Essential Products Inc. – What’s essential?

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Something must-have has to come out of the bag at launch. 

  • Essential Products Inc. is the latest in a long line of protagonists which is aiming to have a crack at the high end of the handset market and while it knows where it should compete, I am not convinced that it will be able to.
  • Essential is a start-up led by Andy Rubin who was the founder of the company that Google very successfully turned into Android.
  • Essential aims to compete in high-end consumer electronics by offering differentiation if the following areas:
    • First: Hardware. In any ecosystem strategy today, the most important device is the smartphone as this is where users spend almost all of their time.
    • Essential aims to compete here by offering a device which has a screen with no or almost no bezel.
    • Xiaomi has already done this quite effectively with the Mi Mix but this currently only available in China.
    • This is also the strategy, that I think Apple might use in the iPhone 8 but Essential should be able to launch well ahead of this.
    • Second: Artificial Intelligence. RFM research has recently identified AI as the 8th Law of Robotics concluding that AI is likely to have meaningful impact on the quality, and hence appeal, of Digital Life services in the medium term.
    • However, RFM research has also concluded that good AI requires a huge amount of time and a vast trove of user data in order to develop.
    • I seriously doubt whether Essential has either of these characteristics and while it may try to develop intelligent services, I suspect that it will struggle.
    • This is especially the case as its services are likely to end up competing with Google’s own which Essential will be obliged to implement on its smartphone and to set as default.
    • Third: Mods. Essential’s patent filings include a design for a proprietary magnetic charging port that can also be used as an expansion slot to add hardware functionality to devices.
    • In this day and age, unless you are Apple, proprietary charging ports are a big no-no and may be an indicator of the inexperience that Essential has in making smartphones.
    • Furthermore, the best mod on the market is currently made by Motorola which already has some volume and a reasonable range of third party brands making devices to connect to it.
    • All other modularity plays have either already failed or are struggling for relevance.
    • I struggle to see how Essential is much different.
    • Fourth: Cross device: Essential intends to produce a series of devices that will work together to deliver its proposition to users in all aspects of their Digital Lives.
    • This is also a vision pursued by Samsung, Xiaomi, Apple, Microsoft among others, and it does make some sense.
    • This is because if devices from one manufacturer all work together seamlessly, it provides a reason for users to buy all of their other devices from the same manufacturer.
    • This is one way of generating device preference without having an ecosystem and hence of earning better than commodity returns.
    • The problem is that getting all of these devices to work seamless together is fiendishly difficult and even the mighty Apple has not really got it right.
    • Microsoft does a reasonable job but there are still glaring holes in the experience that it offers.
    • Combined with this difficulty, will come the capital intensity of having to design a series of device types all at the same time which could easily be beyond the financial resources of Essential Products Inc.
  • With the segment that Essential chosen to compete in, there is very little scope to compete in the ecosystem as it will invariably have to support Google.
  • This is because its target users whether they are on iOS or Android will already have a meaningful part of their Digital Lives invested in Google are unlikely to want to switch.
  • Consequently, I remain uncertain as to what is special or different with regards to Essential Products Inc.
  • I am hoping to be well informed when it launches its proposition at some point during H1 2017.

Xiaomi – State of the nation

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Valuation lifted to $5bn but still 89% below last raise. 

