Android – Fragmentation fix.

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Google and China likely to completely take over their versions.

  • The latest report from OpenSignal strongly implies that Android fragmentation is getting worse but I suspect that the reverse is true.
  • The latest study shows that within a sample of 682,000 devices upon which the OpenSignal App. has been installed, there are 18,796 different Android devices.
  • This is a significant increase on last year where 11,868 different devices were found within the same sample size.
  • This does not mean that there were 18,796 different versions of the software but there are that many different handsets in the market.
  • This is both a blessing and a curse.
  • Greater diversity has made it possible for the cost of Android devices to be substantially lower than that of iOS and Windows Phone.
  • This has been a major factor behind Android’s rise to around 80% of smartphones shipped in Q2A.
  • The ability to buy a smartphone for less than $100 has enabled Android to penetrate huge markets such as China, India and Africa where cost is the single biggest concern of the consumer.
  • At the same time, it has meant that handset makers have had to make huge compromises when designing and building the devices.
  • This includes the removal of many hardware components as well as using older versions of the code which are much cheaper to implement.
  • This has also meant that, in many cases, very little is spent on optimising the standard Android code to run on stripped down hardware.
  • This has meant that third party applications either don’t run or behave erratically on different handsets from the same manufacturer.
  • No one is immune from this problem as RFM’s research has found multiple instances from app developers where their app behaves differently on different models made by Samsung.
  • This is why everyone develops for iOS first.
  • By developing for iOS a developer knows that he is targeting a much more consistent group of devices as well as targeting a higher demographic in the market.
  • This problem is endemic to Android and there is very little that is likely to improve unless something changes.
  • However, I see that change is coming.
  • RFM research reveals that both Google and the Chinese ecosystem players are working on addressing this issue.
  • The only way that this issue can be addressed is for those that are writing the code to take more and more control of it.
  • This is exactly what I see Google doing with GMS.
  • GMS is Google’s proprietary, non-open code that sits on top of the open Android software which contains all of the Google services that users are keen to have.
  • I see Google slowly expanding the scope of GMS to include more and more of the device’s functionality until the open piece is nothing more than a kernel.
  • This will mean that Google will have effectively created its own proprietary OS and in doing so it will be able to control the fragmentation that keeps it behind iOS in terms of quality of experience and security.
  • I see the Chinese players doing exactly the same despite the failure of Aliyun which it appears that Google was successful in blocking a couple of years ago.
  • In the long term, this is likely to result in Android becoming nothing more than a kernel upon which ecosystem players run their proprietary systems and experiences.
  • The end result will be less fragmentation within devices within a single ecosystem but much greater fragmentation between the different ecosystems.
  • Currently, there is nothing visible that will prevent Google from succeeding in this strategy and the end result is likely to be more and more user data being captured by Google on its servers.
  • This will be instrumental in maintaining its market share in mobile advertising and it will also help increase the relevance of the adverts that it sells.
  • This combined with strong user demand for its services is why I do not see any other ecosystem challenging its dominance anytime soon.
  • This is likely to mean growth in revenues above 10% for the next few years making the stock still look interesting despite its strong run over the last few years.
  • Google along with Yahoo! and Microsoft are still the most interesting places to look when considering an investment in the mobile ecosystem.

HPQ Q3A – Gentle drift

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HPQ is drifting from one quarter to the next with no direction. 

