easier access to its 1.6bn users which is an asset not to be sniffed at.
  • Facebook’s aim is to help developers sell more of their games to users and to encourage users to play games on its platform rather than elsewhere.
  • Steam gamers are mostly hard core players but it does also distribute casual games and I think that it is this segment that Facebook is going after at this stage.
  • This makes complete sense because when it comes to the ecosystem, it is the smartphone and the tablet that really matter as the vast majority of games played on these devices are casual games.
  • Hence, when Facebook is trying to entice users to spend more time within its properties, it will be on these devices where it will need to generate the most traction.
  • This is because it is based on the experience on these devices that the user’s ecosystem decision is taken.
  • Hence, I do not see Gameroom as a real challenge to Steam but instead a play to fully colonise the Gaming segment of the Digital Life pie which in developed markets remains largely unoccupied.
  • Facebook is coming at gaming from all angles from VR and Occulus at the high-end to experimenting with gaming within its chat app Messenger.
  • Gameroom adds another string to Facebook’s bow when it comes to conquering gaming and of all of the major ecosystems, it is probably in the best position for gaming (except Tencent in China).
  • Microsoft and Sony also have thriving gaming communities but have completely failed to convince any of these players to play casual games within their systems on mobile.
  • This has left the largest (30%) segment in Digital Life wide open which is why I think Activision bought King Digital (see here).
  • I also believe that this is why Tencent purchased Supercell (see here) but the consortium structure that it is building around this acquisition makes me think twice.
  • This launch further reinforces my belief that Facebook is working at becoming the largest ecosystem of them all with over 2bn users and 80% Digital Life coverage.
  • This would put Facebook in undisputed leadership with Tencent in second place with 77% coverage and over 1bn users.
  • This is how Facebook goes from being a US$20bn revenue company to US$50bn, a large slice of which is likely to come out of Google.
  • However, in the meantime, Facebook has a lot of work to do as its current Digital Life coverage is just 36% and it remains really just a collection of apps rather than an ecosystem in its own right.
  • This is why I am nervous on the short-term outlook for Facebook as market estimates are assuming that revenues materialise from the new ecosystem services long before I see them as being mature enough to generate revenue.
  • I think the slip comes pretty soon, which is why I remain short-term cautious on Facebook despite the fact that it has a lot of long term potential.
  • There will be a better time to get in.

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.

Sony – Achilles heel

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User experience remains a huge risk in the next generation. 

  • Sony’s launch of two new PlayStation 4 consoles broadens the appeal of the platform nicely but these devices do nothing to alleviate the issue that could cost Sony its lead in the console gaming market.
  • Sony launched two new consoles at an event in New York on Thursday, each of which is aimed at spreading the appeal of the platform more widely.
    • First: PS4 update.
    • This is a slimmer, sleeker PS4 with all the same specifications as the original except that it comes in a smaller box with a lower price tag.
    • This is selling at $299.99 and is aimed at bringing new gamers into the world of PlayStation.
    • Second: PS4 Pro.
    • This is device is roughly the same size as the original, except that the graphics have been beefed up to support 4K, HDR as well as higher frame rates.
    • This is aimed at hard core end of its fan base which is always looking for ways to enrich the gaming experience.
    • Developers are already creating downloadable patches that will upgrade existing 1080p games to 4K as well as expanding the colour gamut and frame rates.
    • The 4K will also support video streaming services like Netflix which are already moving to 4K.
    • This device will be priced at $399.99 pretty much where the old PS4 was selling for.
  • These updates are great for widening the appeal of the PS4 for playing games but they nothing to improve the user experience.
  • Sony and Microsoft have carved up the console market between them with Sony doing extremely well in the current generation taking roughly 2/3 of all gamers onto its platform.
  • I have long believed that this was more due to mistakes made by Microsoft at the launch of the Xbox One (see here) rather than the PS4 offering a substantially better gaming experience.
  • Microsoft scrambled to fix these issues but the damage had already been done resulting in PS4 outselling Xbox by 2 to 1.
  • However, I think that the next generation could be very different because then the user experience and the ecosystem will be much more important and here Microsoft utterly destroys Sony.
  • When I compare the Xbox One’s rich and fun user experience to the bare bones of Sony, there is simply no comparison.
  • The PS4 experience appears to be aimed at allowing the gamer to launch the game and little more.
  • Furthermore, doing basic things like uploading a gamer photo, changing a password or setting up payment is tortuous and frustrating. (see here).
  • When one is trying to develop an ecosystem, the user experience has to entice the user to stick around and explore what else is on offer.
  • This is how user loyalty will be generated and how an ecosystem will get its users to spend more time within its community.
  • Furthermore, the look and feel of that experience can then be replicated across other devices creating a feeling of ease and of being at home.
  • With the Sony PS4 user experience it is almost a relief to fire up a game as Sony has provided the user with no reason whatsoever to hang around and explore.
  • This will be much more important in the next generation as most games will be available on both platforms meaning that how well the device delivers other functionality could be the deciding factor.
  • Microsoft is languishing when it comes to its Digital Life ecosystem but the assets themselves are in good condition and Microsoft has long understood what it needs to do to make its console appealing.
  • Furthermore, Microsoft is unlikely to repeat the mistakes it made at the launch of the Xbox One meaning that Sony really needs to pull its socks up.
  • Unfortunately, software is not something that Sony does very well and the company has a habit of ceding commanding market positions with very little resistance.
  • I see no signs of Sony working on improving its user experience and I fear that Microsoft will take a large bite out of its market share when the next generation consoles launch.
  • This is one reason why I fear that Sony’s improved fortunes may end up being short-lived as I think that Hirai-san has applied a Band-Aid rather than addressing the root of the company’s woes.
  • Hence, I would be very wary at getting involved with Sony’s stock even though it remains the only Japanese consumer electronics company with any real chance of longevity.

