Google – Cookie crumbles

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I see no solution to Google’s problems in Android O.

  • Google has released a developer preview of the upcoming Android Oreo (Android 8.0) software, but I can’t see anything here that will help solve either the endemic fragmentation or Google’s chronic inability to update its own ecosystem devices (non-Pixel).
  • The preview of Android O headlines with a series of tweaks that provide incremental improvements to the user experience as well as API upgrades to enable developers to write better apps.
  • A few of these upgrades include:
    • Notifications: tweaks to make notifications easier and more consistent to manage.
    • Autofill framework: includes browser like autofill for commonly used data such as name and email.
    • Picture in Picture mode which is already available on Android TV will now be available to phones as well.
    • Adaptive Icons which can change their appearance depending upon which device they are being displayed.
  • These are all well and good and represent steady improvements in the user experience, but they do nothing to solve the two big issues that continue to hamper the Android user experience thereby keeping usage lower and users less loyal when compared to iOS.
  • These are:
    • First endemic fragmentation: There are thousands of different implementations of Android which behave differently and result in variations in the user experience.
    • RFM research indicates that this variation creates user frustration, lower usage and lower loyalty.
    • Second software distribution: Google has no control over the updates that are applied to the devices that run its ecosystem on Android.
    • This means that it takes up to four years for new software to fully penetrate its user base.
    • This gives rivals plenty of time to copy Google’s innovations and put them into their devices long before Google’s own innovations reach the hands of users.
  • I have long believed that both of these problems are largely responsible (more than demographics) for the much lower usage experienced by Android devices in general.
  • Google’s Android revenues are dependent on usage and I think that these issues are substantially limiting Google’s monetisation potential on Android.
  • This is why I have long held the opinion that Google must take Android fully proprietary to fix these problems and begin to realise its full potential when it comes to monetisation (see here)
  • I am still hopeful that we will see announcements that quietly take Android in this direction at Google i/o this year but the indication from this preview is that i/o 2017 could be yet another year of ignoring the elephant in the room.
  • I remain pretty cautious on Google, preferring instead Microsoft, Baidu and Tencent.

Spotify – Patience pays.

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I think shareholders will see more value by being patient.

  • Spotify is closing in on finally doing a deal with the record labels that I think will remove the last obstacle to the company going public.
  • Spotify and three of the largest record labels have been dancing around each other for a significant period of time without coming to any definitive agreement.
  • This is crucial because without the content from these three labels. Spotify would be unable to provide its current service.
  • I have long argued that as Spotify’s user base grows, so does its negotiating power and that the longer it took to arrive at an agreement, the better it is for Spotify (see here)
  • However, the time for Spotify to go public is approaching fast and I suspect that without a deal with Universal, Sony and Warner, any valuation that Spotify would achieve at IPO would be materially impacted.
  • Furthermore, with this hanging over its head, the stock would be very volatile in the public market as, in theory, the labels could wipe Spotify out at any time by pulling their music from its service.
  • In practice, this is never going to happen because with every month that passes, the labels need Spotify more than it needs the labels and I am pretty sure that if they were going to pull their music from Spotify, they would have done so ages ago.
  • This is because streaming is now the only source of growth in the music industry without which the labels would lose what has become their most important route to market.
  • Spotify is unique in that it is the only major platform to have a free-tier and adding in those users takes Spotify’s total user count well north of 100m.
  • This is hugely significant, as although these users do not pay Spotify directly, they generate vast amounts of data which can be used to improve and train its algorithms.
  • This is critical because it is those algorithms that allow Spotify to both understand the music it has on its platform as well as accurately match it to the users that it has.
  • In the long-term, I think that this gives Spotify the opportunity to cut the labels out completely which would have the effect of substantially enriching both artists as well as shareholders of Spotify.
  • I think that this is why Spotify is not keen to do a deal with the labels that limits the provision of music to free users as data collection and algorithm training would most likely be impacted.
  • The other side of the coin is that I suspect that Spotify has guided its investors to a time when it can IPO, giving existing shareholders visibility as to when they will see a return on their investments.
  • I believe that doing an IPO without a signed deal with all three of the biggest labels has difficulty written all over it which is why Spotify is considering caving in to some of the labels’ demands.
  • Although this will bring some short-term benefits to Spotify and its shareholders, I think that a deal in the short-term could delay Spotify’s ability to supplant the labels which I have long believed is where the real upside lies.
  • This is because I see that this is how Spotify goes from earning $0.30 on the subscription dollar to $0.50 or more.
  • Hence, I think that the best outcome for shareholders will be achieved by being patient and letting the IPO exit window slip for as long as required for Spotify to become powerful enough to dictate terms to the labels.
  • I continue to see only a minor threat from Apple Music as Spotify is still adding paid subscribers much more quickly and shows every sign of having better artificial intelligence with which to differentiate its service.
  • Whether Spotify can convince its shareholder of the merits of delaying their exit remains to be seen.