  • HPQ reported good Q3A revenues as market share was gained but weaknesses in the high margin businesses kept any gains from hitting the bottom line.
  • Revenues / EPS were $27.6bn / $0.89 compared to consensus at $27.0bn / $0.89.
  • The stabilisation in the PC market that helped both Intel and Lenovo was also felt by HPQ but HPQ also managed to gain share in PCs to 18.3% just behind Lenovo on 19.4%.
  • Unfortunately Enterprise Services, Software and HP Financial Services all saw declines in revenue
  • These are the areas where HPQ needs to grow most as it is here where there is value to be added and good margins to be earned.
  • The result of these declines was lower margins which wiped out both benefits from the revenue beat in PCs and benefits delivered from the cost reduction program.
  • Guidance for Q4E was in line with expectations with EPS of $1.03 – $1.07 compared to consensus at $1.05.
  • These results are indicative of the malaise that currently besets HPQ.
  • The company is cruising from one quarter to the next with no real strategic direction which is showing through in the financial results.
  • The improvements delivered through streamlining and cost cutting are being eaten up by weaknesses in business that should be growing and badly need to be set to rights.
  • HPQ needs to decide where it wants to go as a company and make its assets all pull together in the same direction.
  • This is the only way that the company can return to growth because as things stand at the moment, the next time the PC market dips, HPQ’s earnings will go with it.
  • Lenovo, Asustek, Microsoft and Intel remain far better ways to gain exposure to theme of a recovery in the PC market.

Facebook & friends – Internal affairs

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Facebook’s messaging mess highlights a problem for everyone.

  • The number of attempts Facebook is making to crack the millennial messaging market is growing fast and with it the bill for shareholders.
  • Facebook’s travails also highlight a very significant problem faced by all of the ecosystem contenders when it comes to developing their Digital Life offerings.
  • Many contenders are using M&A to grow their way around the Digital Life pie but unfortunately the reality is much more complicated.
  • Facebook seems to be desperately trying to win back the younger part of its user base by trying to address the success of Snapchat.
  • Following its failure to create a clone, it then tried to buy the original and when that failed, it returned to trying to copy it.
  • Its first attempt called Poke failed after a couple of months, Slingshot has suffered a similar fate and now Facebook is trying again with Bolt.
  • Bolt is a standalone app. that is derived from Instagram that effectively replicates the functionality of Snapchat.
  • So far the signs are quite good but it has only been launched in New Zealand, Singapore and South Africa.
  • These efforts also go hand in hand with the Facebook chat app. and the WhatsApp acquisition to make a very confusing messaging strategy.
  • It looks like Facebook is trying to hang onto the younger generation of users many of whom have been put off the main service by the arrival of their parents onto the system.
  • Facebook now has at least three separate messaging strategies for a single service that are all separate and distinct from one another.
  • The value to Facebook of messaging would be many times greater if all of these services were able to interact with each other.
  • Unfortunately, the agreements made at acquisition seem to ensure that the acquired entities remain separate and continue to operate independently.
  • If this remains the case then Facebook will never be able to take WhatsApp into gaming or integrate it with its other services.
  • In my mind this is the only way in which Facebook can have a hope of earning any return on the $19.6bn of shareholder’s money that it invested in acquiring this company.
  • This is the most striking example of a major problem that besets all of the digital ecosystem contenders.
  • To generate value to its full potential, a Digital Life offering needs to have all the services integrated and aware of one another.
  • This way the services work better and the owner of the services can gain a much deeper profile of the user.
  • This is critical to selling value added advertising as well as providing a deeper and richer service to the user.
  • So far only Google has come close to this ideal and this is a major reason why I believe it is by far the most successful at monetising the mobile internet opportunity.
  • Yahoo!, Microsoft, Apple, Amazon, Twitter, Facebook, Sony, Tencent, Baidu, Alibaba and so on must all get on top this issue if they are to really succeed.
  • Almost all the deals struck to date state that the acquired service or app. will continue to operate independently of the acquiring company.
  • I believe independence is the only way in which acquiring companies can entice hot new services and apps to allow themselves to be purchased.
  • Many acquirers believe that once the acquisition is closed, the problems are over but I suspect that the reverse is true.
  • The acquirer has a fiduciary duty to its owners to earn a decent return on the money it invests and without integration, this is very unlikely to happen.
  • Only a very few of the ecosystem players understand this problem and Facebook is not among them.
  • Consequently I see Facebook’s attempts at expanding outside of social networking remaining stillborn and continue to believe that it will run out of growth as soon as the social networking piece is properly monetised on mobile devices.




