Wearables – No show

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Adding LTE to Apple Watch is pointless.

  • The problem with wearables that I described nearly 4 years ago (see here) of a solution looking for a problem continues to plague wearables with Fitbit struggling along, sector consolidation and even Apple seems out of ideas.
  • If the rumour machine citing endless anonymous sources is to believed Apple’s next version of the Apple Watch will feature a LTE modem.
  • This will give the device independence from the iPhone, meaning that the user won’t have to have the iPhone in immediate proximity for the device to work.
  • I think that putting a LTE modem is pointless and could even harm what little appeal the product has.
  • This is for two reasons:
    • First: In the US (I suspect Europe is similar) users are now glued to their smartphones for an average of 300 minutes per day (Flurry).
    • This essentially means that users keep their smartphones in their immediate vicinity at all times and will go to great inconvenience to ensure that that remains the case.
    • As a result, there is only a tiny period (if any) of time when the smartphone is out of Bluetooth range of the user and hence any wearable that he has on him.
    • Therefore, the inclusion of a cellular modem will be able to improve the functionality of the Apple Watch for only a tiny percentage of the user’s day.
    • This renders it effectively useless in my opinion.
    • Second: A LTE modem (even with a soft SIM) is going to cost money, take up space that could be something used for something else and will be a net drain on the battery.
    • Battery life is a major issue for all wearables (including the Apple Watch) and the addition of a modem will place a further drain on already very limited resources.
    • Hence, I think that a modem will cause deterioration of the user experience for no perceptible improvement.
  • What Apple should really be working on is a use case or function for this product that makes it a must have causing everyone to rush out and buy it.
  • This is the genius for which Apple has been known in the past but of which there has not been much sign over the last few years and certainly not with this product.
  • Consequently, I hope that like the large screen TV and the vehicle, this product never sees the light of day.
  • Instead, I am looking for a use case that can really kick start the wearable market as without this spark of genius, it is likely to continue bumbling along with little real interest or volume.

Samsung Bixby– Lightweight

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Bixby is hopelessly outclassed.

  • Bixby voice only shines in the areas where Samsung has given it special access to hardware that competitors do not have.
  • Outside of this area, Bixby is a third-rate experience that is unlikely to generate much traction especially as the vastly superior Google Assistant is just a button press away.
  • The voice piece of the Bixby digital assistant has finally launched but despite months of feverish activity in trying to teach Bixby to speak English, it is still not very good at it.
  • Bixby has been granted exclusive hardware access such that it can work when the screen is off or the device is locked.
  • This is something that Google Assistant cannot do but it also comes with the reality that Bixby is always listening.
  • I think that this will make some users very uncomfortable as a microphone in one’s pocket is far more intrusive than a microphone listening in the kitchen.
  • Voice recognition works best when there is an element of training involved as users often say things in very different ways.
  • Unfortunately, it appears that for some users, Bixby is unable to recognise the training sentences implying that this part of the system still needs work.
  • In effect Samsung has programmed Bixby with a series of standard functions that can be used to operate the smartphone as well as basic functions in the apps.
  • Outside of that area, the user is pretty much out of luck.
  • Unfortunately, these only really work for Samsung apps which outside of the messaging app for SMS, I think no one really uses.
  • Furthermore, for navigation and search, Bixby uses Google but without some of the bells and whistles that make Google so good.
  • For these functions, it makes no sense to use Bixby when one can go straight to Google.
  • Bixby does support third party apps through the “Bixby Labs” program but unfortunately it doesn’t seem to work properly.
  • Bixby can open things like Google Maps, YouTube and so on but does not seem to be able to get past the main screen of those apps.
  • The problem with Bixby is simply that its creator, Samsung, has no artificial intelligence expertise to speak of and digital assistants are only about AI.
  • Google Assistant is the best not because Google knows how to make an assistant but because the AI that runs it is the best in the world.
  • This contrast is so stark, that Samsung has had to resort to hobbling Google Assistant in certain areas (hot word) just to give Bixby a chance.
  • I think that this will encourage users to try Bixby once or twice but when they realise how poor it is, they will go back to Google Assistant.
  • Google will not be losing any sleep over Bixby even though it could end up on a very high percentage of Google ecosystem devices.
  • Samsung is now the No. 1 semiconductor manufacturer in the world, but I still rank it almost dead last when it comes to AI.
  • I think its investments in this space would be better accruing to shareholders in the form of higher profits rather than being invested in functions that are likely to damage Samsung’s reputation rather than improve it.
  • Samsung’s recent rally has removed the valuation argument for Samsung which leaves me preferring Tencent, Baidu and Microsoft.

