Samsung Q1 17 – Roaring 40s

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

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

Google – From Russia with love pt. III

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Google escapes to fight another day.

  • Google has settled its dispute with the Russian regulator but I suspect that Google has managed to avoid having to give away its crown jewel: Google Play.
  • According to the FAS Russia (see here), Google has agreed to:
    • First: Google will no longer prevent the pre-installation of competing search engines or apps on Russian GMS-compliant Android devices or their presence on the home screen.
    • There is no mention of which services will be set as default when the user turns on the phone for the first time.
    • Second: Google will no longer enforce the parts of the previously signed agreements that contradict the terms of the settlement.
    • As the terms of the settlement have not been made public, it is not clear exactly what this entails but I suspect that it refers primarily to point 1 above.
    • Third: Google will ensure that users of Android devices already present in the market will be given the option to change their default search provider via a software update and pop up.
    • Fourth: Google will pay a fine of $7.8m which I calculate is equivalent to around 100 minutes of Alphabet’s cash flow and consequently, is completely irrelevant.
  • This settlement ensures that competing apps can be on the home screen but it appears to do nothing about the requirement to bundle the Google Apps with Google Play nor the fact that they are set by default, albeit, now changeable.
  • The settlement was proposed by Google and accepted by the FAS which admitted that it was under some pressure to have this two-year dispute resolved.
  • This is why I believe that this crucial element was left out if the agreement as I think that it is the unbundling of Google Play from Google’s Digital Life services that could do the real damage.
  • This is because it is widely accepted that in most markets outside of China, it is almost impossible to sell an Android Device that does not have Google Play installed because this is what users demand.
  • This gives Google the power to force handset makers and operators to install the services from which it makes almost all of its Android mobile revenues front and centre on the device and to set them as default.
  • Research has shown many times that installation at the factory and being set as default are big drivers of usage, even if the service in question is considered to be inferior (Apple Maps).
  • This is why I have long believed that Google Play is so important to Google’s Android revenues and that unbundling Google Play could be highly detrimental to its long-term outlook.
  • The good news for Google is that it has now set a precedent with which it may be able to more easily settle its outstanding dispute with the EU.
  • The net result is that I think that while Google has given up a little ground, the fortress of Google Play remains intact and with it its ability to continue dominating the Android landscape.
  • However, this dominance is not enough to make me think that the shares are attractive and I continue to prefer the shares of Baidu, Tencent and Microsoft.

Samsung – Fall before the first

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Bixby falls even before its first hurdle.

  • Samsung’s delay in the roll-out of Bixby is a strong indication of just how far behind Samsung is when it comes to artificial intelligence reinforcing my view that the investment case still lives and dies with hardware.
  • Despite much fanfare at the launch of the Galaxy s8 just a few weeks ago, it turns out that Bixby’s functionality at launch will be greatly curtailed as Samsung can’t get it to work properly.
  • Some of the features such as Vision, Home and Reminder will be available but the key piece that ties it all together which is Bixby Voice will not be available in US until later in the spring.
  • The reason for the delay is that the voice recognition system in English is not nearly good enough and substantially lags behind Bixby’s performance in Korean.
  • This is a significant blunder on Samsung’s part as:
    • First: it appears that Samsung has put more effort into making Bixby work in Korean than English.
    • I think that this was not a very sensible choice as the vast majority of Samsung Galaxy s8 devices will sell to users for whom Korean is not a language they speak.
    • Second: it is a sure indicator of just how far behind Samsung is compared to everyone else when it comes to developing intelligent services.
    • RFM research (see here) has identified three stages of voice recognition of which the first and by far the most simple is the accurate conversion of voice to text.
    • Almost everyone, even Facebook, has pretty much cleared this hurdle but it appears that Bixby has not.
  • Digital assistants face a critical chicken and egg problem.
  • This is that to improve, they need data but if they are no good, no one will use them thereby depriving them of the data they need to get better.
  • At this rate, users will try Bixby once or twice and quickly give up preferring instead to use touch based input and other digital assistants.
  • To make matters even more difficult, Bixby will be competing on its own device with the best in class Google Assistant which will be set by default and will sit on the home button.
  • The net result is that I see the Galaxy s8 competing on the basis of its superb screen, high quality camera and best in class components that together will enhance the Digital Life services provided by others.
  • I do not expect users to pay much attention to any of Samsung’s software innovations as I see them as either not useful (Samsung Dex) or not good enough (Bixby).
  • This leaves Samsung exactly where I left it as a vendor of commodity hardware that makes excellent returns by out shipping its nearest rivals by more than 2 units to 1.
  • As long as it can maintain that gap, I have no fear for its profitability or its outlook but Huawei is keen to capitalise on Samsung’s woes and remains a constant threat.
  • Samsung’s brand has also taken a hit as a result of the Note 7 disaster, leaving the Galaxy s8 as the first real test of how much damage has been done.
  • This combined with the recent very strong rally, is why I still don’t want to get involved.
  • I prefer Tencent, Baidu and Microsoft.

