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.

Microsoft – Silent knife

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Cuts look much bigger than they seem.

  • Microsoft’s planned 18,000 job cuts seems to spell the end of in-house manufacturing and has wide implications for Microsoft overall.
  • A total of 18,000 permanent positions are to go of which 12,500 are coming from the Nokia Devices and Services business.
  • At the same time Microsoft has imposed a policy change to external workers such that they will be now precluded accessing Microsoft’s buildings or its systems for 6 months after every 18 months worked.
  • For many external workers, this will have the effect of preventing them from being able to work for the company.
  • This is significant because Microsoft is thought to have more than 70,000 external or temporary staff on its books.
  • This restriction has been nominally put in place to preserve security but will also have the effect of meaningfully reducing the number of workers on the books.
  • The Nokia devices and services business will now be combined into a single business unit under Jo Harlow and Microsoft will look to migrate as much of Nokia X to Windows Phone as it can.
  • It also looks very much as if the Asha (low end feature phone) business will be meaningfully reduced in size and all in house manufacturing will be ceased.
  • Elsewhere, the organisation is being flattened and streamlined to make it more efficient but above all nimble, aggressive and responsive.
  • In the past it has been slow and lumbering and has missed a number of large market opportunities as a result.
  • It is clear that Nadella is forcing rapid change upon Microsoft but the real cultural shift has yet to happen.
  • The different business lines inside Microsoft have existed for many years in glorious isolation, often proud of the fact that they are independent from one another.
  • If Microsoft is to have a chance at being a successful ecosystem company, the ivory towers have to be destroyed and all the businesses need to start pulling together.
  • Lack of integration is the biggest and most difficult challenge that Microsoft faces when it comes to transforming its ecosystem into one that users will love.
  • There are signs of this coming from the top of Microsoft but this has to filter down through the ranks for it to really have the necessary impact.
  • I am increasingly optimistic that Nadella will be able to implement the necessary change but there remains an awful long way to go.
  • Efficiency will boost the bottom line but the real story will come to life when the top line begins moving once again.

Google Q2A – Top of the pops.

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Good performance justifies the love

  • Google reported good results as advertising volume continued to comfortably outpace pricing declines.
  • Q2A Revenues-exTAC / Adj-EPS were $12.7bn / $6.08 compared to consensus at $12.3bn / $6.25 and RFM at $12.9bn / $6.20.
  • Margins also improved somewhat as revenue from owned and operated sites where no traffic acquisition cost has to be paid away, grew faster than revenue from third party sites.
  • This is mainly due to YouTube which is a key asset for the monetisation of video which is currently the fastest growing area where advertisers are spending their budgets.
  • This was somewhat offset by continued strong growth at Google Play (where gross margins are 30%) but this is still not big enough to have a meaningful impact on margins overall.
  • These factors allowed EBIT to come in ahead of expectations at $4.4bn compared to consensus at $4.2bn and RFM at $4.0bn.
  • However, this was hit by a higher than expected tax rate of 21% compared to RFM’s forecasts of 19%.
  • This is what caused EPS to be weaker than expected despite the better than expected revenues and higher margins.
  • Cash generation was very solid at $5.6bn from operations of which $2.6bn has been invested mostly in data centres and real estate for future installations.
  • No guidance has been given but it is clear that the company is pretty optimistic with its outlook over the next 12-18 months.
  • This is something that is not difficult to believe as the fixed internet revenues are remaining steady while mobile continues to grow at over 40%.
  • Google is doing a masterful job at getting highly specified handsets into the hands of users and then reaping all the benefits from the increased traffic that results.
  • This should keep growth comfortably above 10% until 2017E.
  • With no real challenger on the horizon, Google remains one of RFM’s top picks when it comes to the digital ecosystem.
  • Microsoft and Yahoo! also make the list.

Yahoo! Q2A – Chinese spotlight.

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Alibaba hides very disappointing display revenues.