  • Xiaomi has supplied some details of its performance for 2016 but reading between the lines implies that it is pinning all of its hopes for 2017 on its ecosystem devices outside of phones.
  • There is no doubt that things were tough in 2016 as Counterpoint Research and RFM estimate that Xiaomi handset shipments fell by 16% to 60.8m units globally.
  • If I assume an ASP of around $175, this gives handset revenues of $10.6bn.
  • Xiaomi has also said that its network of ecosystem partners produced (other ecosystem products) revenues (TVs, smart routers, wearables, smart home) for Xiaomi of RMB15bn or $2.2bn.
  • If I assume Internet service revenues (3rd business line) of $100m, this gives a 2016 grand total of $12.9bn or RMB89bn.
  • This is down some 2% from what I think it earned in revenues in 2015 with other ecosystem products revenue largely offsetting the fall in handset sales.
  • This makes the revenue goal of RMB100bn ($14.4bn) look achievable as Xiaomi is calling for 10% growth.
  • I suspect that none of this is going to come from mobile phones as in the tightening environment, I think Xiaomi will hold share and revenues flat in the best instance.
  • Consequently, I think that Xiaomi is looking for revenues from its other ecosystem products to grow by around 64% and Internet service revenues to treble to $300m.
  • Given that the other ecosystem products segment more than trebled its revenues in 2016, this is not too much of a stretch to reach.
  • Therefore, I am comfortable with the revenue target.
  • However, despite whatever Xiaomi says, a viable business needs to make money and it is here where the problems remain.
  • I think that Xiaomi will make EBIT margins of 2-4% on its RMB 100bn of revenues in the best instance in 2017 giving EBIT of US$434m or RMB3bn.
  • I see no reason to change my valuation methodology (see here) and I continue to use Apple as a comparison.
  • I still believe that using the EV/Sales multiple is fundamentally flawed and so I continue to use EV/EBIT.
  • Apple’s forward EV/EBIT is now around 7.7x but because Xiaomi has a good chance of growth in 2017 whereas Apple may not, I will give Xiaomi a 50% premium to Apple.
  • I cannot give Xiaomi a higher premium simply because it is not going to grow fast enough.
  • Applying this premium gives a fair enterprise value for Xiaomi of $5bn, 40% better than the last time I valued the company, but still 89% below its last raise.
  • I think that Xiaomi can survive without raising more money but its ability to really invest and compete against the BATmen in China will be very limited putting it on the backfoot.
  • This valuation is unlikely to change until Xiaomi gets serious about making money for its investors rather than growing its user base.
  • I still see Xiaomi as an acquisition target where it would fit well into Baidu or Tencent.

Alibaba – Shopaholic

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The woeful offline experience offers a real opportunity. 

  • It looks like Alibaba is about to take a leap into the offline world as it is the lead contender to buy a struggling retail chain in China for $2.6bn.
  • The company in question is In Time Retail Group which operates 29 department stores and 17 malls predominantly in the eastern province of Zhejiang where Alibaba’s home town of Hangzhou is to be found.
  • In Time has been suffering from the predations of its would be saviour due to the fact that the retail experience it offers is poor at best.
  • In Time is a great example of why online and mobile have been so successful in the Chinese market.
  • Chinese retail is a fragmented and frustrating experience where decent service and information with regards to inventory, product lines and so on is routinely not available.
  • Consequently, when an online offering appears where this information is clear and one is able to easily purchase goods and know when they will be delivered, shoppers quickly adapt.
  • It is the terrible offline experience with regards to almost everything that has allowed so many other goods, services and activities in China to rapidly migrate from offline to mobile.
  • In Time operates a similar model to Alibaba where it provides the building and merchants and brands pay to sell their products at its locations.
  • This makes it a good fit for Alibaba and if Alibaba can use its technology and logistics to massively improve In Time’s service and its experience for shoppers, then it has a chance to take a piece of the still massive $4.5tn offline retail market in China.
  • By contrast, online shopping is still relatively small (but growing) at US$711bn or 16% of total Chinese retail sales.
  • Consequently, if Alibaba can use what it has developed in online to hugely improve the quality of the shopper experience in the offline world, it could take a meaningful slice of the market.
  • It is worth noting that, China is a massive and hugely fragmented market where retail happens in millions of locations and that In Time is present in only one province.
  • Consequently, I see this as an experiment to see whether Alibaba’s skills in online will also work in offline.
  • Although Walmart clearly understands retail, it does not understand China which is why it has largely failed to make any impact despite years of trying.
  • Hence, there is a clear opportunity for Alibaba but it is very likely to take a long time requiring a vast amount of investment for this to come become a big part of this company.
  • This is why I see this experiment starting in Alibaba’s home town with very limited scale until it is proven that it can work.
  • I continue to prefer both Baidu and Tencent over Alibaba as its valuation remains too rich for me and I see more value elsewhere.

