Magic Leap – Backwards leap.

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Massive setback means more money likely to be needed 

  • It appears that Magic Leap has hit a major problem with the commercialisation of its technology and the question really is: are its investors patient enough to hang on while a new solution is found?
  • Magic Leap is an augmented reality company that has a very high profile because:
    • First: It has promised a user experience that other augmented reality companies can only dream of.
    • In most systems the virtual world can only be superimposed on a portion of the user’s field of vision.
    • Effectively there is a letter box in front of the user within which the virtual world exits and from which it cannot escape.
    • For productivity applications, this is not really a problem but for the consumer, there is no way this will fly.
    • This is the problem that I think Magic Leap has solved and if it can produce a good product, it could dominate the consumer market for AR (see here).
    • Second: It has very high profile investors (Google, Alibaba etc.) and a valuation of $4.5bn.
    • $4.5bn is a sky-high valuation for a company with no product, no prototype and no time frame within which a product will come to market.
  • Despite some rumblings around whether one of its latest demonstration videos is genuine, the older demonstrations show clearly that Magic Leap offers a full superimposition of the virtual world onto the real.
  • However, this is not where the problems that I can see are to be found.
  • The problem is that the device is huge, clunky and uncomfortable to wear making it completely unsuitable for the consumer.
  • I have long held the view (see here) that for AR to work, the entire unit needs to be no heavier or intrusive than a regular pair of glasses.
  • The original idea was that Magic Leap would use a laser shone through a vibrating fibre optic lens to create the light field (see here) but it seems that this solution does not work properly.
  • A recent demonstration (the information) of a head unit attached to a PC with multiple cables produced images that were of a lower quality than Microsoft’s HoloLens.
  • It looks like this has laid bare the weakness in the laser / fibre optic solution in enabling a move from being the size of a fridge into a head unit.
  • Furthermore, the press does not like being made to feel foolish and so the knives are now out following the possibility that the latest video is a concept rather than real footage.
  • Either way, it looks like it is back to the drawing board for Magic Leap in terms of figuring out how to ut full field of view AR into a pair of glasses.
  • This is a huge problem as I suspect it means a lot more time and a lot more money.
  • With no revenues and aggressive hiring over the last 12 months, Magic Leap’s burn rate must be tens of millions of dollars a month raising the likelihood of another funding round probably at a lower valuation.
  • The big question is whether its investors will continue to support the longer development time required and if so, what price will they pay?
  • The longer development time also gives rivals such as HoloLens, Meta and Atheer Labs time to fix their issues with the field of view.
  • With risks increasing and sentiment souring the valuation can only come down.

 

Jolla – Safe(-ish) anchorage

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Sailfish finds a life line with the Russian government. 

  • The hardy sailors at Jolla have had a pretty stormy couple of years but their ship may have found safe-ish anchorage in Moscow.
  • At the end of 2015, Jolla joined the stagger of zombies (see here) when it ran out of money and had to pause its operations.
  • However, in May this year it secured $12m in funding and has recently won a battle with Samsung’s Tizen to be selected by Russia’s Ministry of Communications as its mobile platform of choice for Russia.
  • Sailfish has benefitted from the increasingly frosty relationship between Russia and the US where the fact that Sailfish has nothing whatsoever to do with any of the US-based platforms was a major plus.
  • Local search player, Yandex does not have the advantage that the BATmen do in China where there is a firewall to keep foreign services from being present in the local market.
  • Hence, Yandex is up against Google and has a big incentive to see devices in the market where Google services are absent.
  • This is because Google’s commercial agreements make it very difficult for competing services to be the default option on the device when it reaches the user.
  • Sailfish was also able to beat out Yun OS which is Alibaba’s proprietary fork of Android because, although the OS is secure, the SDK for developers still comes directly from Google.
  • Sailfish also has the advantage of being able to run Android apps using an emulator called Alien from Myriad Group
  • However, because it is an emulator, there are issues with the performance of those apps and games in particular.
  • While Jolla has done well to secure the backing of the Russian government, it is no guarantee that it will see any success in the market.
  • The key will be how well Sailfish can work with services from Yandex which is the local leader in search and has a series of Digital Life services that are applicable to the local market.
  • To make this work effectively, Yandex services will need to be ported to Sailfish which is where a start-up. funded by the head of ESN Energy, called Open Mobile comes into play.
  • This start-up has adopted Sailfish and aims to integrate Russian specific services onto Sailfish to increase its appeal locally.
  • The key to the success or failure of this venture will be how well a Sailfish device can cover the Russian Digital Life pie and how well it fares against RFM’s 7 Laws of Robotics.
  • To date Sailfish has scored poorly on these measures as there has been no real ecosystem available, just an operating system.
  • Furthermore, I think that the backing of Yandex and the local operators will be of crucial importance as the platform will need a big marketing push to raise its awareness with Russian users.
  • Jolla is still running on financial fumes but it now has a chance to see some income should it gain some traction in the local market.
  • In that regard its fate lies in the hands of the Russian operators and Yandex.