GrubHub – Big appetite

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Eats24 is an essential acquisition.

  • GrubHub is making exactly the right moves to give it the best chance to beat its larger and much better financed rivals in the brutal food delivery business.
  • Alongside results that broadly met expectations, GrubHub announced the acquisition of Eat24 for $288m well over double what Yelp paid for it in February 2015.
  • This may seem to a huge premium but when one looks at what Eat24 can bring to GrubHub, it is not difficult to make the case that this could be the most important move GrubHub has made in its history.
  • GrubHub is an online marketplace where diners come to order amd have delivered food from participating restaurants.
  • As an online marketplace (network business) it is subject to exactly the same dynamics as ride hailing, classifieds and so on.
  • 20 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).
  • In effect, by hitting one of these two criteria the marketplace becomes to the go-to place to transact meaning that buyers become somewhat less price sensitive and sellers will pay more to sell their goods there.
  • It is this that allows the marketplace to make proper money but before this level is reached all players will almost certainly be under excruciating pressure.
  • GrubHub is no different in that since the advent of UberEats and Amazon’s entrance into this space, there has been relentless pressure on margins.
  • In the last 12 months EBIT margins have fallen to 13.9% in Q2 17A from 18.7% in Q2 2016 despite a 32% increase in revenues.
  • GrubHub is the market leader with 34% but Uber is not that far behind with 20%, Eats24 with 16% and Amazon on 11% (Cowen &Co).
  • Regulatory scrutiny has been high on GrubHub’s previous acquisitions but the fact that this deal is likely to be passed with barely a ripple is an indication of how much more competitive the market is now considered to be.
  • There is some overlap between GrubHub and Eats 24 but importantly once combined the platform will have 75,000 unique restaurants on its books and 48% market share of transactions.
  • Assuming that the acquisition and integration proceeds flawlessly, then GrubHub will be more than double the size of its nearest rival (Uber) and able to at least stabilise its margins.
  • Furthermore, as long as it can hold onto this advantage, it should be able to withstand the pressure from its rivals despite the fact that they have very big brothers backing them up.
  • Consequently, I think that GrubHub had to make this acquisition otherwise it faced being ground down by its better financed rivals until it was forced to sell itself to one of them.
  • GrubHub has made the right strategic move to ensure its longevity but now it comes down to execution to determine its future.

Spotify – Free foundation

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Apple Music still making no dent.