Xiaomi – No favours

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Xiaomi’s ecosystem remains its biggest weakness.

  • Comparing itself to Costco helps Xiaomi’s valuation somewhat but does no favours when it comes to its business model.
  • In a recent interview, Xiaomi founder said that he sees his company more like Costco than Apple which does make some sense.
  • Xiaomi has pursued a typical Internet economy model which is to gather users as quickly as it can and then monetise when their numbers hit critical mass.
  • It has done this by selling nice looking devices at very low margins and then hoping to monetise users through its ecosystem of services.
  • What Costco does is similar in that it sells groceries at wafer thin margins and makes good margins on the subscription that it charges for membership.
  • However, where Costco and Xiaomi differ is that Costco has a service that users are clearly willing to pay for but I am not convinced that Xiaomi does.
  • Around 15% of all Chinese users have a Xiaomi phone but RFM research indicates that it is the ecosystems of the BATmen (see here) that Xiaomi’s users predominantly use.
  • This strongly implies that users are buying Xiaomi phones due to attractive prices and form factor but do not care about the ecosystem that Xiaomi offers.
  • Overseas the situation is even worse because outside of China, Xiaomi sells its devices with the Google ecosystem installed because its own ecosystem is irrelevant.
  • This is the critical difference between Xiaomi and Costco.
  • I have previously estimated that Xiaomi does make some money from selling content and games ($100m in 2016 (see here)) but this is very far from Xiaomi successfully monetising its ecosystem in China.
  • To try and restore growth, Xiaomi is going into retail and plans to open 1,000 stores in China as well as a good number in India with revenues of $10bn targeted within the next three years.
  • This is the right strategy to break out of the limitations of Internet-only sales, but will have the impact of increasing costs.
  • Consequently, I am comfortable that Xiaomi could hit its RMB100bn ($14.4bn) sales target for 2017, but I am certain that margins will not be going up.
  • If I take this outlook and compare it to Costco rather than Apple, I do get a slightly better valuation but not one that would make Xiaomi’s current shareholders very happy.
  • Using Costco’s 2017 EV/Sales and EV/EBIT multiples and applying them to my estimates for 2017 Xiaomi (see here), I end up with valuations of $8.6bn / $8.3bn respectively.
  • However, in using this methodology, the question needs to be asked should Xiaomi trade at a discount because Costco has already established the service it sells whereas Xiaomi has not?
  • This is somewhat higher than my current $5bn valuation using Apple, but still way below the last raise at $45bn and the $20bn or so where I understand that the shares are changing hands.
  • I do not see any threats to Xiaomi’s viability as a company but I still think it would make a good acquisition for one of the BATmen that I think will need to become more vertically integrated to continue growing in the home market.

Huawei – Rivers of blood pt. IV

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I am pretty sure Huawei lost money in handsets last year.