Yahoo – Earned asset

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This time Marissa has really earned her payoff.

  • Following the sale of the Yahoo core business to Verizon, Marissa Mayer will step down as CEO of Yahoo and will receive a severance package worth $23m.
  • This has once again raised the issue of excessive payoffs to failed senior executives, but I think that for the first time since she became CEO, she has earned every penny of her severance.
  • Yahoo has completely failed to build a digital ecosystem but it has successfully sold an asset that can easily be argued to be worth nothing for $4.48bn.
  • While the core business is cash generative, it is in decline and has also suffered two of the worst security breaches in Internet history.
  • I think that these breaches could easily trigger a mass exodus of users.
  • Over the last 12 months, Yahoo has admitted that around 1.5bn user accounts have been compromised in two very large break ins.
  • This is more accounts than Yahoo actually has, implying that every account that Yahoo has been compromised with a good number of its users having suffered the indignity twice.
  • If this was not enough, Yahoo’s Q4 16 results showed improving margins solely due to cost cuts which deflected attention away from the fact that revenues are still falling, albeit more slowly than before.
  • For the last 10 years, Yahoo has neglected its Internet assets but it has still managed to enjoy high usage and engagement in the fixed Internet despite its failure in mobile.
  • It is this engagement that Verizon is paying $4.48bn for.
  • However, recent events have given users the perfect excuse to finally close their Yahoo email account and move to something else.
  • Following the disclosures of these hacks, Verizon attempted to have the price cut by $925m but Yahoo managed to beat it down to a much smaller $350m discount.
  • Furthermore, Yahoo will only shoulder half of the liability for any class action lawsuits that result.
  • If I was Verizon, I would have been looking for Yahoo to shoulder all of the liability as it was due to Yahoo’s inattention and neglect that allowed the breaches to occur in the first place.
  • Despite is very poor business performance, Yahoo’s management has done a superb job in capitalising on Verizon’s apparent desperation to build a digital ecosystem and on its belief that it needs Yahoo’s assets to do that.
  • I have long thought that there was a very real chance that Verizon would walk away from this transaction leaving Yahoo with a fast depreciating asset and a potentially large liability.
  • Consequently, I think that Marissa Mayer has probably enriched shareholders by more than $1.5bn making her $23m payoff look very reasonable indeed.
  • With Yahoo’s shares now at $46, there is still some upside left but much less than the last that I valued the shares at $50.4 (see here).

Enterprise AI – IBM and Salesforce

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Microsoft to Facebook could be what IBM is to Salesforce.

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

Digital assistants – Man and dog

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Late-comers have very little chance

  • The latest craze to hit the mobile industry is digital assistants where every man and his dog is now building one to try and drive engagement through the ecosystem.
  • LINE is the latest entrant with its offering called Clova but just like everyone else, LINE is going to find that digital assistants are fiendishly difficult because they require top notch artificial intelligence to power them.
  • To make life even more difficult, digital assistants suffer from a chicken and egg problem (see here) where they need usage to improve because its with usage data that they can improve.
  • The problem is that no one will use them if they are not already very good meaning they will be unable to gather the data they need to get to level of quality where users will engage with them.
  • LINE is an instant messaging company that has done an excellent job of monetising messaging through the sale of stickers and games but needs to find other avenues to keep its growth growing.
  • The problem is that when I look at LINE, I see no AI competence to speak nor do I see any history of it working on AI.
  • The search engines are the leaders in AI, but they are not the leaders because they are the cleverest.
  • They are the leaders because they have doing it the longest.
  • This is why RFM thinks that Google Assistant and Baidu Duer are miles ahead of everything else that is being offered including Alexa, Siri and Cortana.
  • Now that Google Assistant is being rolled out onto every Android phone that has Marshmallow, Nougat and above, I think many of the others have very little chance at all.
  • Siri will continue to live on iOS devices but the real battle will be between Google and Amazon for the home speaker.
  • Here Google has a vastly superior product but Alexa is much better at controlling the smart home, albeit with an awful user experience.
  • This is because Amazon has done a great job at getting smart home developers on board whereas Google has been very late in even making the API available.
  • RFM estimates that Amazon has around 8m Alexa enabled devices in the hands of users whereas Google has just over 0.5m.
  • Consequently, Google is at risk of losing (see here) to Amazon but I think the shock of seeing itself wiped out at CES has shaken it from its stupor.
  • Consequently, I think that LINE, Huawei, Samsung Viv, JD.com Ding Dong, SK Tel Ding Dong, Sony and so on have very little chance and would be best served by doing a deal with one of strong ones rather than wasting shareholder’s money.

India e-commerce – Unicorns and Donkeys Pt. V.