  • Spotify has crossed 60m paid users and while its absolute level of growth is slowing due to the law of large numbers, it is still adding paying subscribers at the very healthy rate of 2m per month.
  • In September 2016 Spotify hit 40m, passed 50m in March 2017 and hit 60m at the end of July 2017.
  • For the last 18 months, Spotify has been steadily adding subscribers at around 2m per month which is showing no signs of slowing down.
  • This has held steady for the last 5 months indicating that Apple Music is having very little impact on Spotify despite the substantial advantage Apple has in owning the App Store and having complete control over the iPhone.
  • I continue to believe that this is for two reasons
    • First:  Spotify remains fundamentally a better service.
    • This is driven by the fact that the music is now incidental in that anyone can create a service with 40m tracks and a search box.
    • Where Spotify is different is that it uses the data that it collects from all of its users in order to make its service better.
    • Apple also does this but Spotify’s AI in music continues to meaningfully outperform Apple’s.
    • By understanding the characteristics of the music offered by its service and the preferences of its listeners, it can accurately match the two together.
    • This also allows it to come up with innovative services that keeps its service fresh and one step ahead of the competition.
    • Second: Spotify has a large and engaged free tier of users that serve as the funnel for conversion into paid users.
    • Free users get to spend time with the service without paying for it, making it much easier to make these users understand why the service is better than anything else available.
    • This meaningfully offsets the disadvantage that Spotify has compared to Apple when it comes to marketing.
    • These free users generate data which Spotify can use to train its algorithms which can in turn be used to make the service better.
    • Apple also has a lot of data but has not been nearly as good at turning raw data into actionable intelligence with which it can improve its service.
  • The net result is that Spotify’s position is strengthening with every new user that it adds and between them, Apple and Spotify account for almost all of the growth in the recorded music industry.
  • Consequently, I remain unconcerned that Apple will be able to put real pressure on Spotify and think that its path to better profitability remains clear as the labels increasingly need Spotify more than Spotify needs the labels.
  • This position is becoming clearer as Spotify was able to strike a better deal with Universal (see here) and the outlook is that the rest of the industry will be signed on similar terms.
  • I still think that the key issue for Spotify going forward is to maintain momentum of growth of its free users.
  • It is the free user pool that has been the foundation of its outperformance of Apple, meaning that the free tier will be critical to keep the paid tier (where the real money will be made) increasing at this very healthy rate.
  • I continue to think that there is enough space in this market for 2 big players and with those spots filled, it is the fortunes of Pandora, Tidal, Deezer and so on that trouble me now.

Apple FQ3 17A – No pause here.

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Solid base for new product launches.

  • Apple reported good results and guided strongly for the coming quarter stoking speculation with regards to the possible strength of the coming upgrade cycle with the new iPhones expected to be launched next month.
  • FQ3 17A revenues / adj-EPS were $45.4bn / $1.67 slightly ahead of consensus of $45.0bn / $1.57.
  • While iPhone held steady it was Services that really underpinned the results with YoY growth of 22% to $7.3bn.
    • iPhone shipments were 41m which included a 3.3m inventory reduction ahead of the new launches.
    • iPad shipments were 11.4m up 15% YoY driven mostly by the product refresh that saw a new iPad and the smaller version of the iPad Pro launch in March 2017.
    • Mac shipments were 4.3m units driven mostly by the new MacBook Pro.
  • Services was the star of the show where the Apple App Store is the main driver generating almost double the revenue of its nearest rival Google Play.
  • This was despite the fact that Android devices appear to have closed some of the monetisation gap on iPhone especially at the high end (see here).
  • Guidance was surprisingly strong with revenues / EBIT expected at $49bn – $52bn ($50.5bn) / $11.7bn – $13.0bn ($12.4bn) broadly in line with consensus at $50.4bn / $12.4bn.
  • The result was a relief rally as fears of a pause in performance ahead of the new product launches now looks unlikely to occur.
  • Consequently, all eyes are now on product launches where a major product refresh is hoped to trigger another replacement cycle.
  • Bezel-less devices are now all the rage and if Apple can replace fingerprint ID with an excellent facial recognition system, the iPhone 8 could end up triggering a good cycle of upgrades.
  • Samsung has a wealth of biometric ID systems but none of them work particularly well as the fingerprint sensor is on the back of the device and the facial recognition is not nearly as reliable as it should be.
  • I don’t think that Apple will see a cycle as strong as the iPhone 6 but there is potential for the iPhone 8 to meaningfully outperform the 6s and the 7.
  • That being said, I continue to think that much of this good news is already in the stock and the valuation argument for long term investors has long since evaporated.
  • I remain pretty indifferent to the shares.

Indian e-commerce – Road to ruin.

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The only likely winner in India is now Amazon.