Lenovo Q1A – Breathing space

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Improvements give Lenovo more space to invest and execute.

  • Lenovo reported good Q1 results as its handset business and PC business both grew share.
  • This gives the company more breathing room when it comes to turning around the loss making Motorola Mobility that it is about to acquire from Google.
  • Q1 revenues and net income were $10.4bn / $213m compared to consensus forecasts of $9.9bn / $201m.
  • Lenovo saw a 15% increase in PC shipments despite a stagnant market and also registered a 16% increase QoQ in smartphone shipments against a market that grew by just 4.6% QoQ.
  • Market share in PCs has hit an all-time high of 19.4%, nearly 1% clear of HP while smartphone share has reached 5.1%.
  • Including Motorola, smartphone share is now at 7.6% making it comfortably number 3, although it now has Xiaomi snapping at its heels.
  • EBIT margin has inched up to 2.7% from 2.5% in Q4 but the revenue increase has driven Q1A operating profit to $283m.
  • This combined with the fact that EBIT Losses at Motorola almost halved in Q2 to $99m (Google Q1 10Q) gives Lenovo much more room to effect its strategy.
  • Additionally, the IBM server business is more profitable than the Lenovo group which should also help keep the company in the black when the two transactions have closed.
  • Lenovo has $5.5bn in the bank much of which will be spent on the transactions to come.
  • However, this combined with the improving fundamentals gives Lenovo enough space to give its strategy to become a major player a proper chance.
  • That being said, this will not be easy. I have long believed that at least 10% market share is needed before any scale related benefits start to kick in leaving Lenovo 2.4% adrift.
  • This means that heavy investments are going to have to be made which could easily push Lenovo into loss making territory.
  • Furthermore, sooner or later Lenovo is going to have to contend with the fact that all the value in its industry is migrating to the ecosystem for which it has no answer.
  • It claims to have a stake in the digital ecosystem with its SHAREit application but this is merely a tool for transferring content between different Lenovo devices and is not a Digital Life service in its own right.
  • Hence Lenovo continues to get a 0% score on the RFM Digital Life Pie analysis but I can see it starting to think about being a contender.
  • Historically, I have been concerned regarding Lenovo’s strategic depth but I have to admit that in the last three months it has surprised me.
  • Lenovo remains one to watch but I still think that the new strategy will make a dent in earnings and the valuation before it can hope to come good.

Zynga Q2A – Chalk and cheese

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Bad results show the difference between consoles and handhelds.

  •  Zynga reported weak Q2A results and cut its 2014E guidance as new revisions of its flagship games will take longer than expected to reach the market.
  • The key metric for Zynga is bookings which is the value of virtual goods sold during the quarter.
  • Q2A bookings and EPS were $175m and $0.00 compared to consensus at $191m and $0.00 respectively.
  • Only aggressive cost management enabled Zynga from slipping into negative territory.
  • On this front, it looks very much as if Zynga is cutting in the muscle of its creative machine as crucial new products such as Poker and Words with Friends will now be delayed.
  • The result is that the outlook for the rest 2014E has been cut hard.
  • Q3 bookings are expected to be $165m-$175m with EPS at LOSS$0.01 – $0.00.
  • This is way below consensus at $212m in bookings and EPS of $0.01.
  • Booking for the full year 2014E will now be $695m-$725m which is a meaningful reduction on the $770m-$810m that was forecast in April.
  • The one bright spot was cash. This remained almost unchanged at $1.15bn compared to $1.14bn in April.
  • This gives the company time to turn itself around despite the fact that aggressive cost cutting has meant that everything will now take longer than originally planned.
  • Zynga’s business is now focused on bringing its existing and new titles to mobile in a new and exciting way.
  • Unfortunately, the edge that it once had in social gaming has long since been competed away.
  • Gaming is a brutally competitive space and Zynga seems to lack the innovation that will allow it to regain some of the lustre that it has lost.
  • Mattrick has been in charge for a year and I suspect that he is finding it much more difficult than he expected.
  • There is a big difference between console gaming and casual based gaming in that user loyalty and stickiness is much lower.
  • This means one has to wow users with something that is really out of the ordinary to keep them coming back for more.
  • Against the juggernauts of Clash of Clans (Supercell) and Candy Crush (King), Zynga still has no real answer and its pipeline is not exactly encouraging.
  • Dominance in this industry can change very quickly which gives Zynga the opportunity.
  • However, it will have to come up with something pretty special to breathe new life into the financials.
  • Of this there is currently no sign.