  • Once again Yahoo! has managed to keep poor results hidden amongst the spotlight glare of Alibaba.
  • Q2A Revenues / EPS were $1.04bn / $0.37 compared to consensus at $1.09bn / $0.38.
  • The biggest disappointment was in revenues from display advertising.
  • Yahoo! has been promising a turnaround in these revenues for some considerable time and last quarter (see here) saw the first uptick for a very long time.
  • As a long-term believer in Yahoo!, I was hopeful that this was a sign that the transformation of the core products was at last bearing fruit.
  • Unfortunately, this quarter’s display revenues are down 7% YoY compared to up 2% YoY that was seen in Q1 14A.
  • Yahoo! attributes this to poor revenue mix but the fact that search revenues and revenues from mobile have not been able to take up the slack is worrying.
  • Consequently, I have to conclude that Yahoo!’s efforts to migrate its usage into mobile is still floundering which is why it is not seeing anything like the growth of Google, Facebook or Twitter.
  • Yahoo! has great services and great traction in fixed Internet but its efforts in mobile have yet to bear any fruit and time is running short.
  • The good news is that Yahoo! has reduced the number of shares that it will sell in Alibaba from 208m to 140m and will return at least half of the net proceeds to investors.
  • The problem is that as soon as the IPO is over, the share price of Alibaba will crystallise the value at Yahoo!.
  • This will end the speculation and return the market’s focus to the underperforming core business.
  • With the IPO expected in mid-August, Marissa effectively has one more quarter to show some progress before the grace period is over.
  • Yahoo! has the assets with which to create a great ecosystem but currently the assets are disparate with the majority of the traffic being generated in fixed.
  • These assets have to be integrated and modified such that they work well together to encourage the user to use his Digital Life within Yahoo!’s services.
  • Critically, Yahoo! must entice the user to do that on his mobile device.
  • Yahoo! has been working on this for a long time and with the progress shown to date, there still seems to be a long way to go.
  • Hence, I am worried that there are more difficult quarters ahead where there will be no glitter from Alibaba to spice up the earnings report.
  • Yahoo! still has great potential but execution is becoming a serious concern as time continues to drift by.
  • Yahoo! remains in my top 3 but is certainly drifting to the back of the pack behind Google and Microsoft.

Microsoft – Field of dreams.

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If all you do is build it, they won’t come.

  • Nadella’s recent memo says all the right things but reveals the vast amount of work that is needed to make this dream a reality.
  • All through the 3,000 word memo it is clear that Microsoft intends to make the most of the assets it has and become a full ecosystem company.
  • With its combination of corporate and consumer assets, Microsoft is unique in being able to address both the Digital Life Pie and the Digital Work Pie.
  • With its mixture of software and services, it has an offering for almost everything that a user does in his personal and professional life but the key will be bringing it together.
  • It is here where the hardware assets of Surface, handsets and Xbox come in.
  • The idea is to use these as a showcase for how both Digital Work and Digital Life can work seamlessly on cool hardware.
  • The boundaries are becoming blurred with many users using devices in both a professional and a personal capacity.
  • At the end of the day Microsoft wants a user to feel that almost every digital need that he has can be taken care of in a seamless, easy-to-use and incredibly fun way.
  • If this can be achieved, then Microsoft will have a unique ecosystem giving it both appeal and pricing power.
  • This is the biggest driver for long-term revenue and profit growth.
  • If Microsoft is to decouple from the PC and enterprise spending cycles, it is here that it will be achieved.
  • However this is where the trouble starts.
  • In order to achieve this, every asset that Microsoft has must be fully integrated with everything else.
  • Every service must be fully aware of the other services that the user is signed up for and be able cater to that.
  • The current state of Microsoft’s portfolio is very far adrift of this requirement and the required integration is going to be a herculean effort of messy plumbing.
  • Examples of the problems are:
    • There is a personal and professional version of OneDrive but the two have nothing to do with each other.
    • Integration between Lync (Professional VoIP) and Skype (Personal VoIP) is almost non-existent.
    • The databases for many of the Personal Digital Life services remain separate from each other and do not share user information.
  • Furthermore Microsoft must completely change the way markets its offering and deal with the fact that users have no real idea of what the Microsoft ecosystem can for them.
  • The market is likely to remain fixated on a potential headcount reduction at Nokia, share buybacks and the PC market but the real future of this company will be decided by its ability to execute this vision.
  • Microsoft has the right vision and my confidence that the culture can be changed continues to improve.
  • Hence, I am increasingly optimistic that Microsoft can achieve this vision and as a result increasingly place Microsoft in my top 3 companies to look at when considering the ecosystem.
  • These are Google, Yahoo! and Microsoft.

PCs Q2A – Signs of life

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RFM still expects the PC market to grow in H2 2014.

  • Both IDC and Gartner gave their estimates of the PC market in Q2 and both are seeing signs of improvement.
  • IDC saw a 0.1% growth YoY in Q2 while Gartner saw the slowest decline since Q2 2012 with a fall of 1.7% YoY.
  • Between the two the message is clear: The PC market has stabilised, setting the scene for a better H2 2014E.
  • RFM continues to believe that both IDC and Gartner are not counting the market correctly.
  • This is because all devices in the tablet form factor are counted as tablets while RFM believes that a portion of them should be counted as PCs.
  • The Surface Pro 3 is a great example. This is a device that is capable of performing as a laptop or even as a desktop and it runs desktop software.
  • This device, and many, like it are actually PCs and represent sales for Intel, Microsoft as well as the usual supply chain.
  • Hence RFM removes these devices from its estimates for the tablet market and includes them in its estimates for the PC market.
  • This makes sense because RFM believes that these tablets are finally in a position to begin replacing laptops or even desktops and are in fact part of the PC market.
  • When these devices are added back into the estimates for the PC market a better picture emerges.
  • The laptop replacement cycle is very overdue for a bump and now there is a reason for users to make the upgrade.
  • Consequently, RFM expects that the next two years will see improving growth from the PC market that lasts for two or three years before slowing down to low single digits again.
  • This is already being helped by the expiry of support for Windows XP which has triggered a surge in corporate upgrades to Windows 7.
  • Consequently RFM is expecting a couple of good years for the PC market, regardless of how it is classified, and Intel and Microsoft will benefit.
  • Going into an upturn, I would look at Intel, Microsoft and also Asustek and potentially Lenovo. (Lenovo needs to digest Motorola (see here)).


