Category Archives: Market Commentary

HPQ Q2 – The Meg diet

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Austerity buys time for a proper strategy to be formed.

  • HPQ posted good Q2 results and guided nicely as the cost cutting plan began to show results.
  • Q2 Revenues and EPS where $27.6bn / $0.87 compared to consensus at $28.0bn / $0.81.
  • Revenues from the PC segment where the real culprit for the top line falling 20% YoY to $7.58bn.
  • This was in part exacerbated by aggressive actions on the part of Dell to hang onto market share with inferior products.
  • HPQ declined to participate in a price war and so share was lost.
  • Dell caused problems this quarter but in reality the real danger is coming from Samsung, Asustek and Lenovo.
  • These vendors have a proper strategy in place and are much better positioned to thrive in the new market that the PC industry has become.
  • It is here that HPQ must focus its attention as Dell does not represent much of a threat to HPQ in the longer term.  
  • The real story was cost cutting where 29,000 positions are being eliminated to eradicate the inefficiency that has been endemic to this company for many years.
  • Consequently operating cash flow also grew by 42% YoY and due to a substantial reduction in capex, free cash flow grew 100% YoY.
  • Guidance was positive with Q3 EPS $0.84-$0.87 compared to consensus of $0.83
  • This combined with relief that the damage from the PC market and Dell’s predations were not worse, drove the shares up 14% in after-hours trading.
  • These results have all the hallmarks of a company teetering on the edge of long term decline.
  • To HPQ’s credit, it is showing good progress on fixing the company to face the very difficult environment it faces.
  • However, it is doing this by cutting investments and this raises concerns about a recovery to revenue growth in the longer term.
  • I suspect that HPQ cutting investments because it has not yet really decided what it wants to invest in for the long term.
  • HPQ is currently sitting at a strategic cross-roads and needs to decide what it wants to become and how it will show growth once again.
  • Meg is buying HPQ time through a stringent diet but there is still no clear picture as to what HPQ wants to become and how it intends to show sustainable growth.
  • The stock remains inexpensive and there is enough cash for a the formation and execution of a properly considered strategy but shareholders will not wait forever.

Google – Out front

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Google is extending its lead except in games.

  • Google regaled its fans with a three hour keynote that revealed updates and upgrades that push it further into the lead in the provision of Digital Life.

First the numbers:

  • 48bn applications have been installed and 900m devices have been activated.  
  • This is a huge number but I suspect it is cumulative in that users that have replaced one Android device with another have been double counted.
  • Adjusting for replacements, I calculate that the total number of Android users is currently around 750m and well on target to hit my forecast of 858m by year end.
  • If I also then adjust for the number of devices that are 1) Google compliant and 2) capable of delivering a decent user experience, I estimate that only 30% of Android devices are actually generating revenues for Google.
  • There are now 750m active users of the Chrome browser.
  • Chrome is now the No1 browser globally and promises to be much more if only people will buy the chrome books.
  • This still looks like a long shot but critically I don’t think Google cares.
  • As long as people use Chrome and Google can harvest data from the traffic then it will be happy.
  • Google + now has 190m active users, a long way adrift of Facebook, but Google is adding to functionality such as Hangouts to try and draw users into its environment.

Developers

  • The Android tools have improved making it much easier to develop in multiple languages and multiple screen sizes.
  • This is an important development because the quality of applications on Android is still substandard to that on iOS.
  • This is particularly the case when the applications run on screen sizes that they have not been designed for.
  • This should help application quality improve meaningfully and close the gap on iOS.

Maps

  • The user interface has had a big overhaul and will be available over the summer months.  
  • The focus here is to improve the user experience and make Google Maps even stickier than it already is.
  • Its decimation of the paltry Apple Maps is evidence enough of this.
  • I like what I have seen and the hill for Apple becomes even steeper. Nokia / Microsoft have work to do but they are hot on Google’s heels.  

Music

  • Google announced a music subscription service like Spotify but critically there is no free option.
  • This is unlike Google and I suspect that it balked at the cost of providing free service with no tangible revenues to put against the cost.
  • Without free starter package, I can’t see many users switching and so Spotify won’t be losing any sleep yet.

Games

  • Very little was announced which is surprising when you consider that smartphone users spend 32% of their time playing games.
  • New services (Google Play game services) have been launched that allow achievements, cloud saves and leader boards. These are all integrated into Google +.
  • I found this very disappointing.
  • In terms of capturing user eyeballs, this is a huge segment on mobile, and Google’s efforts here look perfunctory at best.
  • This is great news for Microsoft and Apple as their offerings are much more developed and Google’s unwillingness to properly address this segment of Digital Life leaves the door open for them.