 

Sonos – Sounds of sameness pt. II

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I do not see the boldness required to save Sonos 

  • Sonos has announced a change in leadership with its 14 year veteran CEO / founder John MacFarlane handing over the reigns to President Patrick Spence who joined Sonos in 2012 as COO.
  • Patrick Spence was previously with BlackBerry in a sales and marketing role.
  • Although Sonos reportedly has had a reasonable end to 2016, it remains in a strategic quandary that I think will take a very bold move to fix.
  • The problem is essentially that as it now supports the major music streaming services, it has relinquished a large part of its long term differentiation.
  • Sonos’ strategy to date has been to lock its users into its ecosystem and only allowing them to use popular services such as Spotify, Amazon and so on via its own app.
  • The idea was to create a compelling user experience such that users would choose a Sonos even if something of equivalent quality was available at the same price point.
  • Unfortunately, this is where it has all come unstuck as Sonos’ ecosystem delivers a frustrating, buggy and substandard user experience that I think users would not use if they had a choice.
  • By enabling both Spotify Connect and Amazon Echo, Sonos has removed the requirement for users to use its software which I think is a sign that it is giving up on trying to create user preference around an ecosystem.
  • Because Amazon Echo and Spotify Connect are keen to work with any speaker on the market, Sonos’ differentiation now becomes: audio quality, design and its multi-room function.
  • Hence, I see Sonos’ only chance is to either
    • First: invest in cool new hardware features and stay ahead of its competition to maintain its price premium or
    • Second: to go for volume and gain scale advantages by significantly outselling its rivals.
  • Given Sonos’ current position, I think that both of these options will require a bold strategic move from Sonos that would probably have most chance of success if led by an outsider.
  • Hence, I fear that Sonos’ outlook remains rather bleak and hence it may end up being acquired.
  • I see it making a good tuck-in acquisition for any company trying to create a cross device ecosystem as its brand is very well known.
  • I see Samsung, Apple, Sony and Amazon all as potential acquirers.

Alphabet – Great thrall of India

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Africa warning as India falls into Google’s thrall. 

  • Google is moving consolidate its growing grip on the Indian market and unless rivals act quickly, there will soon be nothing left.
  • Furthermore, Google’s tactics in India is a sign of what it is to come in Africa providing a warning for those intending to address that market.
  • Google’s coverage of Indian railway stations with free WiFi has past 100 stations up from 52 at the end of Q3 16 and is well on its way to 400.
  • Just a few years ago, India was a reasonably open market but the failure of the local players to act (see here) allowed Google to grab the market and I see it being just one step away from its goal.
  • Several years ago, buyers of smartphones in the Indian market would ask for Android such that it was difficult to sell a device without a picture of the green robot on it.
  • Now, users have moved one step on and are demanding devices with Google Play just like users in developed markets.
  • This puts the handset makers on the backfoot as while it is easy to make an Android device, to get Google Play, one has to jump through all of Google’s hoops.
  • This means that in addition to Google Play, one has to install Google’s major services, put them front and centre on the device and set them by default.
  • Having apps and services pre-installed on the device and set by default has long been known to be a big driver of usage.
  • This is even the case even if the service is inferior as is the case with Apple Maps.
  • Consequently, once Indian users move from demanding Google Play to using, enjoying and demanding Google Services then there will be very little that any competitor can do.
  • I see India being close to this tipping point now.
  • I think that the EU will force Google to unbundle Google Play from the rest of its services (see here) (as it did with Microsoft) which could cause Google problems in distributing its services to users. .
  • However, if Google can migrate users from demanding Google Play to demanding Google Services then this remedy will effectively have been neutered as Google will no longer have to enforce the bundling of its services with Google Play in order to generate usage.
  • This is why I think Google is rolling out free Internet in India as fast as it can and why it was keen to stop Facebook from getting a grip on the Indian market (see here).
  • I think that this should also serve as a warning shot to anyone who is intending to develop an ecosystem in Africa.
  • Africa remains one of the last reasonably untapped market where users are largely ignorant of any Digital Life services.
  • I suspect Google intends to repeat its Indian strategy in Africa giving any domestic player a relatively short window in which to act.
  • I continue to prefer Microsoft, Tencent and Baidu over Alphabet and Alibaba.

CES Day 1/2 – Winners and losers.

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Winners

Amazon.