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Flipkart likely to buy Snapdeal. 

  • The latest in a series of woes that has hit the Indian e-commerce market reinforces my view that in network based businesses, there really is only space for one player to do well.
  • This time around it is Snapdeal which is cutting costs by laying of 800 people, cutting the salaries of its founders to zero and exploring the sale of its mobile wallet FreeCharge at a big discount to what it paid for it in 2015 ($400m).
  • The founders of Snapdeal admit to spreading themselves too thin and not executing optimally, but I think that the real issue here is much more fundamental.
  • Snapdeal and Flipkart like Alibaba and to a lesser degree Amazon are market places which bring together merchants and buyers in one easy to use location and from which they can take a small cut.
  • In effect, they are network businesses just like Uber, Alibaba, AirBnB, Craigslist and so on and consequently, they are bound by the same rules.
  • 18 months ago I proposed a rule of thumb that states: A company that relies on the network must have at least 60% market share or be at least double the size of its nearest rivals to begin really making profit (see here).
  • This, in a nutshell, is the problem faced by both Flipkart and Snapdeal in India.
  • Flipkart is bigger than Snapdeal and so it is in a slightly better position but it is not double the size of its nearest rival.
  • Furthermore, both have to contend with Amazon which is determined not to make the same mess of India that it made in China when it went up against Alibaba and lost.
  • Amazon is not the largest in India, but it has the backing of the mothership meaning that it can lose money for far longer than either of the other two.
  • Flipkart has the best chance of reaching this hallowed status as it is the largest in India with around 35% of monthly active users but it will need to reach at least 50% before it is double the size of Amazon (7Park Data).
  • This is why I think it could end up acquiring Snapdeal, because adding Snapdeal’s users to its own would get it pretty close to achieving that milestone.
  • Without this combination, we are likely to be left with 2 unprofitable donkeys that are slowly ground out of existence by the vastly more powerful foreign player.
  • This uncertainty keeps me from recommending investments in either of the Indian e-commerce companies even at the discounts now being offered but if I had to go for one, it would be Flipkart.

Yahoo & Verizon – Final execution.

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Finally, Yahoo executes.

  • Yahoo may have badly failed to create any value for investors in mobile, but its execution on the sale of its core business is finally generating significant value for its long-suffering shareholders.
  • Verizon will now pay $4.48bn to acquire the core business of Yahoo a reduction of 7% of $350m and the two companies will share any legal and regulatory liabilities that arise from the two massive data breaches that Yahoo has suffered.
  • I think that this is a triumph for Yahoo which is capitalising on Verizon’s apparent desperation to build a digital ecosystem.
  • For the last 10 years Yahoo has neglected its Internet assets but it has still managed to enjoy high usage and engagement in the fixed Internet despite its failure in mobile.
  • It is this engagement that Verizon is paying $4.48bn for.
  • However, recent events have given users the perfect excuse to finally close their Yahoo email account and move to something else.
  • I have long believed that Yahoo Mail is the service that generates most of the usage and should users leave Yahoo, then the value that Verizon is attributing to Yahoo will have to be written off.
  • Top of the list of Yahoo’s many misfortunes are two massive hacks, one of which took Yahoo 4 years to detect.
  • Over the last 12 months, Yahoo has admitted that around 1.5bn user accounts have been compromised in two very large break ins.
  • This is more accounts than Yahoo actually has, implying that every account that Yahoo has been compromised with a good number of its users having suffered the indignity twice.
  • If this was not enough, Yahoo’s Q4 results showed improving margins solely due to cost cuts which deflected attention away from the fact that revenues are still falling, albeit more slowly than before.
  • On top of Yahoo, Verizon already owns AOL and is trying to rebuild its Go90 mobile video service using the team and assets acquired from Vessel in 2016.
  • The problem I have with Verizon’s strategy is that it is late to game meaning that it has ending up acquiring all of the assets that no one else wanted.
  • Furthermore, Yahoo and AOL have both badly failed to generate any traction on mobile but somehow Verizon seems to think that putting all of these together will create a thriving ecosystem.
  • This is of course possible, but if Yahoo was unable to hold onto the talent capable of executing this dream, I think that Verizon has very little chance.
  • Consequently, instead of a thriving ecosystem, I see a bunch of disparate assets from which users are likely to drift away from at the first opportunity.
  • The real winner here is Yahoo which is receiving far more value for this asset than I think that it is worth and has also managed to halve its exposure to liabilities that I think it should be fully on the hook for.
  • Combine this value with the continued strong performance of Alibaba and Yahoo Japan, and it is not difficult to still see upside in the Yahoo share price.
  • Marissa Mayer may have been terrible at executing on a digital ecosystem but she seems to be a great salesperson.

Alibaba – Five guns east

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Alibaba is going guns blazing for offline. 