  • Snapdeal has ended merger discussions with Flipkart in a move that, I think, snuffs out the one chance the local players had to keep Amazon at bay.
  • At the same time Softbank is now looking at committing $1.5bn – $2bn into Flipkart in a move that I think will solve nothing because in a network economy, two halves do not make a whole.
  • I think Softbank should not put any more money into Indian e-commerce as the most likely winner in this market is now Amazon in which Softbank has no stake.
  • Snapdeal’s strategy is now to become a niche player and is cutting costs and selling assets in order to raise the capital required to reach profitability in its niche.
  • In my opinion, this strategy demonstrates a fundamental misunderstanding of how Amazon works and what it is likely to do to win the Indian market.
  • Most companies have a strategy that involves trade-offs such as offering high quality or low prices.
  • This is the route that Snapdeal is taking by deciding to streamline and focus on by giving sellers the best experience in India.
  • This is not how Amazon functions as there is no either / or in its vocabulary.
  • Instead Amazon goes for dominance and offers high quality and low prices or in this case the best experience for both sellers and buyers
  • How Flipkart will alter its strategy following the failure of the merger remains to be seen, but without the scale that Snapdeal would have given it, its chances of seeing off Amazon are greatly reduced.
  • Flipkart, Snapdeal and Amazon are network businesses just like Uber, Alibaba, AirBnB, Craigslist and so on and consequently, they are bound by the same rules.
  • 20 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 will now have to contend with Amazon which is absolutely determined not to make the same mess of India that it made in China when it went up against Alibaba and lost.
  • I estimate that Amazon pumped $400m of losses into the Indian market in Q1 17A and roughly the same amount again in Q2 17A and I don’t think it will be afraid to up the ante from here if needed.
  • Amazon is not the largest in India but it can lose far more money for far longer than either of the other two.
  • Flipkart has 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 a Snapdeal merger made sense, because adding Snapdeal’s users to its own would have got it pretty close to achieving that milestone.
  • Consequently, Amazon will now be able to grind its two main rivals down to the point at which they either exit the market or agree to be acquired.
  • Both of these scenarios are likely to result in much lower valuations than were being discussed as part of the deal.
  • Hence, I think that Amazon is the only real winner from the failure of this merger which I think raises existential questions for local providers of e-commerce marketplaces in India.
  • In the short-term this is unlikely to help Amazon’s fundamentals much and so I remain unenthused with an investment in its shares.
  • I continue to prefer Tencent, Baidu and Microsoft.

 

iOS vs. Android – Catch-up

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Android is snapping at Apple’s heels.

  • Android is showing signs of catching up with iOS in terms of user spending at the high-end, but further down the pricing tiers and in mobile advertising, I think that iOS remains miles ahead.
  • A recent study of the habits of 1.4m USA based users during the month of June 2017 was carried out by DeltaDNA, an analytics firm.
  • The study only measured gaming but this is already well known to be by far the biggest revenue generator from any Digital Life segment.
  • Almost all games these days are free to play and have in-app purchases for monetisation.
  • It is these that the survey measured and I have expressed these as ARPU $ / month.
    • Samsung Galaxy s8 / s8+: $6.30 / $16.20
    • Google Pixel / XL: $6.30 / $9.60
    • iPhone 7 / 7+: $8.40 / $10.80
    • Other US Android devices: $6.00
  • From this I conclude:
    • First: Screen size and quality is a big determinate in game monetisation.
    • The Samsung Galaxy s8+ which has by far the best screen (and the best audio in my opinion) available on the market today, is clearly making a difference to game play with the observed results.
    • Second: On normal screens, iPhone is still comfortably ahead of both the s8 and the Pixel but the gap is closing.
    • Third: Both the s8 and the Pixel are not meaningfully better than other Android devices implying the that user experience on the s8+ and Pixel XL has nothing to do with their better monetisation.
  • Although these models are clearly closing the gap on the iPhone, when it comes to total revenue generated there still remains a vast chasm in terms of total revenues generated.
  • In Q1 17A, Apple generated $7.04bn in revenues from services while Google other revenues were $3.10bn ($3.09bn in Q2 17A).
  • These figures are not direct comparisons as there are other businesses also included in these figures, but I think it is pretty safe to say that Apple App Store is easily generating double the revenue of Google Play.
  • A large part of this will be because in the high-end segment Apple has much higher share but also because Apple does still clearly offer a higher quality apps and services experience as the data for the regular sized phones indicates.
  • Furthermore, I have not seen a shift in the mobile advertising metrics and so I still believe that an iOS device generates double the advertising revenues of an Android device.
  • This data should send a warning shot across Apple’s bows as the better Android devices are certainly snapping at its heels.
  • Should they finally catch up, Apple may find it starts to feel the dreaded pricing pressure that will hurt profitability.
  • This is why I continue to believe that Apple needs to make its ecosystem sticky in areas other than its App Store which is what I think its strategy around HomeKit, HealthKit and Apple Pay are centred around.
  • However, to date, not a huge amount of sustainable traction has been generated by any of these services and so Apple has to radically improve them or think of something else.
  • This is one reason why the iPhone 8 is so important as once again it has slipped too far behind the hardware curve and needs to catch up.
  • With the rally that we have seen in 2017, the valuation argument for holding Apple has long since evaporated which is why I would prefer to hold Tencent, Baidu or Microsoft for this year.