  • Huawei reported strong growth in revenues in 2016 but that growth cost it dearly as I think that the handset business lost money as it slashed prices and ramped up spending to gain market share.
  • FY 2016 revenues grew 32% to RMB523bn ($75.1bn) but gross margin fell 114bp to 40.3% and operating margin fell by 205bp to 9.1%.
  • Huawei entered 2016 in a buoyant mood confidently stating that it would become the Number 1 seller of smartphones within 5 years.
  • In line with that goal it massively ramped up spending and cut the prices of its devices in order to close the gap to the global No. 1 smartphone maker: Samsung.
  • Unfortunately, while it was focused on Samsung, Oppo and Vivo really turned on the juice at home, costing Huawei 190bp of local market share in H2 2016.
  • The net result was lower than expected global market share gains for the full year.
  • This was a problem, because Huawei had planned for higher volumes in 2016, meaning that its OPEX budget for the year was too high.
  • Consequently, I am pretty sure that the consumer business entered negative territory which has resulted in a much more measured approach to 2017.
  • RFM research indicates that the focus of 2017 is the generation of profit, which given that Samsung still meaningfully outsells Huawei in terms of volume will require much greater austerity when it comes to OPEX.
  • Huawei is now a comfortable No. 2 in Android but because Android devices are commoditised, that means that I still see it making margins of just 2-4% in the best instance.
  • In order to earn better margin, it must become the No. 1 in terms of volume and outsell its closest rival by a factor of more than 2 to 1.
  • It is this volume advantage that allows Samsung to earn 10-12% margins on Android devices which I think is sustainable for as long as it can maintain that volume advantage.
  • This advantage closed somewhat in Q4 16A but I suspect it will widen once again in Q1 17 as Samsung recovers from the Note 7 disaster.
  • Because of these economics, Huawei has got to do far more than just catch Samsung; it must outsell it by more than 2 to 1.
  • This will be very difficult to achieve which is why I think that Huawei is also working on differentiating its products through software and services.
  • If it can create a good user experience and services that users are prepared to pay something to have access to, then it should be able to make better than commodity margins.
  • However, this is easier said than done and I think that Huawei has a lot of work to do before it will be in this position.
  • This is why, I continue to believe that its best chance of success remains in China where a tie up with Baidu or Tencent could help it plug the service gap it currently has.
  • However, this won’t help in developed markets and here Huawei must do everything that it can to develop the appeal and attractiveness of its Honor brand.
  • This will be difficult given the dominance of the Google ecosystem in these markets but there are cracks in Google’s position that might just give Huawei a chance.
  • In the meantime, I remain unconvinced that Huawei does not have the stomach or the resources to wade through the rivers of red ink that it will take to knock Samsung off its perch.
  • Consequently, I see 2017 as a consolidation year for Huawei, holding share steady and focusing on a return to profit before it considers its next move.
  • I would continue to be wary of any of the Android handset makers whose outlook is increasingly difficult as the market for devices continues to slow.
  • Apple is the only handset maker I would touch at the moment.

Samsung – Still in the box

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Bezels break the box but Bixby stays inside.

  • While Samsung is bursting out of the box in pushing the limits of screen real estate, its voyage into the increasingly crucial user experience shows that it remains boxed in by smarter and better alternatives.
  • Samsung finally launched the Samsung Galaxy s8 / s8+ whose main features include:
    • First: A big improvement in screen real estate with the home button now being under the glass as well as improvements in colour, contrast and brightness.
    • Second: A digital assistant called Bixby (see here) that aims to be much more than an easy way to find stuff out (see below).
    • Third: Samsung Dex which allows the Galaxy s8 to work with an external monitor, mouse and keyboard to give a desktop like experience.
    • Samsung demonstrated very basic PowerPoint editing features confirming to me that the Galaxy s8 will be capable of running the stripped-down Office apps rather than the full fat versions.
    • I still think that without full fat Office, Photoshop etc, there is not much point in this functionality as content consumption has largely already moved off form factors that use a mouse and keyboard and onto touch.
  • The net result is that Samsung is continuing to almost entirely differentiate in hardware as this device is still first and foremost a Google ecosystem device.
  • This is just one area where Bixby will run into problems as it will be the best-in-class Google Assistant that sits on the home button meaning that Bixby has a fearsome competitor even on its own flagship device.
  • To counteract this, Bixby is trying to do things a little differently but careful assessment of what Samsung demonstrated shows a service that has very little intelligence at all.
  • Bixby is a very far cry from what Viv demonstrated would be possible with its assistant prior to the Samsung acquisition, making me suspect that Viv has not proved to be nearly as clever as promised.
  • Bixby is activated with a side key (to get around the problem of Google sitting on the home button) and aims to get stuff done rather than just finding stuff out.
  • Consequently, Samsung has taught Bixby a range of skills such as screen capture and image recognition and plugged that functionality into a select number of apps.
  • By keeping the number of apps that use it limited, Samsung limits the number of possibilities that has to program further highlighting that Bixby is probably incapable doing very much outside of the box.
  • This appears to be contrary to how Viv marketed its capabilities (see here) before it was owned by Samsung, again making me wonder about the true capability of Viv / Bixby.
  • Bixby offers a series of cards (left swipe from home screen) that adjust based on usage and the time of day as the system learns what apps and services the user uses most and when.
  • This is merely clever statistics but if this proves to be a useful tool, then Samsung will achieved some much needed differentiation outside of hardware.
  • Although I have suspicions about the lack of intelligence in Bixby, I cannot be 100% certain of this opinion until I have tested it to destruction.
  • The net result is a very nice looking device that Samsung has made huge efforts to show is both high quality and extremely safe.
  • Most importantly this device is also the first real test that Samsung has had since the Note 7 disaster which is why the s8 needs to sell very well, confounding the big fall in trust that Samsung has suffered over the last 6 months (see here).
  • I think that Samsung has produced the device that it needs to cement its recovery but now it comes down to consumers, a number of whom have already switched to iOS (see here).
  • With Samsung’s share price very close to its all time high, a lot of recovery is already priced in which is why I remain a little nervous.
  • Hence, I prefer Microsoft, Tencent or Baidu.