VR / AR – legions of limitations

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VR hits a bump but AR in the enterprise fares better.

  • It looks very much as if 2016 for augmented reality (AR) and virtual reality (VR) has panned out much as I feared it would (see here) in contrast to the optimism and hype at CES 2016.
  • The supply chain has invested heavily in production of VR and AR units but has subsequently seen HTC’s Vive, Occulus Rift and Samsung’s Gear VR all undershoot expectations with no immediate improvement on the horizon.
  • Worst of the lot is Sony’s Playstation VR which was expected to ship 2.6m units during 2016 but now looks set to ship just 750,000 (SuperData).
  • Google Daydream has also disappointed with shipments now expected to be around 250,000 rather than 450,000.
  • This is a strong indication that the limitations of VR in particular remain legion including:
    • Price: Many of the devices cost several hundreds of dollars and also require a PC to run, further increasing the cost.
    • Clunky: VR and AR units are still large, clunky and uncomfortable to wear.
    • In many cases they also make the user feel foolish when wearing one.
    • Comfort and security: VR in cuts the user off from almost all sensory inputs from his immediate environment severely limiting the situations in which the user would feel comfortable using one.
    • Many units also cause feelings of nausea due to an imperfect replication of the real world compared to what the brain is expecting.
    • Cable: Many units require an HDMI cable which prevents the user from moving and also increases the risk of a fall should the user trip over the cable.
    • Content: Both games and content remain in short supply limiting the reasons for users to immediately adopt the platform.
    • The adult entertainment industry is a good yardstick for the adoption of new media types and even this has been slower than expected to jump in.
  • The low volumes of the Sony PlayStation VR headset is the most surprising as I have long been of the opinion that it has the best chance of success.
  • This is because the unit is cheaper than the others, runs on the PS4 which already has an audience of nearly 100m dedicated game players.
  • For these reasons, I think that PS4 VR has a big advantage over the others but its marketing efforts have not been particularly aggressive which has also hurt its appeal.
  • The net result is that VR is clearly not ready for the prime time and there remains a lot of work to do before volumes will really take off.
  • I do not see this happening in 2017 meaning that the outlook for next year remains pretty grim.
  • AR has exactly the same problems with the exception that it has plenty of applications in the enterprise where the content, comfort and price limitations are less important.
  • Consequently, those AR companies that are focused on productivity applications are likely to fare better in the short term.
  • I would steer clear of any investment depending on VR for now and HTC in particular.

Lenovo – All mod cons

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Motorola is the only one with a chance of succeeding with modularity. 

