Facebook – Internet.cash.

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Connecting the next 4bn is about making money. 

  • Facebook has entered the next stage of its strategy to connect the next 4bn with the launch of OpenCellular, a base-station product that it aims to give away to anyone who wants it.
  • OpenCellular is a shoebox sized device that enables cellular connectivity from 2G to LTE with a maximum cell radius of 10km and a maximum of 1,500 devices supported at any one time.
  • With that specification it is clear that this device is aimed at rural areas which makes complete sense as this is where the majority of the 4bn unconnected people live.
  • However, what is unclear at this time is how the device will be powered and what will serve as backhaul as rural areas are typically devoid of this type of infrastructure.
  • RFM research indicates that OpenCellular is just the beginning and that there are a series of network infrastructure products being developed all of which are aimed at reducing the cost of internet access to mobile devices.
  • The main way that Facebook aims to reduce the cost of access is by making both the designs and the software fully available in open source for anyone that wants them.
  • I see this as a declaration of war on the hardware industry which makes its margins by keeping the designs and software that make its products superior proprietary.
  • To put it mildly, this is bad news for Ericsson, Huawei, Cisco, Nokia and so on.
  • If Facebook’s products prove to be just as good, then the industry has a huge problem as their customers will be able to take the designs and have them manufactured by any company in Asia.
  • This will put huge pressure on their margins but it will reduce the cost of network roll-out meaningfully thereby achieving Facebook’s aim.
  • This is all being done under the banner of connecting the unconnected but just like Google, Facebook is not a charity.
  • I suspect that any traffic that is generated by these products will flow through Facebook’s servers at some point giving Facebook a means to monetise the extra traffic generated.
  • This is how I think it will aim to earn a return on the money that it is investing in creating these designs, but they will be a long time coming.
  • Facebook is firmly upon a path to become the largest ecosystem of them all but it does have a lot of work to do before it will get there.
  • It currently dominates two very important segments of the Digital Life pie but this is a far cry from an all-encompassing ecosystem.
  • If it can execute on this strategy then I can see a very clear path to Facebook reaching over $40bn in revenues over the next 5-10 years.
  • Unfortunately, I think that the market is already giving the shares credit for this strategy before the revenues are likely to emerge.
  • This is why I continue to believe that it could miss estimates in Q3 16 or Q4 16 this year which would most likely result in a big correction.
  • It is at that point that I would look to pick the shares up for the long-term.

Qualcomm – Built to serve

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Triple whammy benefit no longer held up by software?

  • Intel finally has a credible challenger in the server market as Qualcomm has made an entrance in conjunction with partners Mellanox and Xilinx.
  • With growth rapidly declining in smartphones, tablets in negative territory and MediaTek aggressively attacking at the high-end, Qualcomm has been looking for new avenues for some time.
  • Wearables, IoT, e-health, automotive and so on all offer long-term potential but servers are big and are here and now.
  • The data centre generates $12bn – $14bn of revenues for Intel where it has over 90% share of the market.
  • Furthermore, the rationale for using an ARM based chip in the server is very strong as the operator of the data centre gets a triple whammy in terms of benefit.
    • First: The ARM processor consumes far less power than the equivalent processor from Intel, meaning less power consumed and less heat generated.
    • Second: Less heat generation obviates the need for fan cooling meaning cheaper build costs and a smaller footprint.
    • Third: Less heat consumption also means less air-conditioning is needed for the data centre, reducing costs even further.
  • The net result is substantially lower running costs because power is far and away the biggest operating expense of a data centre (excluding depreciation).
  • Hence, at first glance it would seem to be a no brainer to run all one’s servers on ARM based chips but there is a huge problem: software.
  • Intel has dominated this market since its inception and because of this, all the software written to run on servers is based on the x86 processor.
  • This means that any company that wishes to switch to an ARM-based server will have to completely re-write the software that runs its operation.
  • To date this has been an unsurmountable challenge as the cost and difficulty of doing this has vastly outweighed any of the benefits gained from using ARM.
  • However things have changed such that an alternative to Intel might just have a chance.
  • In the early days of servers, everyone got them off the shelf from suppliers like IBM of HP but that has now changed.
  • The really big ecosystems like Google, Facebook and Apple increasingly want customised servers which means that they design the hardware and write the code themselves.
  • This gives them the ability to do whatever suits them in the data centre.
  • Furthermore, they are now at such a size that the power bill has become so huge that it is worth considering alternatives.
  • I suspect that this will begin with a new Digital Life service or design of server where the code has not yet been written and where it is just as feasible to write it for ARM as Intel.
  • This is why the Qualcomm offering is targeted directly at the hyper-scale data centres where the servers are custom designed and built.
  • I think that Qualcomm represents the first really credible entrant into this field which to date has been populated by a series of start-ups who have been unable to overcome the software problem.
  • Qualcomm is the king of execution and if it can get a foot in the door, then there could be real trouble on the horizon for Intel.
  • Intel’s financial performance for the last few years has been almost single-handedly driven by the data centre and the outlook for it to get a position in mobile remains extremely bleak.
  • Its early days but Qualcomm is threatening to do to Intel what MediaTek has done to it.