MWC Day 1 – The time machine

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The taxonomy of MWC is changing

  • Nokia has through nostalgia has created some excitement in the mobile phone industry but elsewhere the signs of maturity are everywhere.
  • The notable fall out coming from Microsoft, Blackberry, Huawei amoung others who have substantially reduced the sizes of their stands has been replaced with:
    • First: Automakers who outside of BMW still seem to be a little unsure of what they are doing at this show.
    • They have realised that mobile holds the key to preventing them from becoming Android handsets on wheels but are very uncertain how they intend to address this problem.
    • I think that Tesla has a very good idea of what it is doing in this space and consequently does not feel that it needs to be here.
    • Second: An endless list of handset brands who are all selling almost exactly the same device where the proposition is very unclear.
    • Two exceptions are Wiko and LeEco who are at least trying to offer points of differentiation on the device even if they are having a very hard time doing so.
    • Condor from Algeria and Accent from Morocco are doing stock Android but are attempting to achieve some differentiation by focusing on their respective regions.
  • Furthermore, the app industry, largely present in Hall 8,8.1 and the hallways, has moved into a new phase of development.
  • Gone are the heady days of 2015 when it was all a out adding users at any cost.
  • Now the focus is clearly on engagement, analytics and monetization.
  • Developed markets are pretty much saturated from a user perspective meaning that how to delight those users and making sure that they stay engaged is of paramount importance.
  • Consequently, the suit count in Hall 8.1 has gone up substantially as has the size of the average stand.
  • This implies that many of the smaller, ineffective players have been weeded out leaving the bigger players who have much larger marketing budgets.
  • Consequently MWC has revealed an industry that looks very mature (just like it did in 2005) but this time I can’t see anything on the horizon to upset the status quo.
  • I continue to prefer the ecosystems over the handset and PC makers in general as they, at least, have a way to differentiate

MWC Day 0 – Prominent feature.

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A feature phone steals the show.

Huawei – Rear view mirror.

  • Huawei launched its latest flagship the P10 and P10 plus but did not seem to be very excited about its products in a press conference that felt like it was simply going through the motions.
  • This was exemplified by the fact that Huawei had Pantone on stage talking for 15 minutes about two of the multiple colour variants in which the P10 is being launched.
  • Elsewhere, Huawei made incremental improvements to the camera and photography experience as well as marginal tweaks to the user experience.
  • At its heart, just like every other Android phones in developed markets, the P10 is a Google device and where Huawei is able to drive further usage, it will be Google that really benefits.
  • This is because, Huawei’s products remain largely undifferentiated to the user meaning that Huawei cannot charge a premium.
  • Huawei has made good progress with its brand this year rising to No. 72 (Interbrand) but even Samsung at No. 7 only really makes money from its volume, not premium prices.
  • Consequently, Huawei must find something with which to excite users otherwise it will continue to grind out 2-4% operating margins in the best instance.
  • Huawei has made good share gains but barely enough to be seen only as a dot in Samsung’s review mirror.