Samsung vs. Apple – Hint of sanity

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The glacial creep towards a settlement continues.

  • Samsung and Apple have agreed to drop all litigation against each other that is taking place outside the US.
  • No licencing terms have been signed and both companies will now focus their efforts on pursuing their fight in the US.
  • This is similar to the agreement between Apple and Google in May 2014 where both companies dropped their suits and walked away. (see here).
  • It is known as a second class settlement and does not prevent hostilities from being re-opened should either wish to do so.
  • However, I think that this is very unlikely and believe that both companies are beginning to realise the futility and crippling expense of this long running and increasingly pointless war.
  • Events have shown that Samsung does infringe some of Apple’s IP but they have also shown that it is very difficult to force Samsung to pay for it.
  • Furthermore, the value of Apple’s portfolio took a massive blow when it was awarded just 5.4% of what it asked for at trial (see here).
  • Combine this with the legislative agenda moving against the use of standard essential patents in US and EU, and it is clear that the whole landscape is becoming very difficult for both sides.
  • For both of these companies, the US is their biggest market in terms of revenues and I suspect that they will use the outcome from this market for a global agreement.
  • This gives me hope that there is some pragmatism and rationality growing in both camps as this war has already cost both sides more than either is ever likely to earn or pay in royalties.
  • Apple’s approach has historically been more emotional in that it did not want others to use its innovations and sought to keep them from the market.
  • While well within its rights, it has proven to be impractical and I am hopeful that Apple is beginning to realise that it will have to do a deal of some description with Samsung.
  • This deal is likely to involve a net payment by Samsung to Apple but the ending of crippling legal fees is likely to mean a profits increase at Samsung.
  • I remain optimistic that a deal will be reached this year.
  • This issue is increasingly irrelevant for Samsung which is struggling with the profitability and growth of its smartphone business.
  • Now that it ceded control of the ecosystem to Google there is nothing to prevent margins falling to 11% over the next 3 to 4 years. (see here)
  • The result is a 25% decline in group EBIT and a share price very likely to underperform.

Google vs. Apple – Traffic story

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Traffic reveals the critical weakness in Google’s ecosystem.

  • The latest data from Chitika shows that Google is still struggling to improve the quality of its ecosystem.
  • Size is a great measure of the importance of an ecosystem but its real value is determined by usage.
  • High usage is the best indicator of user loyalty and this is what will drive user preference.
  • In the digital ecosystem industry, this will be one of the only drivers of pricing power and consequently of profitability.
  • I believe that the fact that the iOS user experience is still substantially superior to that of Google, is the single biggest reason why Apple’s hardware margins remain very high.
  • The latest data from Chitika combined with Radio Free Mobile’s ecosystem analysis gives an indication of how large the gap still is.
  • In UK and North America RFM estimates that 30% of smartphone users are on iOS while Android has around 65%.
  • Chitika usage figures show that iOS makes up 50% of mobile web traffic with Android at around 46%.
  • Looking at the average usage per device shows the average iOS user is generating 137% more traffic than an Android user.
  • In these markets, almost all android devices are running the Google ecosystem.
  • Demographics play a large part of this discrepancy as Apple has a disproportionately large share of high end users and these users will use any device more.
  • However, the difference is so great that it is clear that the quality of the ecosystem is also a major factor.
  • Critically the last six months have seen no meaningful change in this state of affairs.
  • This is an issue that Google must address if it wants to develop the kind of loyalty that is critical to its long term success.
  • This is why I believe Google is moving to take complete control of the software on its devices.
  • The randomness and chaos of open source is a hindrance to the security and quality of its user experience.
  • By taking control it will be able to ensure that its experience will be as good and as secure as iOS or Windows Phone.
  • This remains the single biggest weakness of the Google ecosystem and one that Microsoft has the potential to exploit.
  • The window remains wide open but as Google takes more and more control of its ecosystem its disadvantages will gradually decrease.
  • Those attempting to challenge Google must do so now before it is too late.