Take Home Message

  • This was a good day for Google which was reflected with another all-time high on the share price.
  • I am concerned about its unwillingness to address gaming properly as this is the only piece of the Digital Life pie that it is missing.
  • Corporate governance also remains a concern but I think that that is accounted for in the fact that its valuation is still meaningfully below that of many of its rivals.
  • I would rather buy Nokia or Microsoft for the upside but I can’t argue against a happy holder of Google.

 

BlackBerry – Roll of the dice

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Making BBM available elsewhere is a very risky move.

  • The launch of the BlackBerry Q5, upgrades and extensions to BBM make it very clear how BlackBerry intends to regain its former glory.
  • The Q5 is an interesting looking device sporting two bright colours and a 3.5” touch screen as well as a full QWERTY keyboard.
  • However, BlackBerry has not said how much it is going to cost and in order to appeal to the target market, it is going to need to come in around the $200 mark.
  • This is because one of the main draws of BlackBerry is the BlackBerry Messenger (BBM) which will now be made available to users of Android and iOS.
  • While this substantially increases the scope for growth of the user base of BBM, it means that more and more, BlackBerry devices have to stand on their own merit.
  • A major reason to buy a BlackBerry device has now been removed meaning that the user experience and hardware specification must now win over users on their own.
  • This is an incredibly risky move as previously locked-in users may now abandon the platform while still being able to access BBM.
  • The functionality of BBM has also been expanded to include BBM Channels which is a little bit like following a group or community on Twitter or Facebook.
  • The Mercedes Petronas Fomula one team is the first brand to have its own channel on BlackBerry to which users can subscribe and contribute.
  • This is all about expanding the functionality of BBM into a more fully fledged ecosystem capable of offering users more scope to live their Digital Lives within BlackBerry.
  • If this works then RIM will be learning more about its users and will benefit from greater loyalty resulting in higher share, prices and margins but also from the potential to sell targeted advertising.
  • BlackBerry still has more than 70m subscribers of which more than 60m are BBM subscribers.
  • This puts the proposition on a knife edge in my view.
  • To be sustainable, BlackBerry must increase its subscriber number to over 100m but in order to do that it needs for its devices to be competitively priced.
  • It must now achieve this without the draw of DDM to BlackBerry devices.  
  • When it comes to counting users, I am not inclined to include those that start to use BBM on other platforms as they are not really part of the ecosystem proposition in the same way that users of BlackBerry device will be.
  • Most importantly of all, BlackBerry will be unable to make money from these users for a long time and so for the moment they should be excluded from any economic analysis of BlackBerry.
  • Looking at the price of the Z10 and Q10, I am not hopeful that the Q5 will end up being priced at a level that allows it to compete with low to mid-range Android or even Windows Phone 8.
  • BlackBerry is doing the right things but I need to see some market traction before I can have confidence in a recovery.
  • It’s a cheap stock but Nokia has a better chance of seeing a proper turnaround.

 

 

 

 

 

Intel – Killing the Monkey

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ARM is looking less and less threatening to Intel.

  • Thanks to the blunder that is Windows RT (Windows 8 on ARM), ARM has made no real impact in the PC space and the outlook for it to do so is fading fast.
  • On top of this, Intel is far from standing still and the more time that goes by the closer Intel gets and the less that the gap matters.
  • Last week, Intel revealed its latest chip core aimed at the mobile space called Silvermont.
  • This is the first chip for mobile that makes use of the trigate technology which adds further improvements on top of Intel’s process advantage.
  • The problem that Intel has faced over the last 6 years has been the inherent design of the x86 processor which, all other things being equal, will always consume more power than an ARM processor.
  • This has been the monkey on Intel’s back as it is unable to change the nature of the processor as it is the foundation upon which 30 years of success is built.
  • As more and more of its market becomes battery powered, this represents an obvious threat for Intel, which was really brought home by Windows 8 being made available for the ARM processor.
  • Fortunately for Intel, Windows RT is so limited that the devices have not sold in volume and manufacturers are pulling support for the platform.
  • Furthermore, it is going to be some considerable time before the Microsoft Windows OS is properly harmonised to run ARM as well as Intel.
  • In the meantime Intel continues to innovate and the new cores will shortly appear in real devices.
  • The first chipset is Bay-Trail which will be in tablets later this year and handsets in 2014.
  • Intel has already done a reasonable job at closing the gap with ARM and this development will take that one stage further.
  • I have already seen Intel powered smartphones that are sleek looking, competitive on specification and price and can go a full day on a single charge.
  • For me, this turns the tables.
  • For years, I have been concerned that Intel stood to lose share in its core markets of PCs and servers, but now I am starting to think the opposite.
  • As handheld devices need to be increasingly powerful, there is scope for Intel to even take market share from ARM as it is at last beginning to compete on a level playing field.
  • Intel is not expensive and seems to be showing results in mitigating the greatest threat that it has ever faced.
  • I am inclined to have a careful look at this one.