Sony – Game off.

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Sony misses the wood for the trees. 

  • Sony has decided to have another go at the mobile gaming market but the structure of the company and its lack of understanding of the ecosystem will make success very difficult.
  • Sony appeared to up its commitment to mobile gaming at IFA by stating that it was aggressively getting into mobile gaming but how it intends to succeed remains unclear.
  • I suspect that incredible rise of Pokemon Go has reminded Sony that although it has the by far the strongest multiplayer gaming community outside of China, it has failed to do anything with it beyond the console.
  • I have long believed that gaming in developed markets is by far the biggest opportunity for a new entrant because it is the biggest slice of the Digital Life pie (31%) and currently completely unoccupied by a dominant player.
  • Almost every other Digital Life segment has a strong player (Google, Facebook, Amazon) but in gaming there is currently no-one.
  • This is exactly why I think Activision bought King Digital (see here) and why Tencent is buying Supercell (see here).
  • It is also why Google wanted to buy Twitch but failed much to the benefit of both Sony and Microsoft (see here).
  • To become dominant in this space, a gaming offering has to have both a good stable of games but most importantly a thriving community of online players.
  • Sony has neither of these things in mobile and its efforts to date to bring PlayStation Network into mobile have been ignominious failures.
  • These failures came before Sony was re-carved up into a series of independent legal entities with each being focused on their particular activity.
  • This gives them greater autonomy, allowing them to act quickly, but it also makes them hostile to any form of co-operation with the other members of the Sony group. (see here).
  • One of these entities is called ForwardWorks which was tasked in April 2016 with producing games for mobile devices.
  • ForwardWorks is a fully owned subsidiary of Sony Interactive Entertainment which also owns PlayStation and PlayStation Network but it appears to operating in a vacuum.
  • Consequently, I see ForwardWorks as nothing more than a game studio and not an attempt to really create a thriving community in mobile by leveraging its existing world leading gaming assets.
  • For me, the top contenders in this field are Activision, Tencent and Amazon but all of these remain pretty far away from having a thriving community on mobile in developed markets.
  • However, they understand the importance of the community and they have some grasp of the importance of bringing together as many Digital Life segments as possible.
  • Sony appears to have none of this understanding and its moves in the last year to re-organise into silos is a case in point.
  • Consequently, while Sony may make some extra revenues if it has a couple of mobile hits, it is almost certain to miss out on the incremental value that a thriving gaming community on mobile could bring.
  • RFM estimates that if Sony was to migrate its PSN network successfully into mobile, it could generate at least $1bn in incremental revenues per year not including sales from games or content.
  • With its current trajectory, this opportunity is likely to accrue to others, of which Tencent is by far my favourite way to play the opportunity in mobile gaming.

Mobile Gaming – Pokemon went.

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Tencent and Activision can breathe a sigh of relief. 