Amazon Q2A – Disciplinary matters

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Amazon’s prioritisation of customers over investors shows no sign of abating.

  • Amazon reported in-line Q2A results but guided very badly for Q3E as it continues to invest heavily in the growth at the expense of profitability.
  • Q214A revenues / EPS were $19.3bn / LOSS $0.27 compared to forecasts of $19.4bn and LOSS $0.13 respectively.
  • The EPS surprise was not derived from operating as adjusted EBIT was $376m which was in line with expectations of $380m.
  • The real problem was to found in the guidance where Amazon continues to spend as much as it possibly can on expanding its operations and driving user loyalty.
  • Q314E guidance is for revenues of $19.7bn-$21.5bn ($20.6bn) and adjusted EBIT of $0m – LOSS $400m. (LOSS $200m midpoint).
  • Consensus was looking for revenues of $20.8bn in revenues and $309 in adjusted EBIT some $509m worse than expected.
  • With a sky high valuation, there is no room whatsoever for error and the market sent the shares down 10% in after-hours trading.
  • Amazon has a unique retail proposition and cloud proposition but its inability to turn a profit is starting to be a major issue.
  • Furthermore, its digital strategy looks to me to be a series of very expensive experiments which have not been properly thought through (see here and here).
  • A cursory glance through the financial statements also reveals that Amazon has spent a massive $1.4bn on corporate office space in the last quarter alone.
  • Buying spanking new offices is one of the biggest signs of inadequate fiscal discipline.
  • This, combined with the inability to turn a profit and the fuzzy thinking that surrounds digital, makes me very worried that money is being frittered away.
  • I believe strongly in investment for growth but the kind of concerns that this report highlights, keeps me well away from the shares until I can see some dimes in investors’ pockets.

Apple and Microsoft – Quiet before the storm

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Both Apple and Microsoft reported humdrum results ahead of big events.


  • Apple reported Q314A results that were broadly in line with expectations but guided weakly as the lag effect in front of such a major hardware upgrade is going to be greater than expected.
  • Revenues / EPS were $37.4bn / $1.28 compared to consensus at $36.9bn / $1.23.
  • 35.2m iPhones shipped vs. consensus at 35.5m.
  • 13.3m iPads shipped vs. consensus at 14.3m.
  • 4.4m Macs shipped vs. consensus at 3.9m.
  • Guidance was weak with revenues of $37bn-$40bn expected compared to consensus at $40.8bn.
  • The soft guidance is pointing to a later than expected launch of the iPhone 6 and a greater period in fiscal Q4 when users are holding off from upgrading their devices.
  • All eyes are now fixed on the product launched that are expected in the September / October time frame and very little else is likely to happen before that is out of the way.
  • So much has been built into the launch of the next generation iPhone that there appears to be very little left on the table for investors in the short-term.
  • This combined with my longer term concerns around its lack of Digital Life services (see here) keeps me indifferent to the shares.