Nokia – No downside to old glory.

  • Nokia relaunched itself into the handset market with a throwback to its old glory days but the key ingredient, profit, looks unlikely to make a reappearance.
  • Global HMD, a company backed by Foxconn, launched three Android devices and new version of the classic 3310.
  • The 3310 has three features of note:
    • First: the battery lasts a month
    • Second: it has the Snake game
    • Third: it has the old Nokia ringtone.
  • Beyond that it is a design classic and while not sexy, it is likely to appeal in Africa and India where nearly 100m feature phones still sell each quarter.
  • Global HMD also launched the Nokia 3,5 and 7, which are three unremarkable Android devices that are really going to struggle to compete against the Chinese brands.
  • The real clue to the situation at Nokia and HMD Global is in the prices being charged for these new devices.
  • The 3310 is starting at $51 which in Nokia’s heyday would have been priced at almost half that and Nokia still would have made great margins on it.
  • The Android devices are priced at $150, $200 and $315 which in my opinion do not stack up that well against what the Chinese are offering.
  • This is clearly because Nokia no longer has the power of 40% global market share or its brand.
  • Consequently, if it wants to make headway in Android, it will have to do something interesting with the devices or cut its prices.
  • Good news for Nokia (the company) is that its exposure to this is simply the brand licence fee that it receives upon which gross margins will be almost 100%.
  • Consequently, there is no downside for Nokia if this does not work out as planned.

Samsung – Comes in the box.

  • Samsung launched a series of devices that I think need to have the accessories included in the box to drive user interest high enough to make a purchase.
  • Following a pitch on the needs of 5G and the launch of some infrastructure, came 2 tablets of which innovation around the new S Pen was the most interesting.
    • First: the Samsung Galaxy Tab S3 which was an unremarkable Android Tablet other than it has four speakers and that the S Pen comes in the box.
    • Second: the Galaxy Book which is a Windows 10 Pro tablet that is very thin but in my opinion is far from cutting edge.
    • At the cutting edge, I find the Eve V which is 7th generation i7 and is remarkable in that the device is fan-less.
    • The Eve V is a little thicker at 8.9mm but it delivers a more powerful processor, double the RAM, double the storage, more USB ports and a kickstand.
    • To jazz the Galaxy Book up Samsung is including both the S Pen and the type cover in the box with the device.
  • The S Pen stole the show in my opinion as it works with both Android and Windows Tablets, is integrated with Photoshop and Staedtler is doing a version of the S Pen that looks just like its classic yellow and black pencil.
  • Finally, a new version of the Gear VR was launched in conjunction with a hand controller that, of course, also comes in the box.
  • Of software, services, artificial intelligence and ecosystem there was no real mention other than a nod to Samsung’s cross device strategy powered by Samsung Flow.
  • The net result is that with the launch of the Galaxy s8 now on March 29th, these launches are unlikely to have any real financial impact this year even with the accessories already in the box.

Take Home Message

  • The launch of the new Nokia 3310 was the highlight of my day which is an indicator of how difficult it has become to innovate in smartphones.
  • Industry profits are gobbled up by Apple, Google, Baidu, Tencent and Alibaba leaving those without an ecosystem struggling for relevance.
  • Add this to a market that is unlikely to grow much in unit terms and may decline in monetary terms leads to a pretty grim outlook all round.
  • This is why I continue to prefer the ecosystems of whom Tencent, Baidu and Microsoft are my top choices.

Samsung – Residual fall-out.

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It is still the long-term damage that I fear. 