Amazon & Baidu Q2 17A – Back to basics

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Amazon and Baidu get back to what they do best.

Amazon – Not making money

  • Amazon reported disappointing results and guided weakly as it once again spent everything it could on investing in future revenue growth.
  • Q2 17A revenues / EBIT were $38.0bn / $628m compared to consensus at $37.2bn / $1.0bn.
  • AWS put in another mighty performance with revenues of $4.1bn and margins of 22% but this was gobbled up by the international operation where margins have fallen to -6.3% from -1.4% in Q2 16A.
  • I am pretty sure that is mostly driven by Amazon’s absolute determination not to lose India to Flipkart / Snapdeal the way it lost China to Alibaba.
  • The good news is that Flipkart and Snapdeal are squabbling over their merger and the longer it takes them to get it done, the less chance they have to keep Amazon out of their home market. (see here).
  • This heavy investment looks set to continue with Q3 17E guidance disappointing once again.
  • Q3 17E revenues / EBIT are expected to be $39.25bn – $41.75bn ($40.5bn) / LOSS $400m – $300m (LOSS $50m) compared to consensus at $39.9bn / $1.1bn.
  • There is no sign of this “bumbling around break-even” in sight and consequently the valuation of Amazon looks more stretched than ever.
  • I prefer not to pay now for profitability that very fleetingly materialises.

Baidu – Performing in line with China.

  • Baidu reported good Q2 17A revenues as the regulatory impact on its revenues has past and the company kept a tight lid on expenses.
  • Q2 17A revenues / net income were RMB20.7bn / RMB4.4bn compared to consensus at RMB20.7bn / RMB3.3bn.
  • A large part of this improvement has come from cutting back on investments in its food delivery business but also from a big fall in traffic acquisition cost which fell from 15.9% of sales in Q2 16A to 11.9% in Q2 17A.
  • Despite the cuts, investments in AI and content remain intact and are the two main thrusts for revenue growth beyond search.
  • In AI, I rank Baidu highly, although it is very focused on China, and think that this is its biggest strategic advantage to remain a big player in Chinese Internet.
  • Baidu should be able to make its services more intuitive and useful compared to those of its competitors which should help its services win and keep more users.
  • The outlook for Baidu remains steady, now that the regulatory problem is in the rear-view mirror, and I see an upwards correction as it catches up with its peers.
  • I continue to like Baidu alongside Microsoft and Tencent.

 

Facebook Q2 17A – Cash community

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Community is about cash generation.