  • In my mind, the star of CES 2017 is Amazon which is beginning to show signs of doing to Google what VHS did to Betamax.
  • Betamax was a vastly superior technology but a slick marketing campaign by JVC ensured that VHS was adopted and Betamax struggled to remain relevant.
  • These battles are now fought online and in the developer community and here it is currently Amazon all the way.
  • On the show floor everyone who is developing a device that goes anywhere near the home is ensuring that it works with Amazon’s Echo.
  • Google Home has barely put in an appearance.
  • Furthermore, Huawei’s Mate 9 has included Amazon’s digital assistant Alexa because Google’s Assistant is currently only available on Pixel.
  • This is a huge and lucky win for Amazon because as it has managed to kick start the virtuous circle where more developers mean more devices sold which mean more developers and so on.
  • The issue is that when it comes to the digital assistant itself, Alexa is far too dim to be of any real use (see here) but if users adopt it for a hub in the smart home, Amazon will then have time and data to improve.
  • Using Echo as a smart home controller could easily evolve into other areas as the device will already be present in the home which could really hurt the appeal of Google Assistant in the long term.

NVIDIA.

  • NVIDIA is the word on everybody’s lips and despite a somewhat lack lustre set of demos, the stand has been heaving every time I have walked past it.
  • Most attention is being paid to what NVIDIA is doing in automotive and how it could represent a challenge to Intel in the server space.
  • Its key proposition is to use its parallel graphics chipset designs in other tasks where parallel processing is an advantage such as artificial intelligence and in servers and data centres.
  • NVIDIA has neatly combined the two hot potatoes in the tech industry (AI and automotive) which has resulted in a disproportionate amount of interest being generated.
  • NVIDA has gained great momentum from CES but whether it can keep that going through 2017 is a valid question.

HERE.

  • HERE is one of the few that has shown ground breaking progress over the last few days.
  • The addition of Tencent, NavInfo and Intel as partners (see here) has continued with addition of Nvidia and Mobileye as partners.
  • For HERE, the addition of Mobileye is a particular endorsement of its strategy as only 12 months ago, Mobileye was adamant that autonomous driving did not require a map.
  • This embarrassing about-face gives HERE’s credibility another meaningful boost.
  • HERE is now a credible threat to Google Maps but the time has come to turn the ink on the partnership agreements into action.

Losers

Google.

  • Google is the big loser when considering the traction that Amazon Echo is generating among the smart device companies.
  • This is because Google Home should be a superior product when compared to Echo because Google Assistant is much smarter with better functionality than Echo.
  • However, early users of Google Home complain of poor voice recognition which appears to be preventing the superior intelligence that underpins the user experience from shining through.
  • Combine this with the fact that on all the IoT stands, there is barely a Google Home device to be seen and one starts to wonder whether Google Home will make it at all.
  • This is a sign that Google’s execution on Google Home (and potentially Pixel) is not going as well as hoped.
  • I am increasingly worried that Google will squander the opportunity to both capitalise on the market that Amazon has opened for it as well as benefit from Samsung’s misfortunes.

LeEco.

  • While LeEco has a good presence at CES with a range of devices and two cars, it has a real PR problem.
  • Chatter in and around the stand is all centred around the financial difficulties that LeEco is experiencing with very little focus attention being paid to the products or the proposition.
  • For a consumer device company this is a massive problem as it can quickly lead to a death spiral of confidence.
  • If people think that the company’s future is doubt, then they won’t buy the products which, in turn, will increase financial pressure, bad news flow and so on.
  • LeEco needs to break this cycle before it is too late and I still think that the only way out is for the company to ditch both its own car as well as that of Faraday Future (see here).

Apple.

  • Apple does not publicly attend trade shows but the degree to which it has been absent in the last few days is striking.
  • No one is discussing Apple on the stands and I have been greatly surprised with the degree with which two of its long-term initiative appear to be being ignored.
  • I have long believed that Apple’s long-term strategy to maintain its differentiation (and its margins) is to a large part predicated on its ability to offer a great experience around the home and in health.
  • This is where HealthKit and HomeKit (see here) come in but to work, device makers need to ensure that their devices are fully interoperable with this software.
  • Of the entire multitude of devices that I have seen in the last two days these two words were not mentioned once.
  • While Apple remains the strongest ecosystem, it needs to ensure that it continues to be the place where home and health devices come together because that is where the real value is to be had.
  • Amazon is showing up Apple just as it is Google.

CES Day 0 – Square one.

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IoT – everywhere and nowhere.