  • While Samsung appears to have contained the disaster that was the Note 7, I remain concerned that the reputational damage could have an impact in market share in developed markets and especially at the high-end.
  • Samsung has taken a massive $5.4bn hit to profits, apologized profusely for the recall and admitted shortcomings in its quality and assurance process but I don’t think that the full effects of this issue have fully hit home.
  • This is because there is also the potential for market share and pricing pressure to materialise from the weakening of its brand and its reputation as a vendor of high quality consumer electronics.
  • The first sign of this is in with a survey from Harris Poll which shows that Samsung reputation has fallen from No 7 in USA to No. 42, just one position above the US Postal Service.
  • Apple and Google have remained pretty steady at no. 5 and 8 respectively but Samsung is now thought to be less reputable than Hewlett-Packard, GE and Sony, which are competitors that do date, Samsung has had no trouble in defeating.
  • What concerns me is that when the Galaxy s8 and s8 edge are available, users in developed markets are likely to think a little bit harder before purchasing and may go so far as to consider something from LG, Google, Sony or Huawei.
  • Hence, I think that Samsung will have to price the Galaxy s8 and s8 edge quite carefully as well as go on a major charm offensive to calm user fears that these products will suddenly burst into flames.
  • I am certain that these products will be the safest that Samsung has ever made but that is not how the mindset of the average smartphone buyer operates.
  • Both of these charm offensives will cost money in terms of pricing and marketing spend.
  • The high-end devices that Samsung makes generate the majority of its handset profits and I am somewhat concerned that profits could suffer as the aftershocks of this disaster make themselves felt.
  • This is why I have been cautious on Samsung since the problem with the Note 7 surfaced, and why I would be thinking of taking some profits following the recent excellent performance in the share price.

Huawei & Baidu – Bodies and time.

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I think Huawei would be better off doing a deal with Baidu.  

  • It looks like Huawei has decided to build its own Chinese language digital assistant to cement its recent gains at home but no matter how many bodies it throws at this task, its lack of the core raw materials (data and history) is going to cause problems.
  • The digital assistant is the first real Digital Life service that is entirely dependent on artificial intelligence for its functionality which creates a huge challenge.
  • Furthermore, in order to evolve, all digital assistants need to generate usage data which can then be used to improve the algorithms that power the user experience.
  • Even the best assistants out there today are hugely limited in terms of what they can understand and what they can achieve.
  • For example, to accurately answer questions around exchange rates, the assistant has to be taught what these are, how they work and in what form the questions are likely to be asked.
  • For example, asking Amazon Alexa how many US Dollars there are to the GB Pound provides the correct answer but ask for UAE Dirhams to the Pound or Dollar and Alexa falls silent.
  • Only Google Assistant was able to provide the right answer due to the combination of the best search system and the best AI available.
  • In effect RFM research has found that Alexa, Cortana and Siri have been programmed with a fairly narrow set of capabilities and the AI and data set is simply not there to support the service when something unexpected is requested.
  • Fortunately for Huawei, Google is not present in China but at home it will be facing an opponent that is almost as good: Baidu.
  • Baidu dominates the search market in China and has been working on its AI algorithms for nearly 20 years.
  • Furthermore, Baidu has already launched its own digital assistant called Duer which I suspect will be significantly better than anything that Huawei is likely to produce in the medium term.
  • However in China, none of the ecosystems are preinstalled devices meaning that Baidu will be unable to install Duer on the device and set it as default.
  • RFM research (see here) has found that this could confer a substantial advantage to any ecosystem as strategy is virtually absent in the Chinese market outside of the app stores.
  • Huawei as a handset maker will have this advantage and so I can see a scenario where users try its digital assistant but unless it is superb they will quickly switch to Duer.
  • This is where I think Huawei will have difficulties as even though it has 100 engineers working on this product, it is starting from scratch and building decent AI takes years and requires vast quantities of data.
  • Hence, I think it unlikely that Huawei will ever come up with a product as good as Baidu’s.
  • This is where I think Huawei and Baidu could help each other as Baidu has the product and Huawei a mechanism for distributing it.
  • A deal where Huawei installs Duer at the factory and sets it by default in return for being paid TAC (traffic acquisition cost) makes more sense to me than paying 100 engineers to come up with an inferior product.
  • This will not help Huawei’s ambitions to develop an ecosystem and generate better profitability, but TAC revenue from Baidu would certainly help improve margins.
  • Given its recent market share gains at home, the time to negotiate this deal is now rather than when its own assistant has tried and failed.
  • Although Baidu looks like it may be backing out of its ecosystem, the short-term improvement in its financials that cost cuts could generate could give the shares a lift (see here).
  • This is why it is still on my preferred list along with Tencent and Microsoft.