  • Lenovo’s Motorola is increasing its commitment to its modular mobile phones with the promise of more mods and remains the only one with a chance of making this strategy work.
  • Modular mobile devices are nothing new and the mobile phone graveyard is littered with various attempts that have been made over the last 15 years.
  • The latest to be interred is Google’s Project Ara which was closed down a couple of months ago.
  • On the surface, a modular mobile phone is a great idea as it gives users flexibility to specify the exact device that they want or to swap components in and out based on their requirements.
  • However, this comes at the cost of complexity and history has shown that making modular devices is extremely difficult.
  • This is because there are fundamental limitations inherent to the design that must be overcome.
  • These are:
    • First: Each module requires an individual case and a connector. These take up space, making the resulting device bulkier and less sleek-looking than a normal device.
    • Second: Each swappable component has to remain distinct from all the others. Integrating components together is a tried and tested method of cost and size reduction meaning that a modular device has always been more expensive to make.
    • Third: Every swappable component has to be tested with every other in every possible configuration to ensure that they all work together properly. This means that testing and certification is much more onerous meaningfully increasing development costs.
  • Motorola has overcome many of these limitations by designing a very thin mobile phone that uses a single magnetic connector on its back to communicate with any other component that is connected to it.
  • Only one mod can be attached at a time greatly simplifying the solution to the above problems.
  • The end result is that the Moto Z, Moto Z Force and Moto Z Play come by far the closest to meeting my rules of the road for a modular device to succeed.
  • These are:
    • First: It must be the same size and weight as competing products.
    • Second: It must make no compromises in terms of styling,
    • Third: It must offer the same functionality as competing products.
    • Fourth: It must come at the same price point as non-modular variants.
  • With mods added the device can become thicker than one would expect for a mobile device and once mods are included in the price, it also becomes more expensive.
  • However, these compromises are compensated for with excellent functionality including creating a great point and shoot camera from Hasselblad as well as audio speakers from JBL.
  • I think that the key to real success for this strategy will be the creation of many more mods by third parties and here Motorola is working hard to create a third-party ecosystem around its connector.
  • If Motorola can increase the traction around this device category then it will be able to create device preference which in turn will lead to better margins which are badly needed by Lenovo’s mobile unit.
  • I suspect that 2017 will be a make or break for this strategy.
  • Overall, Lenovo remains my favourite PC makers as it is the market leader, has a good grasp of what it needs to do to thrive and a pretty good track record in execution.
  • I would prefer this over all of the other PC makers.

Amazon AWS – Brain game

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Amazon is stepping up its efforts in the coming battle of the brains. 

  • Amazon is following its competitors by announcing a series of services based on its AI research but the performance of Echo makes me think that there is still an awful lot of work to do.
  • The headline of the AWS re:invent conference was the launch of three new services based on the AI work that it has done to date.
    • First: Amazon Recoknition.
    • This is a service that provides image and facial recognition as well as being able to assess the mood of the subject as well as detect glasses and so on.
    • Second: Amazon Polly.
    • This is a text to speech service that takes text input and returns an MP3 stream that sounds like a real conversation rather than a mechanical expression of just words.
    • Amazon Lex
    • This is a service that provides natural language understanding and automatic speech recognition.
    • It is also the system that powers the speech recognition of the Alexa digital assistant in this regard it performs reasonably well.
    • It is in Alexa’s ability to understand context, multi part enquiries and respond to enquiries that it falls short.
  • These launches have also gone hand in hand with a new initiative with Intel where Intel will launch a reference design for a home speaker that includes the Alexa digital assistant.
  • This is a good idea because at this early stage all the digital assistants need to collect as much data as possible in order to improve.
  • Hence, I expect that there will be a slew of devices that use Alexa for their brain with a range of designs, capabilities and price points.
  • I would not be surprised to see Google follow suit in this strategy with Google Assistant where, once again (see here), it will have the advantage.
  • This is because I have long believed that Google Assistant is vastly superior to anything else in terms if the user experience that it offers and the usefulness of its responses.
  • Consequently, if Google executes well and users like its product, it should be able to encourage manufacturers to deploy its digital assistant rather than Amazon’s.
  • Once again Google’s success (just like Pixel) is hinging on execution and only time will tell whether the recent re-organisation has been successful in solving Google’s historical problems in this area.
  • I continue to think that Alphabet is pricing in success in most of its endeavours and so prefer Microsoft, Tencent and Baidu from an investment perspective.

Android Security – Swiss cheese pt. IV

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Another horrible hack that Google is powerless to address. 