  • With the press cycle already revved-up well before the official opening of CES, almost everything that is on show is a known device, tool, utensil or appliance that can now work with a smartphone.
  • However, this is pretty much what we saw last year and it feels like the electronics industry remains at square one waiting for the next revolution that will drive it forward.
  • The smartphone remains firmly at the centre with almost every innovation being displayed involving a device of some description that can be controlled by the smartphone.
  • This is what I think off as IoT 1.0 or square one.
  • This is where every device is controlled by the smartphone but where every device exists in glorious isolation to all of the others that are out there.
  • For example, controlling a light bulb or air conditioning unit from my smartphone is great but other than saving on shoe leather, it doesn’t really offer the user any real benefit.
  • However, a system where all of my devices are aware of each other and can be controlled in an integrated way or can control themselves based on the user’s preferences is much more interesting.
  • This is what I refer to as IoT 2.0 and of this there is very little to be found with systems, standards and protocols remaining completely proprietary.
  • This is a problem that Apple is trying to solve with HomeKit and HealthKit and it is very telling that of the multitude of companies that I have seen in the last two days these two words were not mentioned once.
  • I suspect that this is because even the small companies have realised that the real value remains in the data and fear that while HomeKit will allow them to work well with other devices in the home, the real value will accrue to Apple rather than to themselves.
  • This is the deadlock that has to be broken before the utility of smart pet feeders, shoes, sunshades, beer makers, door locks, beds, pillows and so on really come into their own.
  • Of this there is no sign and without it, is suspect that the electronics buying public will be unenthused with paying $179 to be able to control an air conditioner for which it already has a remote control.

 Huawei – Double down. 

  • After a difficult 2016 where it fell to third place in its home market, Huawei is doubling down with the launch of its new flagship the Honor 6X.
  • The 6X is the first device to use 2 rear cameras on a mid-range device and offers a few funky photo modes to try and make its photography offering stand-out.
  • Huawei promises much better performance and battery life and is targeting to ship 30m units, double that of the 5X.
  • Its main differentiator in achieving this goal is price where the device will sell for $250.
  • The problem here is that all of its competitors are doing the same thing and while Huawei might sell 30m units of this product, I am certain that it will make almost no money doing so.
  • Huawei is symptomatic of life in smartphones where a one needs a huge scale advantage or a thriving ecosystem to make money.
  • Huawei has neither and difficulties in its home market are making it more reluctant to really invest to achieve these aims.

HERE – Pole position.

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HERE is closing the gap to Google with the Chinese and Intel joining up. 

  • HERE gets one over on Google by filling the biggest hole in its portfolio with the formation of a strategic partnership with NavInfo to provide maps and services into the Chinese market.
  • It has also announced a key partnership with Tencent which, together with GIC (Singapore sovereign wealth fund) and NavInfo, will become 10% shareholders in HERE.
  • HERE has also announced that Intel will become a 15% shareholder
  • Details include:
    • First: a 50/50 joint venture with NavInfo to supply maps and services into mainland China.
    • I see this relationship as NavInfo having the data and HERE having the software and services to bring it to life in the Chinese market.
    • This will begin with the HERE Auto SDK for in car services and then continuing into HD maps, autonomous driving and advanced location based services.
    • I suspect that foreign car makers selling their models in China will be the first customers but it to be successful the local makers need to also be won over.
    • This is a major challenge to Baidu which uses NavInfo data in its map which has helped it to become by far the leader at home in all things to do with location.
    • It is also a big challenge to Alibaba which owns AutoNavi, the mapping company that supplies much of the Chinese auto industry as well as its map of China to Google.
    • Second: Tencent looks set to use HERE’s location platform and its map in all areas of its ecosystem both in and outside of China.
    • This is HERE’s second win of a major ecosystem which, combined with Facebook, gives it the world’s two largest ecosystems by number of users.
    • However, both of these ecosystems are very immature but should they successfully execute their strategies, then HERE will find itself as the leading provider of location globally.
    • Third: NavInfo, Tencent and GIC will jointly acquire a 10% stake in HERE with the three existing shareholders (Audi, BMW and Daimler) correspondingly reducing their shareholdings.
    • Fourth: HERE will work with Intel to ensure that all of HERE’s systems are optimised to run on Intel’s chips which should provide Intel with a good boost to getting its silicon more deeply embedded in the car.
    • Having Intel as a shareholder will provide HERE with a big boost to its credibility in its objective to become the pre-eminent supplier of global location.
  • These announcements are a major step forward for HERE as it has fixed its previously blank spot in China as well as added another major ecosystem and the global silicon leader to its stable.
  • Furthermore, this will increase and enrich the data that is available to HERE to train its algorithms which should help it to make its services smarter and richer than those of its competitors.
  • This will also help HERE close the gap on Google which has an excellent map in China (from Autonavi) but which is effectively useless as it does not work when the user is in China without a VPN.
  • I suspect that data from Tencent and NavInfo will be used to create points of interest, thereby enriching the Chinese map.
  • This is an area where HERE has really struggled to keep up with Google historically.
  • I see the risk of the China transaction lying in the regulatory approvals.
  • Both the j.v. with NavInfo and the co-operation with Tencent require Chinese regulatory approval which may not be as straightforward as it would seem.
  • This is because HERE is a foreign company whose venture with NavInfo is a significant challenge to two of the homegrown ecosystems Baidu and Alibaba.
  • China has a history of making it difficult for non-Chinese companies to compete in its home market where the foreign company threatens to take share from locals.
  • The one exception is Apple, but I have long believed that Apple has succeeded in China by taking share from Samsung rather than any of the local companies and hence it has represented no real threat.
  • Hence, I think that HERE needs to tread carefully and show that in China, it is its local partners (Tencent and NavInfo) that will derive the most benefit from working with HERE.
  • Should these announcements win regulatory approval then HERE will have filled the biggest hole in its global coverage as well as moved into pole position to become the biggest supplier of global location to the digital ecosystems.
  • Just Japan remains as a blank spot.