  • Pokemon Go is already showing all the hallmarks of being a craze rather than a revolution as the appeal of the game is already beginning to pall despite only being 6 weeks old.
  • Data from Apptopia shows that daily active users peaked at around 45m users three weeks after launch but have since declined by 40% in the last month to 27m users.
  • Google Trends is also showing that the spike of interest in augmented reality caused by the launch of the game has also declined precipitously as it is almost back to where it was prior to launch.
  • Furthermore, in the last two weeks Pokemon Go has fallen in the US Apple App Store to No. 16 although it remains at No. 4 on Google Play.
  • The good news is that Pokemon Go remains No. 1 on the grossing chart for both iOS and Android.
  • This indicates that the number of new users joining the game is collapsing fast although revenue generation from those that are still playing the game remains very healthy.
  • I suspect that this will translate into rapidly stalling revenue growth at Niantic and how long existing players will keep paying is the real question mark.
  • From my perspective, the real potential for Pokemon Go was to fill the vacuum that exists in developed markets when it comes to mobile gaming.
  • Both Xbox and Playstation Network have failed to gain any traction on mobile devices leaving the largest Digital Life segment unoccupied.
  • To fill this segment a thriving multiplayer gaming environment is needed that has comfortably more than 100m MaUs but to dominate it, I think 300m MaUs or more is needed.
  • With Pokemon Go having made just half of that and now showing signs of decline, those that are working quietly to fill this segment can breathe a collective sigh of relief.
  • Top of this list are Activision which has purchased King Digital (Candy Crush with 500m MaUs) and Tencent which has purchased Supercell (Clash of Clans 100m DaUs).
  • These two need to take these single game franchises and entice their players to try the other games and services that they have to offer.
  • This is how they can turn a single game community into a place where users come to play games against each other.
  • Pokemon Go seems to have fallen short of the critical mass needed to challenge the scale of King Digital or Supercell, Tencent and Activision remain the most likely winners.
  • The Gaming segment remains unoccupied and I suspect that there is room for one dominant service and a host of smaller followers.
  • Tencent has the most experience of mobile gaming with its dominant position in China but it knows very little of the market outside of China.
  • However, at the same time Activision has no experience of mobile which could prove to be an even greater challenge.
  • Tencent is the company I would look at for exposure to gaming on mobile devices but I think that Nintendo could fall further as it is still meaningfully above pre-launch levels.

Tencent Q2 16A – Stairway to heaven?

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Tencent remains a few steps away from greatness. 

  • Tencent followed Alibaba in reporting a mighty set of numbers driven not by user numbers, but by its ability to generate more revenues from the users it already has.
  • Q2 16A revenues / EPS were RMB35.7bn / RMB1.13 compared to forecasts of RMB33.3bn / RMB1.00 and RFM at RMB31.1bn / RMB1.02.
  • Weixin / WeChat reported 806m MaUs while its PC based chat system QQ recorded 899m MaUs with 667m of those engaging with Tencent’s content and gaming offerings.
  • This combined with an improving level of monetisation of the traffic that it generates and returns on investments made in premium, international content underpinned the very strong quarter.
  • Very much like Alibaba, Tencent is beginning to make the right noises that indicate that it is starting to think like an ecosystem but the proof will remain in the pudding.
  • This is because while Tencent offers single sign-on across many of its properties, the services that sit underneath this sign on remain independent and discrete.
  • For example, it makes no sense at all for QQ and Weixin / WeChat to be independent systems and I think that much more value could be derived if Tencent was to put the two together.
  • However, there is no sign of this and I think that this will ultimately limit the degree to which Tencent will be able to monetise its users.
  • Despite this, the organic growth of Weixin / WeChat into areas outside of instant messaging is impressive.
  • Weixin can be used for instant messaging, shopping, social networking, gaming, banking and payments as well as many O2O services such as ride hailing and food ordering.
  • Consequently, it is possible that Tencent may end up with a fully integrated ecosystem through the organic growth of Weixin / WeChat.
  • This would solve the integration and data sharing issues that I think are holding it back from realising its full potential.
  • Unfortinately, most of Tencent’s usage (in terms of time spent) and almost all of its monetisation lie outside of Weixin / WeChat leaving me thinking that this alone will not be enough.
  • I need to see Tencent fully embrace the ecosystem concept across all of its properties before I can start to believe that Tencent will maximise its potential.
  • This potential is significant as RFM estimates that 2018E revenues and profits could be 40-50% higher if Tencent is able to fully monetise the traffic that is being generated by its services.
  • This could allow a further substantial appreciation in the share price which is why I am watching Tencent very closely for any sign of moves in this direction.
  • In the meantime, Samsung, Microsoft and Baidu remain my top choices for 2016.

Amazon – Curse of integration

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Amazon still misses the wood for the trees. 