Samsung Q2A – Brave face

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The decline may have started early.

  • Samsung reported very disappointing Q2 14A results but it looks like the whisper numbers and comments from the CFO last month have already taken care of the valuation impact for now.
  • Q2A revenues and EBIT were KRW51tn-KRW53tn / KRW7.0tn-KRW7.4tn. The median points are KRW52tn and KRW7.2tn.
  • This is meaningfully weaker than RFM’s estimate of KRW55.4tn in sales and KRW8.9tn in operating profit.
  • It is also meaningfully below consensus at KRW54.5tn / KRW7.9tn.
  • Expectations in Korea have been quietly falling for the last month, explaining the 10% decline in the share price since early June.
  • Samsung highlights two big problems:
  • Currency.
    • The Korean Won has appreciated by around 5% against the dollar during Q2 and this has been blamed for a big part of the weak earnings.
    • However, it is important to remember that Samsung buys much of its components and pays a large part of its work force in foreign currencies.
    • This means that the majority of the impact will be felt in revenues not in profitability.
    • It is profitability where things have been really disappointing.
  • Smartphones and tablets.
    • Shipments fell QoQ as the Galaxy S5 did not go as well as expected and share was lost at the mid to low end as the Chinese ramped up competition.
    • RFM was forecasting a small increase QoQ.
    • Samsung was also forced to ramp up marketing spending to wind down the inventory ahead of new model launches in Q3.
    • This is a very bad sign as it looks like both share and margin suffered during Q2.
    • Typically, I would expect market share to be defended at the expense of margin but clearly the Chinese still do not care that much about profitability.
    • Samsung is hoping that new models in Q3 will boost its shipment numbers and margins but it has already launched its key product for 2014 and I can’t see why the Galaxy Note 4 is going to rescue the situation.
    • Samsung’s decision to not compete in the ecosystem (see here) means that it has nothing with which to compete against the Chinese other than hardware.
    • Consequently, I believe that this is the first of many quarters where Samsung bemoans the aggressiveness of its competitors.
  • Weakness in IT and Mobile Coms also impacted results from the Display and Systems LSI businesses but their overall impact was marginal.
  • Samsung is putting a brave face on it but I suspect that the coming quarters will report more of the same rather than the much hoped for recovery.
  • RFM continues to expect a 25% decline in group EBIT between 2013A and 2014E driven by falling margins in IT and Mobile Coms.
  • RFM will revise its estimates for Samsung Electronics when the full results are published on July 31st.
  • For now RFM continues to see significant downside in Samsung’s share price and prefers Google, Microsoft and Yahoo!

HTC Q2 – The spiral

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One quarter does not make a recovery.

  • HTC reported good Q2 results as cuts to marketing expenses allowed profitability to make up for weak sales.
  • Q2A revenues / net income were NT$65.1bn / NT$2.26bn compared to consensus at NT$66.9bn / NT$2.06bn.
  • This was well adrift of the company’s own forecast of revenues at NT$65bn-NT$70bn.
  • This quarter saw the first shipments of its flagship product, the M8, which really drove revenues in April.
  • Unfortunately it was unable to sustain the momentum and revenues started declining again in May and June.
  • The appeal of this product appears to have been much shorter than anticipated which is why revenues have fallen short of forecasts.
  • The bigger problem is that profitability has been achieved at the expense of marketing.
  • This is not trimming waste and becoming more efficient, it represents a substantial cut into the muscle of the business.
  • From now on, HTC will have less resources with which to market its products and consequently it will ship fewer devices
  • This is extremely worrying as it paints the picture of a company in a vicious circle of decline.
  • Resources are cut to stem losses resulting in lower sales and so resources have to be cut again and so on.
  • The M8 is a great product but it is in a market filled with great products from companies with much greater resources with which to market their wares.
  • Hence, unless HTC can come with something that clearly differentiates its devices from the competition, then the outlook is very bleak.
  • Hardware is no longer a differentiator meaning that the difference has to be made in the ecosystem.
  • HTC makes Android devices where Google has complete control and Microsoft devices where Microsoft owns the ecosystem.
  • Hence, HTC has no way to differentiate itself as its competitive edge has long since been commoditised.
  • Consequently, I expect that HTC will not make it as a handset vendor as it is shipping commoditised products against bigger and stronger competitors.
  • We may see the occasional bounce, as we have this quarter, but the long term trend remains inexorably downwards.
  • Google remains the only company to consider among the players trying to wring a living from Android.