 

RFM 2017 – Top 5.

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Artificial Intelligence. 

  • AI is likely to be the most important theme in the technology sector this year.
  • This is because AI could become a major differentiator in determining which Digital Life services are the best and therefore preferred and paid for by consumers.
  • AI will also underpin the autonomy of any machine be it an automobile, a drone, a piece of factory equipment or a thermostat.
  • Hence, I expect that the hype and the claims being made with regard to AI will intensify further in 2017 making it even more difficult for executives and investors to see what the realities are.
  • While the hype will be huge, the progress will be slow as developing truly intelligent machines requires far more than just advances statistics.
  • I am looking for companies that are addressing the three real challenges of AI (see here) as it is the solution of these problems that will allow the quality and richness of services to really evolve.
  • RFM research finds that it is the search engines, Google, Baidu and Yandex that lead this field because they have been doing it the longest.
  • Everyone else is scrambling as fast as they can to catch up and are making an increasing amount of noise at the same time.
  • I expect to see feverish M&A activity in 2017 as AI currently takes so long to create that many players may feel they have no other choice than to acquire.

Autonomous time bomb.

  • Autonomy is likely to be everywhere at CES from domestic robots and drones to cars but I still think this is very far away from becoming viable.
  • The technology still has a long way to go before it is reliable enough before it can be trusted with the lives of every day users but I do not see this as the biggest problem.
  • The biggest issue, as I see it, remains me feeling that the market will not be ready to receive autonomy until long after the technology itself has matured.
  • This is because transport involves risk and with risk comes liability when, inevitably, something goes wrong.
  • I have written numerous times (see here and here) about why the technology will be ready long before the market is ready to deploy it.
  • I think that this will result in a shakeout.
  • Investors have been promised results and when the technology they have invested in has to sit on the shelf for several years, they are unlikely to be forthcoming with further capital.
  • Hence, I think that there is no real need to invest everything in autonomy now (outside of AI) as there is a very good chance that there will be bargains to be had when everything takes far longer than expected to start earning a return on investment.

 User growth slowdown. 

  • The growth of the hardware companies has been hammered over the last 12 months as smartphone shipment growth has slowed to below 5%.
  • I think that this is likely continue in 2017 resulting in consolidation (see below).
  • In contrast the companies whose revenues are based on the number of users, Google, Alibaba, Tencent, Facebook and so on, have enjoyed a great 2016 as the number of ecosystem users has continued to grow very healthily.
  • RFM calculates that global mobile ecosystem users grew by 12% in 2015 which combined with good growth in usage per user underpinned the 20%+ revenue growth seen from most of these players.
  • However, I think that 2017 will see both of these metrics slow with users slowing to around 8% YoY.
  • I think that this will still allow the companies whose growth is based on users not devices to show comfortably more than 10% but where investors have very high expectations, I see disappointment.
  • Facebook has already done this in saying that growth will slow materially in 2017 (see here).
  • I doubt it will be the last.