  • Microsoft reported Q414A and FY14A in line results that come right before one the most important events in the coming year: MGX FY15.
  • MGX FY15 is a big internal conference and one of the best chances for Nadella to push his vision deeper into the ranks of the company.
  • Revenues / EPS were $23.4bn / $0.66 compared to consensus at $23.2bn / $1.23.
  • Guidance was conservative with Q1FY15E revenues of $21.2bn-$22.3bn expected compared to consensus at $23.1bn.
  • This did not concern the market too much as Microsoft has taken on a habit of guiding conservatively on a quarterly basis.
  • The end-of-life of XP was a driver during the quarter, as Intel results predicted, but the trend started to taper off towards the end leaving tablet PCs with the job of keeping growth going during the first half of FY15E.
  • The strategic vision of becoming a full blown ecosystem was again discussed but with a bit more flesh on the bones.
  • Leaving aside the ongoing difficulties at the Nokia devices and services business, Microsoft saw great progress in the cloud and was even brave to enough to forecast that Bing will break even in FY16E.
  • Microsoft is taking the right path when it comes to differentiating itself by offering both Digital Work and Digital Life in a single device experience but there remains a very long way to go.
  • Services like Lync and Skype or OneDrive and OneDrive for Business may now be in the same teams but the applications remain blissfully ignorant of each other.
  • These and many there services have to be integrated such that they are fully aware of each other if this strategy is to work.
  • This is a herculean task and Nadella needs to really rouse his troops to get them to understand how important it is in order to get it done.
  • This week sees the first step of many Nadella will need to take to lead his company home.

Samsung vs. Google – Sun Valley tea party

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Fight over wearables looks like a storm in a teacup.

  • Samsung and Google are at it again but this time the fight is over what software Samsung should use on its wearable devices.
  • At a recent industry event in Sun Valley, Idaho it was clear that tensions between Samsung and Google are still running high.
  • This is despite a crushing victory on the part of Google when it convinced Samsung to back off from its own ecosystem in mobile phones and tablets. (see here)
  • In wearables, Samsung is not using any of Google’s software but has decided to use Tizen (Gear 2) and a proprietary RTOS (Gear Fit).
  • In Google’s mind this is bad news because it means that its services will not be running on these devices meaning that any traffic generated will not be flowing through its servers.
  • If true, it would mean that Google would understand less about what Samsung users are doing and hence not be able to target them as effectively when it comes to selling marketing to advertisers.
  • This is where all of Google’s sensitivities are to be found. If it won’t run Google apps in a way that Google likes then Google is unhappy.
  • Google’s position is that Android and its variant Android Wear should go everywhere but I think that this unlikely to be the case.
  • The biggest problems with wearables today are:
    • They are a solution looking for a problem. They don’t make the user’s life any better and consequently I can’t see users buying these devices.
    • Wearable devices today are large, mostly ugly with horrible battery life.
    • Wearable sensors to monitor things like heart rate, blood sugar and so on are large and unreliable.
  • These short comings are likely to mean that the first generation wearable devices that users are going to accept are likely to be sensors with no screens, BLE, proprietary RTOS software and very long battery lives.
  • They won’t run third party apps and will be highly specialised for the function for which they have been designed.
  • It will be the mobile device or tablet that ends up as the collection and control point for all of this data meaning that fighting over the wearable software is pointless.
  • Google now controls the software on the vast majority of Android devices that ship outside of China.
  • This means that the data from these wearable devices can be collated and used by Google regardless of what software is running the wearable or sensor.
  • Consequently, what Google should be doing is encouraging the development of wearable devices and making it very easy to collate and analyse the data on a Google Android device.
  • That way, Google will be the glue for many types of devices all optimised for different functions.
  • They won’t be using Google software but Google will still be collecting the data and reaping all the benefits.
  • This opportunity remains Google’s to lose and reminding everyone of how much power it has is unlikely to win it many friends.
  • Google remains one of my top picks (alongside Microsoft and Yahoo!) in the global digital ecosystem.