  • The worst part of this latest breach is that the hackers are targeting vulnerabilities in Android that have been well known for some time which no-one appears capable of fixing.
  • This only serves to reinforce my view that Google’s only way out of the nasty mess of Android fragmentation where virtually no phones can be properly updated remains to take Android fully proprietary.
  • 3m Google users appear to have had their accounts stolen which are now being used to generate $320,000 per month in fraudulent advertising scams.
  • The Gooligan exploit is a variant of Ghost Push which came to light in September 2015 some 14 months ago meaning that there has been plenty of time to issue a fix.
  • The problem with Android is not that it has any particular flaws that make it less safe than iOS or Windows but that none of the fixes for these problems ever make it onto the affected devices.
  • There remain two reasons for this:
    • First: The infrastructure for updating Android devices is horribly fragmented with each manufacturer or operator having control if its updates.
    • With all the different variations and add-ons, extensive testing is required to ensure that the variations and add-ons don’t break when the phone is updated.
    • Furthermore, because none of these players own the end relationship with the customer they have no incentive to improve it.
    • I think that this is Google’s most pressing problem (see here).
    • Second: Most Android handsets cannot be updated.
    • Android is a commoditised, brutally competitive market meaning that in the mid-range, every cent of cost matters.
    • Making a device updateable means that extra storage and memory must be added to the device which are never reflected in the price.
    • Hence, the vast majority of Android devices are not updateable to later versions of Android as there is no incentive for the device maker to add this capability.
  • The net result is that there is very little prospect for owners of these devices ever to be free from this problem or any of the others that have emerged for Android without buying a new device.
  • This is far beyond the means of most Android users meaning that they will constantly be exposed to any new threat that emerges with little prospect of it ever being fixed.
  • This is just another reason why usage of Android devices is likely to continue trailing that of iOS and why these devices are likely to yield a much lower return for the ecosystems that run upon them.
  • For example, RFM estimates that Google can earn $31.6 per user per year from an iOS device whereas its own Android devices can only generate $14.0 per user per year on average.
  • Part of this is due to the differences in demographics between the two ecosystems but I am certain that most of it is due to the fact that Android devices are more difficult to use, less secure and as a result generate much less traffic.
  • Consequently, I think that Google has to take control of Android because in its current state, it is very unsecure where very little is likely to change.
  • I continue to believe that this may happen in 2017 as Oracle has provided Google with the perfect excuse to do so (see here).
  • I remain pretty cautious on Alphabet preferring instead Tencent, Baidu and Microsoft.

Amazon vs. Google – Open goal

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Amazon Echo opens a market for Google Home to dominate. 

  • The Amazon Echo has sold reasonably well but I think that the device is not clever enough nor integrated enough to make it a must have product.
  • This leaves the goal wide open for Google Home to dominate as 60% of Amazon’s customers are already aware of the device category but only 2% of them have bought one.
  • A report from CIRP has found that Amazon has shipped 5.1m Echo devices since inception but only 30% of users use the device for information while 40% use it as a speaker.
  • A very meagre 10% use it to control the home.
  • This is a problem because unless Amazon can convince users to use Echo for things other than listening to music, it will quickly become just another speaker.
  • The problem is that Alexa, the digital assistant that resides inside Echo, is not very clever and much of the time simply does not answer even when it has heard the user.
  • Furthermore, there is no real integration meaning that the other functions of the device are not intuitive and easy to use.
  • For example: the statement “Alexa, I am cold” does not have any effect at all.
  • Instead the user must say “Alexa. Open Nest. Increase to 75 degrees. Close Nest” which can probably be done more intuitively from a mobile phone.
  • This is just one reason why the understanding of natural speech is so important and why apps and services on devices need to be able to talk to each other.
  • Consequently, I think that there is a huge opportunity for Google Home as best-in-class Google Assistant resides in the device and Google understands the importance of integration.
  • Furthermore, I think that Google is the world leader in natural speech recognition and processing and should therefore be able to deliver the best, most easy and fun to use experience of any.
  • The icing on the cake is that Amazon has prepared the market for Google Home as 60% of its customers are aware of a home speaker, that one can ask questions of, but only 2% have bought one.
  • Hence, the main issue for Google Home remains its execution to make the most of this opportunity just as it is for Google Pixel to capitalise on Samsung’s Galaxy Note 7 disaster.
  • This is a rare opportunity for Google to capitalise on the trailblazing and mishaps of its competitors but I still think that all of Alphabet’s upside has already been captured in its share price.
  • Consequently, I still prefer Baidu, Tencent and Microsoft which offer more upside although they have different market exposures to Google.