  • Twitch has announced that it will be acquiring Curse which further underlines how disparate and independent Amazon’s properties are and how far Amazon is from becoming a real ecosystem.
  • Twitch is a website that streams gaming videos and has created a community around that with 100m monthly active users (MaUs) of whom around 10% visit every day with an average engagement time of 2hrs.
  • Curse is a games company that sells software that allow game creators to easily add communication functions for players to their games.
  • In essence Curse has tools that can help turn a standalone game into a multiplayer community.
  • This is exactly where Twitch has gone with its website and it has been very successful at creating a thriving community around computer game video feeds.
  • Consequently, this acquisition makes sense for Twitch but it throws into sharp relief how its owner Amazon, has no real understanding of the ecosystem and the opportunity it is passing up.
  • In developed markets, the Digital Life pie is dominated by Gaming but it is the one segment that is completely unoccupied.
  • All of the other segments are dominated by at least one major player but Gaming is completely vacant.
  • This is because both of the two major developed market multiplayer gaming communities Xbox Live and PlayStation Network have completely failed to create any traction in Gaming on mobile devices.
  • I have long believed that this is why Google wanted to buy Twitch, why Activison bought King Digital and why Tencent has purchased Supercell.
  • With Twitch sitting as part of Amazon, it is being completely left to its own devices meaning that it is making no effort at all to conquer the last great wilderness of mobile or even doing anything with any of Amazon’s other gaming assets.
  • Twitch has all the elements required to begin developing a thriving multiplayer based gaming environment for mobile devices, which is exactly why I think Google wanted to buy it.
  • However, Google understands the importance of integration to create a seamless experience for users and consequently required that Twitch become fully integrated into Google.
  • Amazon clearly does not which is why it has been happy to allow Twitch to take the money but carry on doing its own thing as if nothing had happened.
  • In the meantime, a vast opportunity is being left unaddressed which gives both Activision and Tencent a shot at creating a thriving multiplayer gaming environment on mobile.
  • If I thought that Amazon had a chance of capitalising on this opportunity, I could be more forgiving of its valuation which I think still needs to come down quite some way before I can get interested.
  • I prefer Microsoft, Baidu or Samsung.

Tencent & Supercell – Mix of clans

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Integration with China not critical but it is elsewhere. 

  • Tencent has announced that it is leading a buyout of Supercell but the structure of the transaction raises questions as to whether Tencent will be able to earn a good return on its investment.
  • Tencent is establishing a 100% owned consortium which will acquire an 84% stake in Supercell at a valuation of $10.2bn.
  • This represents the entirety of Softbank’s holding in Supercell as well as some of the shares that are currently owned by the employees of Supercell.
  • Tencent is leading this transaction and expects that other investors will join it as consortium members but its holding will not decrease below 50%.
  • Supercell will remain wholly independent from Tencent and will continue to manage its own business but will have access to Tencent’s expertise as well as its user base.
  • This independence is so great that Tencent will not consolidate the financial performance of the consortium even though it has a majority investment in it.
  • While this is great for those at Supercell that want life to carry on in the way that it has do date, it raises further concerns with regards to Tencent’s understanding of how to build an ecosystem.
  • Tencent has the best coverage of Digital Life in China (77%) and scores the best globally but when it comes to RFM’s Laws of Robotics it does not fare so well.
  • This is because RFM research indicates that Tencent has not fully taken on board what is required to really build a thriving ecosystem as opposed to series of discrete services.
  • Consequently, when ecosystems acquire Digital Life services to round out their portfolios of services, they really need to be fully integrated to offer the maximum potential for a return.
  • However, Tencent’s situation here is unusual.
  • I see Supercell as Tencent’s strategy to expand overseas and given that very little of Tencent’s existing portfolio is relevant overseas, integration of Chinese assets with Supercell is not important.
  • The real upside for Tencent from this transaction is for Supercell to become the basis of an ecosystem strategy outside of China.
  • Gaming is a great place to start as in developed markets, the segment is completely wide open as Microsoft, Sony and Amazon have not been able to convert their gaming communities to mobile.
  • This fact has not escaped Activision and this is why I think it acquired King Digital (see here).
  • I think that in order to really make a return on this investment Tencent will need to build on the success that Supercell has had in developed markets.
  • This include creating a deep and rich community around Supercell’s 100m daily active users with more games or other Digital Life services.
  • These could be added into the consortium and it is not impossible to imagine new partners contributing their assets in return for a share of the consortium over all.
  • The caveat here is that within the consortium asset integration will be of paramount importance and I don’t see this level of rigour within Tencent’s own Chinese ecosystem let alone a consortium that it claims not to control.
  • Hence, the consortium will need to operate with laser focus and execution to create real value outside of China.
  • Given the performance of other industry consortia to date, I have doubts as whether this will be achieved.
  • This is why I see more upside in Baidu, as I think Baidu understands these issues much better than Tencent does and as a result is likely to derive the most value from its ecosystem.
  • I continue to prefer Baidu, Samsung and Microsoft over Google, Amazon and Twitter.
  • Tencent, Facebook and Apple all have upside but face hurdles to overcome before that value can be fully realised.