  • Facebook reported another set of excellent results and laid out pretty concrete plans of how it aims to put off, for as long as possible, the inevitable slowdown in its growth.
  • Q2 17A revenues / adj-EPS were $9.3bn / $1.32 compared to forecasts of $9.1bn / $1.32.
  • Mobile advertising, and especially video, underpinned most of the growth as mobile now accounts for 87% of total advertising revenues.
  • Facebook now has 2.01bn MaU of which 1.32bn visit everyday
  • Two major themes have emerged over the last 6 months which were further emphasised at these results.
    • First: community. Facebook is moving away from connecting friends (as it has already done this) and towards creating communities.
    • There are already 100m members of groups around particular interests which Facebook aims to push much higher.
    • These groups meet both virtually and physically and I think they represent an incremental monetisation opportunity.
    • This is because they represent the most engaged users where their interests are as clearly defined as they are on Twitter.
    • This means that Facebook should be able to monetise them much more effectively as the advertisements served will be more relevant and therefore can be more highly priced.
    • Furthermore, should Facebook succeed in growing the membership of these groups meaningfully, the average time spent by users on Facebook will also rise.
    • This will give both a price and volume lift to revenues allowing much faster growth.
    • Second: Artificial Intelligence. It is clear that this is Facebook main strategic priority.
    • This is because it is very far behind the curve when it comes to the quality of its AI, and it badly needs to at least be able to understand and categorise the huge amounts of data that it generates every day.
    • Facebook also intends to use AI to understand its users better so that it can suggest content that exists outside of their social circle in which they might be interested.
    • This will also have the convenient side effect of enabling Facebook to target its users more effectively, thereby increasing the price it can charge to marketers.
    • AI still remains a major weakness for Facebook but importantly, it is aware of the problem and is working on fixing it as fast as it can.
  • Behind the desire to connect people and create communities lies a Sheryl Sandberg’s highly efficient cash collection machine.
  • At the end of the day Facebook is a business not a philanthropic organisation and it is doing an excellent job of earning a good return from the data it collects.
  • I still remain concerned with short-term growth due to the maturation of its core businesses and the fact that new areas like messaging and gaming have yet to really generate revenues.
  • So far in 2017, Facebook has been able to defy both its own (and my) forecasts for revenue growth but the comparisons are getting tougher and tougher to keep up this pace.
  • Hence, I doubt that Facebook can keep this up until its new businesses mature and I still see a pause coming in revenue growth over the next 6 to 9 months.
  • It is at that point, that I am looking to get in for the long term as Facebook is showing all the signs of becoming the biggest ecosystem of them all.

Facebook – Empty head

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Another smart speaker that badly needs a brain.

  • It looks like Facebook is joining the ever more crowded smart speaker bandwagon, but without a decent brain inside the box, it may as well be a paperweight.
  • One possibility is for the device to use Cortana as it comes from one of the few companies that doe not compete directly with Facebook: Microsoft.
  • The device looks like it will be using a 15-inch screen from LG and will be manufactured by Pegatron but beyond that there are very few details.
  • I suspect that Facebook may be trying to take a slightly different tack here.
  • This is because:
    • First: the smart speaker market is already very crowded,
    • Second: Facebook has no brain of its own to install in the box,
    • Third: Facebook is more focused on community than smart home.
  • Facebook’s main objective in life is to bring its users closer together using its apps and to give them a sense of community.
  • While this all sounds great for users, the reality is that they will end up spending more time inside Facebook’s fledging ecosystem, generating more traffic and thereby increasing Facebook’s ability to make money from them.
  • Hence, I suspect that this device may be aimed more at making it easier for Facebook friends to spend time with each other by voice, video, messages or even images.
  • However, to earn a place on the increasingly crowded countertop of consumers, it is going to need voice functionality of some description.
  • I think that Facebook M, which is Facebook’s own digital assistant is hopelessly inadequate to fulfil this role, meaning that Facebook will have to get one from somewhere else.
  • Top of my list for this is Cortana which, while not the sharpest tool in the box, it is the only one whose owner is not competing directly with Facebook.
  • In fact, I have seen Microsoft and Facebook creeping closer together (see here) over the last few years and this is a collaboration that could make some sense.
  • With a bit of tinkering on Microsoft’s part, Cortana could be taught how to deal with the majority of the tasks that users ask smart speakers to perform.
  • This work is probably already going as Microsoft may already be working on a smart speaker of its own.
  • Combining this with the screen and Bing would give the device a reasonable shot at doing a decent job of answering queries.
  • This is just another example of how badly Facebook needs to bring its AI up to a level at which it can compete on a level playing field with Google.
  • This would also help Facebook deal with the objectionable content problem that it has on its platform as its current answer to this is to throw more humans at the problem.
  • For me, this has to be Facebook’s number one strategic priority and the progress displayed at F8 on image and video recognition was somewhat encouraging (see here).
  • I am still quite cautious with regards to Facebook’s outlook for this year as I don’t think that either its video offering or its gaming offering are mature enough to bring the company back to high growth in 2017.
  • This combined with requirement to really improve its AI to compete with the other digital ecosystems leads me to still prefer Baidu, Tencent and Microsoft.