 

Ola. vs. Uber – Welfare state.

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I suspect Ola will need state intervention to survive. 

  • Ola looks to have become desperate as it appears to be pursuing a new round of funding at a valuation 40% below where it raised money just one year ago.
  • This is just yet another sign of the malaise that has hit the Indian start-up arena as Flipkart has already run into difficulties resulting in lay-offs and management change and funding for Indian start-ups is down 50% compared to the first 3 quarters of 2015.
  • This echoes exactly what happened in Silicon Valley during 2015 where much more attention was put on profitability and valuation after a series of so-called unicorns failed to execute on their plans.
  • I think there is still plenty of money available for investing in India but it is now much more difficult to get one’s hands on it and founders will end up having to give more of their companies away.
  • Furthermore, I think the departure of Nikesh Arora from Softbank has caused it to be far more passive in the region which has also had a knock-on effect on valuations.
  • On top of this, Ola’s operational outlook is looking increasingly difficult because it no longer has a significant advantage in the Indian market.
  • Car hailing is one of the best examples of a networked economy and just like classifieds it is extremely difficult to make money until one of two criteria are met:
    • First: one must has at least 60% market share or
    • Second: one must have double the market share of the next largest player.
  • Earlier this year it was thought that Ola had 80% market share but when one looks at completed rides, it turns out this number is closer to 50%.
  • To make matters worse, its chief rival Uber has roughly the same position meaning that two are likely to fight it out until one cracks.
  • In the Chinese market it was Uber that cracked as it became clear that it would never be able to compete on a level playing field with Didi Kuadi (see here) but in India things are different.
  • The problem that Ola faces is that Uber is much larger and better financed meaning that it will be able to compete aggressively and lose money until Ola goes out of business.
  • Consequently, unless the regulatory landscape shifts more in favour of the local player (as in China), it looks like Ola will end up selling itself to Uber.
  • Car hailing, like food delivery and all other online market places are winner takes all markets and there are no prizes for second place.
  • As I result, I remain concerned with the long-term outlook for Ola and I would be very cautious at putting money in even at $3bn.
  • If nothing changes, Ola is likely to end up being worth far less than that.

Microsoft – Back to front

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Back to front strategy of Surface Phone looks sure to fail. 

  • Mobile phones are a bit of a blank spot for Microsoft but 2017 is likely to see it give it another go despite the fact that Office 365’s success in iOS and Android have made this feat almost impossible.
  • It has been a very long time since Microsoft has done anything meaningful in the mobile phone and with the massive write down of the Nokia acquisition and the lay-off of the vast majority of the staff, it would almost seem that it has given up.
  • However, there is still a device in the works which will be part of the Surface portfolio to add to the excellent Surface Pro, Surface Book and Surface Studio.
  • This device will be called the Surface Phone and very much like its big brothers it will aim to be the ultimate mobile device and appeal to a certain set of users.
  • Unfortunately, I suspect that no matter how good this Surface Phone is, it will not appeal to even Microsoft’s hardest core fans.
  • This is because the mobile phone is a device that is predominantly used for Digital Life whereas the Surface products excel at Digital Work.
  • In Digital Work the Surface products are aimed at content creators and in that instance they are best in class.
  • However, every content creator is also a content consumer who predominantly uses an Android or iOS device for his Digital Life.
  • Therefore, Microsoft will have to make its Digital Life offering utterly compelling to convince even these users to move their Digital Lives to Microsoft and in that regard I see nothing but neglect and malaise.
  • This is why the Surface Phone will fail because no matter how good the hardware is, the ecosystem has deteriorated to a point where most of the apps that the user would want are not available.
  • Microsoft’s coverage of the Digital Life pie has deteriorated from 71% to 57%, developers are rapidly deserting the platform and user numbers are in free-fall.
  • This is how Microsoft has it back to front as users tend to being their digital lives with them into Digital Work and not the other way around.
  • Furthermore, the fact that Microsoft has made good quality versions of Office 365 available for iOS and Android devices substantially reduces any reason to buy a Surface Phone.
  • I have long believed that Microsoft’s most valuable asset is Office 365 meaning that it is in Microsoft’s interest to ensure that it works as well as possible on as many devices as possible.
  • Therefore, using Office 365 as a differentiator for the Surface Phone could actually do more damage than good to Microsoft as it could dent Microsoft’s reputation on the other, far more important platforms.
  • Hence, the only option would be for these users to have two devices, one for Digital Work and one for Digital Life.
  • However, because iOS and Android offer Microsoft’s Digital Work services to an acceptable level of quality and because the Surface Pro and Surface Book are so good at Digital Work and so portable, there is no reason whatsoever to buy the Surface Phone.
  • Hence, I think Microsoft would be best served in quietly dropping this idea and focusing its resources on the things that it does best and where it can succeed.
  • I think the mobile phone ship has already sailed.
  • Despite the inevitable disappointment, Microsoft’s share price does still not fully reflect the opportunity available in Digital Work which is why I still like it alongside Tencent and Baidu.