Nokia – Here and now

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It is too early to sell HERE.

  • It seems that Nokia may be seeking to acquire part of Alcatel-Lucent (I presume the wireless assets) and to pay for it by selling the HERE business.
  • The acquisition of Alcatel-Lucent’s wireless business makes some sense as infrastructure is a brutal market dominated by two players.
  • At one end of the market there is Ericsson which is the technology leader and at the other there is Huawei which is the cost leader.
  • Between them they have created a balance in the market but for anyone caught in the middle, the outlook has always been pretty bleak.
  • That being said, Rajeev Suri has done an excellent job at turning Nokia Networks around and the timing of buying Siemens’ out of its share was perfect.
  • Now it is running smoothly, it is time to turn his mind to the long term and with Ericsson and Huawei both meaningfully bigger than Nokia Networks, the outlook is pretty tough.
  • More than handsets, infrastructure is a game of scale where one needs to maximise the revenues over which to spread the fixed costs of Research and Development and Sales and Marketing.
  • If one lacks scale, then the bigger competitors can still make a decent return while squeezing smaller companies out of the market.
  • This is exactly what is happening in Android and what has been going on for years in semiconductor memory.
  • As a smaller player, Nokia Networks clearly needs more scale and buying the wireless assets of Alcatel-Lucent will help it do that.
  • However, this is a road fraught with risk, as execution of these sorts of mergers in the past has proved very difficult and in every case it has failed to fix the problem.
  • Given Rajeev Suri’s execution of the turn-around of Nokia Networks, He has a good chance of making this work but history is dead against him.
  • The bigger problem for me is that it looks like Nokia is thinking of selling HERE in order to pay for it.
  • HERE is one of only two really credible solutions for a high quality map and following the divestment of the handset business, HERE is the only independent choice.
  • I am pretty sure that Microsoft wanted to acquire HERE as part of the handset deal but was rebuffed in its advances.
  • This is because there is an opportunity for Nokia to really grow market share as Google Maps deals expire and then sell it on for a much higher price.
  • Many of the deals with Google were struck some time ago and many customers now view Google as a competitor and I think would welcome an independent supplier of mapping data.
  • I think that much of this opportunity still lies in front of HERE and as a result selling HERE now for E2bn is doing shareholder a disservice.
  • Consequently, I think that Nokia would be better off holding onto HERE and raising the money via debt.
  • The fact that there are a number of private equity shops all considering bidding for HERE is a good sign of how much value Nokia will be leaving on the table if it sells now.
  • Shareholders will be worse off if it does.

 

 

Nokia – Best buddy

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Nokia’s new strategy is focused on the shareholder.

  • With the deal to sell the handset business to Microsoft now closed, Nokia has announced its new strategy, capital structure and leadership team.
  • Nokia will position each of its three remaining businesses for growth, return €3bn to shareholders over the next 18months and pay down €2bn of debt.
  • What will emerge will be a slow growing but steadily profitable infrastructure business with two smaller business both of which have significant upside potential.
  • First: HERE
    • HERE is one of only two really decent maps available to makers of devices and services that have a location element to them.
    • Now that devices has been sold, it is also the only truly independent offering and on that basis, there is scope for substantial market share gain as Google’s contracts come up for renewal.
    • This is going to be a slow burn but I expect that 2 or 3 three years will see this business significantly bigger than it is today.
    • Furthermore, I suspect that the strategic value of maps is only going to increase and I can see this business attracting some big suitors with deep pockets in a few years’ time.
  • Second: Technologies
    • This is primarily the patent portfolio which to date has really only licensed standard essential IPR, using its implementation IPR to defend its device business.
    • With this defensive strategy no longer relevant to the business, Nokia will now seek to licence this implementation IPR to make a return on the investments made.
    • Assuming there are no major hiccups, revenues should increase steadily over a few years significantly enhancing its value.
    • Again, IPR is a core strategic asset in the technology sector and I can see big suitors willing to pay a very high price for this asset in a few years’ time.
  • Nokia’s core business of infrastructure has no reason to need these businesses to be in house and I believe that if the suitors turn up, Nokia will sell both HERE and the patent portfolio.
  • This is unlikely to happen for a while as both of these businesses need to be developed and this will take time.
  • However, I believe that if suitors are willing to pay more for these assets than they could ever be worth to Nokia on a standalone basis, then Nokia will act in the best interest of the shareholder, sell them and return the cash to the shareholder.
  • In a sector where a number of the biggest and fastest growing technology companies suffer from poor corporate governance it is refreshing to find one with the right values at heart.
  • I don’t think the stock is going to reflect any of this value anytime soon, but for those with a 3-5 year horizon, Nokia is very worthy of a close look. 