Hardware consolidation. 

  • The further slowing of smartphone device shipments is going to put more pressure on those trying to make a living by selling hardware.
  • There will be less and less differentiation in Android as Google and the BATmen (see here) take more and more control of the software that runs their ecosystems.
  • This leaves the hardware companies with the opportunity to differentiate through a cross device strategy (like Samsung, Apple and Microsoft) or by competing for scale (Samsung).
  • The execution of both of these opportunities increases the scope for consolidation among the hardware companies and I expect to see more deals in 2017.
  • Samsung buying Harman and Qihoo acquiring Blephone are good examples of the type of M&A I expect in hardware this year.

Year of the donkey. 

  • Unicorns are, by definition, very rare and I think they will become even rarer in 2017.
  • Many companies masquerading as Unicorns have been unable to execute on their promises leading to falling valuations and high executive turnover.
  • These are what I have referred to many times as donkeys (see here) who fear are going to have an even tougher time in 2017 than they did last year.
  • In the networked economy, a true unicorn needs to be almost unopposed in its field or be in a position to develop a commanding position in its market.
  • Furthermore, it must have management that is capable of executing as the best idea is worthless unless it can be brought to life.
  • Facebook, Uber, Airbnb, Linked-in, Amazon and Spotify are all good examples of companies that meet or are close to these criteria and it is these that I would consider to be the true unicorns.
  • Snap Inc., Magic Leap, LINE , Flipkart, Ola and so on are good examples of companies that currently command the valuation but where I am reluctant to put them in that hallowed territory.
  • I expect the list of unicorns to grow shorter as more and more of these companies show their true colours in the more difficult environment.

Yahoo – Calculated gumption

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Even if Verizon walks, there is value in Yahoo. 

  • Yahoo has revealed yet another hack casting further doubt over its deal with Verizon, but thanks to Alibaba, there still remains a good opportunity for those with a calculator and a bit of gumption.
  • Yahoo’s latest revelation involves yet another hack, this time twice the size of the previous one with an estimated 1bn user accounts affected.
  • To me, this looks like essentially all of Yahoo’s users have had their details stolen with half of them having suffered the indignity twice.
  • This latest event appears to have occurred over three years ago in August 2013, and worryingly, Yahoo has no idea how the incident occurred or what went wrong.
  • Alongside 1bn users, are 150,000 accounts belonging to US government, military and law enforcement personnel who have given Yahoo their professional contact details in order to unlock their accounts in the advent of a lost password.
  • For the last 10 years Yahoo has neglected its Internet assets but has still managed to enjoy high usage and engagement in the fixed Internet despite its failure in mobile.
  • It is this engagement that Verizon is paying $4.8bn for but I think that this latest hack is just another reason for users to finally wash their hands of Yahoo and use something else much safer such as Gmail, mac.com or outlook.com.
  • Furthermore, Yahoo has been experiencing a fall-off in traffic, falling one place in Alexa’s global rankings from No. 5 to No. 6, which is an initial indication that users have already started to leave.
  • Consequently, I think that Verizon has a fiduciary duty to its shareholders to at least demand a discount on the acquisition price or risk an ignominious write off not unlike that suffered by HP after its acquisition of Autonomy.
  • Fortunately for the shareholders of Yahoo, no such write-off is likely as the core business now makes up only a tiny part of the valuation of the company.
  • This comprises:
    • Alibaba in which Yahoo owns 383.6m shares with a market value of $34.9bn.
    • Yahoo Japan in which Yahoo owns 35.5% with a market value of $7.6bn.
    • Net Cash of $5.3bn.
    • Patents which I have previously valued at $500m but am becoming increasingly concerned that they are of little value.
    • Hence, I am reducing Yahoo’s patent value to zero.
    • Core business for which Verizon is nominally paying $4.8bn but given the risk that it walks away, I am now valuing it at zero.
  • This sum of the parts calculation values the equity of Yahoo at $47.8bn which with 948.5m shares in issue gives a price per share of $50.4.
  • This is some 23% above where the shares are currently trading meaning that, even in the advent of Verizon walking away and the core business imploding, there is still significant upside in the shares.
  • Yahoo looks very attractive but it will stake someone with gumption to risk real money in the shares.