 

 

Handset Industry – Oranges and lemons

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I think Apple earns between 64%-68% of industry profits, not 91%. 

  • I believe the notion that Apple makes almost all the profits in the mobile phone industry is not accurate because Apple’s handset margins are underpinned by both hardware and its ecosystem.
  • Strategy Analytics has analysed the profits of the global handset makers and concluded that of the $9.4bn in industry profits in Q3 16A, Apple accounts for 91% of them (see here)
  • To get the real picture, I think one must either separate the ecosystem from the hardware or include companies like Google which has effectively drained the Android industry of its profitability.

Separate ecosystem from hardware.

  • In order to do this, one has estimate what margins Apple would make if iOS did not exist and it was merely a handset vendor selling Android devices.
  • In Q3 16A Apple sold 45.5m devices with an ASP of $625 giving revenues of $28.44bn and EBIT of $8.5bn giving an EBIT margin of 29.9%.
  • If Apple was selling Android devices, I suspect that its gross margin would be around 20% and its EBIT margin 4-5%.
  • This leads me to believe that in Q3 16A Apple made $1.4bn in profits from hardware and $7.1bn from its ecosystem.
  • This is a fairer comparison to the other handset makers who don’t have an ecosystem and using Strategy Analytics’ numbers would lead me to include that hardware profits of the industry were $2.2bn of which Apple earned 64% and the Android handset makers 36%.
  • It is important to note that Samsung’s dreadful Q3 16A due to the Note 7 has substantially skewed the current numbers in Apple’s favour.

Include the ecosystem.

  • I have long believed that the real difference between Apple and Google is much less than many commentators believe.
  • Both companies own global ecosystems from which they derive most of their profits.
  • However, they monetise them in different ways (hardware for Apple, advertising for Google).
  • Consequently, to compare oranges to oranges, one must include the profit that Google generates from mobile devices to get a real picture what is happening in the industry.
  • I have excluded the Chinese ecosystems from this analysis for reasons of simplicity and the fact they only operate in China.
  • In Q3 16A, RFM estimates that Google generated $7.8bn in revenues from mobile devices upon which it made margins of at least 40%.
  • This means that the mobile ecosystem generated $3.1bn in profits for Google which I have long believed comes at the expense of the Android handset industry.
  • This means that hardware and ecosystem profits (adjusting SA’s numbers) in total were $12.5bn of which Apple earned 68%, Google 25%, leaving the Android handset makers with just 7%.

Take Home Message.

  • Whichever way one cuts the cake, comparing oranges to oranges or lemons to lemons, the end conclusion is the same:
  • Apple earns the majority of the industry’s profits but it is not the huge 91% that a simple calculation indicates.
  • Furthermore, the re-addition of Samsung into the mix once it has got back on its feet after the Note 7 disaster will further reduce Apple’s real share of industry profits.
  • I expect that as time passes, more and more of the profits of the consumer device industry will be made by those that have ecosystems at the expense of those that do not.