  • Alibaba appears to be moving into offline retail much more quickly than I had anticipated as it is complimenting its $2.6bn bid for Intime Retail Group with a partnership with Shanghai Bailian Group which owns 4,700 stores in 200 cities in China.
  • This is a huge step forward from its bid to acquire Intime retail group which operates 29 department stores and 17 malls predominantly in the eastern province of Zhejiang where Alibaba’s home town of Hangzhou is to be found.
  • The idea of this partnership is to bring Alibaba much further into the physical world where $4.5tn of sales are still transacted every year as well as improve the offline experience that users have in Bailian stores.
  • Chinese retail is a fragmented and frustrating experience where decent service and information with regards to inventory, product lines and so on is routinely not available.
  • Consequently, when an online offering appears where this information is clear and one is able to easily purchase goods and know when they will be delivered, shoppers quickly adapt.
  • It is the terrible offline experience with regards to almost everything that has allowed so many other goods, services and activities in China to rapidly migrate from offline to mobile.
  • It these problems that Bailian hopes to fix via its partnership with Alibaba which will provide its technology, its understanding of logistics and its processing systems to modernise Bailian.
  • In return Alibaba will get a large physical presence, access to shopper data and the first big launch for Alipay into the physical world.
  • There are two large mobile payment systems in China.
  • One is Alipay which utterly dominates B2C e-commerce and the other is WeChat Pay which dominates peer to peer as well as payments to shops, restaurants and service providers.
  • This move will bring Alipay into direct competition with WeChat Pay for the first time.
  • I think this partnership will be similar to the potential deal with Intime but on a much larger scale.
  • I have previously viewed (see here) the potential deal with Intime as an experiment in retail which would then be rolled out more widely once it had been proven to work but it looks like Alibaba is going national regardless.
  • Fortunately, as this is a partnership, there will not be much downside risk if it goes wrong which leads me to believe that for Alibaba, this is really about data and pushing Alipay into a new domain.
  • If Alibaba can have a deeper understanding of, and relationship with Chinese shoppers then it will be able to more accurately predict their shopping patterns resulting in better purchasing rates and the ability to charge a higher percentage of GMV to its merchants.
  • This will translate into better revenue and profit growth as was the case in 2016 where increasing monetisation underpinned a large part of the company’s outperformance.
  • I think this expansion will be much slower in 2017, and so I remain cautious on Alibaba preferring Tencent or Baidu in China.

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.

Facebook – Brainless video.

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Focusing on video first makes complete sense.

  • I think that Facebook is making the right choice in targeting video first as it already has traction and video-based services tend to have the lowest requirements for artificial intelligence to make them easy, fun and useful.
  • With the launch of a TV app being just the latest move Facebook has made in video, it is increasingly clear that Media Consumption is Facebook’s number 1 priority for 2017.
  • The TV app that is being launched is very simple in that it makes it easy for a user that does not have time to watch videos on Facebook during the day to easily to so at night on a larger screen.
  • This should enable a better video experience and begin to spread engagement across other devices but it will come with the added complication of multiple resolutions and bit rates.
  • On a mobile device the screen is small which means that lower resolution videos and bit rates are acceptable, but once these are played on a larger screen, their shortcomings quickly become obvious.
  • This move into TV comes hot on the heels of the addition of a tab at the bottom of the Facebook app which links to the top trending videos as well as videos that Facebook thinks that the user might like.
  • The TV app will initially be available on Amazon TV and Apple TV but I expect that it will quickly spread to Xbox, PlayStation and the other streaming TV devices that are available.
  • The one place I don’t expect to find it is Chromecast as Facebook’s video aspirations are clearly a challenge to YouTube.
  • Of the three new areas of Digital Life (Gaming, Media Consumption and Search) that I see Facebook targeting (see here), going for video first makes complete sense.
  • This is because Facebook already has a lot of traction in this space and also because it is the least demanding in terms of requiring intelligent automation.
  • The total number of video items that are present is very low compared to other things like music or searches and knowing who posted the video is a good indicator of its content and who will like it.
  • I continue to see Facebook as the laggard in AI (see here) and targeting video is sensible as it gives it more time to improve its AI before having to apply it to more difficult tasks.
  • Furthermore, the fact that video is a fast growing, but likely soon to mature, medium for digital advertising also means that the time to really address it is now.
  • I see the app on the TV as just the beginning and would not be surprised to see this being followed up with premium content taking it into the realm of Netflix, Hulu, YouTube and Amazon Prime.
  • That being said, I don’t think that Facebook’s offering in Media Consumption is anything like mature and so I think it will be some time yet before it becomes a real destination like YouTube.
  • Consequently, I still see a slow period of revenue expansion while its new strategies mature before revenues take off again.
  • As this reality sinks in, I think the valuation could unwind somewhat providing a better opportunity than now to invest for the long-term.