Huawei 2013 – Harder road ahead

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Huawei will miss its 10% revenue growth target this year

  • Huawei has released its preliminary statements regarding its performance in 2013.
  • Like Ericsson, 2013 has been a great year with revenues growing 8-9% but profits growing around 40%.
  • This increase in margin that drove the profit growth is symptomatic of the recent product mix away from new network roll-outs towards capacity upgrades and software.
  • New networks are very competitive and most manufacturers will take tiny margins in order to get a foot in the door.
  • All networks need to be upgraded at some point with both new line cards and new software.
  • The innards of the boxes and the software code are proprietary to each manufacturer in question.
  • Hence, no one else can upgrade the line cards or the software other the vendor itself.
  • This makes the business of upgrading the system extremely profitable with gross margins of 80%+.
  • Therefore, when telecom capex shifts from roll-outs to upgrades, vendor margins increase substantially.
  • This is what lies behind the profit growth which is unlikely to be repeated in 2014.
  • This is where I have a problem with Huawei’s forecast of 10% revenue growth over the next 5 years or so.
  • The infrastructure market is likely to grow very modestly and I am somewhat concerned that capex spending could be even weaker than that.
  • Huawei’s growth will have to be found elsewhere.
  • Handsets do not really offer this opportunity as the smartphone market is slowing and the Android segment which Huawei occupies is already horribly overcrowded and brutally competitive.
  • Enterprise and network infrastructure is also not that promising as Cisco’s performance is a canary for this sector.
  • This is because Cisco has a very high percentage of its business in turns (short term orders) and therefore it feels spending cuts long before others with longer term contracts.
  • Consequently, I think that the outlook for infrastructure and network equipment is weak for 2014 and that Huawei will miss its 10% revenue growth forecast by a greater margin than it did in 2013.
  • I would look to PCs and the forgotten stories in the mobile ecosystem for the excitement this year.
  • Hence I like Microsoft, Yahoo! and Intel for this year.

 

LTE – Rough patches

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LTE has great promise but it is still very immature.

  • Everyone seems very excited by the prospect of LTE and how much it will add to the mobile experience.
  • However, just like last time, everyone has forgotten that it is a new technology and as such it is going to have teething problems.
  • The first and most pressing of which is handover.
  • LTE brings the number of totally different radio technologies co-existing to three. (OFDM (LTE), CDMA (3G) and TDMA (GSM))
  • To be effective, the basestation and the handset need to be able to flip between each of these three during both voice and data sessions without dropping the connection.
  • Furthermore they must be able to do with an array of equipment from different vendors.
  • To date seamless handovers between LTE and 3G have been reported but only between handsets and infrastructure made by the same vendor.
  • Telefonica has now claimed to be able to affect the handover with equipment from different vendors but only in its labs.
  • This was exactly the same with the 2G to 3G transition and because of this (among other things) it took much longer than expected for 3G to really take-off.
  • This time around, the experience from 3G should help 4G to mature more quickly, but there still going to be a lengthy period where 4G devices constantly drop calls as they switch from one radio to another.
  • They will also tend to gobble battery power significantly faster than 3G, much to the annoyance of users.
  • This will be construed as bad service and immature technology which, combined with the high prices being charged for the services, is likely to keep users at bay.
  • I am a big fan of LTE as it offers superb spectral efficiency and flexibility to efficiently offer all manner of services but it is going to take time before it is good and cheap enough for all and sundry.
  • As a result, I think that those expecting LTE to drive the next big explosion in mobile will be disappointed for a little while yet.