 

Nokia – Brutal for a bit

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Nokia’s new platform does everything right except address the horrors of low end Android.

  • Nokia has launched a big update to the Asha platform and the release of a new handset the Asha 501.
  • The new platform runs on software proprietary to Nokia and uses Java for applications development.
  • To date, Java has been awful in mobile phones but the Asha platform optimises Java to run more efficiently and Nokia has extended functionality to make the applications more appealing.
  • At the same time Nokia has made its Software Development Kit (SDK) and web tools available for designing and coding applications to run on these devices.
  • Also included in the package will be an in-App payment system to make it easy for developers to earn a return on their investment.
  • Developer support for the new Asha platform looks pretty encouraging ensuring that most of the core functions of digital life will be available to users.
  • The Asha 501 was also launched which sports a 3” screen, 3.2MP camera, WiFi but no 3G, full touch and a range of bright colours.
  • The device will sell for $99 and will ship in June.
  • I am a huge fan of Asha as I believe that it delivers fantastic functionality and quality for the price asked.
  • It also capitalises on Nokia’s core strengths of scale, logistics and platform.
  • Unfortunately smartphone buyers at the moment don’t seem care.
  • All they seem to care about at the moment is the largest screen for the lowest possible price.
  • Consequently the endless medley of Chinese and Indian smartphone makers are churning out devices to meet that demand.
  • A typical device will have almost all of the BOM invested in the display with a little left over to invest in the MediaTek baseband and applications processor.
  • During Q1 these devices did Nokia’s Asha series considerable damage in the $35-$100 price range and I can only hope that the Asha 501 and its successors can reverse the trend.
  • Nokia has invested in functionality but the majority of the demand in that segment at the moment is hardware only.
  • These users are often first time smartphone users and I suspect that as they become more sophisticated they will start to realise the drawbacks of a device where all the investment has gone into the display.
  • Until then, life is going to remain tough as Nokia is selling a proposition that the market may not be ready for.
  • In the longer term, Nokia has the right characteristics to be a dominant low end handset supplier and as long as it can hang on through the tough times, life should be much sweeter on the other side.
  • Asha is right answer for Nokia to address low-end Android, but the users need to realise the realities of the proposition first.

IPR – The Weakness of Essential (part iv)

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The latest EU ruling weakens the case for using SEPs for protection.

  • The strength of standard essential patents (SEP) has taken another hit as the EU has found that Motorola has been abusing its position as a SEP holder.
  • SEPs are patents that have been used to implement a technology standard such as 3G or LTE.
  • They reason they are so powerful is that they have to be infringed in order to implement a standard.
  • Hence, anyone who makes a LTE device will have infringed any patent that is standard essential to LTE.
  • Therefore it is very much easier to prove infringement of an SEP than it is for any other patent.
  • However, there is a catch.
  • When the standard is created, those that hold the patents agree to licence their technology on a fair, reasonable and non-discriminatory basis (FRAND).
  • The holders of these patents are also not supposed to seek injunctions but Germany is a territory that has historically allowed injunctions on SEPs.
  • This is why the vast majority of patent infringement lawsuits in Europe are tried in Germany as it is the most plaintiff friendly.
  • However, this may all change, as the EU finding is clearly frowning on the practice of seeking injunctions for SEP infringement.
  • This is going to make life difficult for anyone trying to defend themselves using SEPs.
  • This is basically everyone except Apple and Microsoft who have had considerable success in prosecuting non-essential patents.
  • With non-essential patents, there are no rules covering the terms under which they may be licenced making them much more powerful once infringement has been proved or admitted.
  • What most of the industry has done is to buy as many SEPs as they can get their hands on and then try and use those to defend themselves against the predations of Apple and Microsoft.
  • This ruling from the EU (albeit a preliminary one) is likely to set a precedent which could scupper attempts to seek injunctions as a remedy for SEP infringement.
  • This is a real problem as the threat of injunction is one of the few remedies that will get an opponent to cave in.
  • Hence, I suspect that days of usefulness of SEPs are numbered which is going to make life increasingly difficult for the Android community in particular.
  • The winners here are Microsoft and Apple both of whom offer good value for investors even if the shorter term outlook looks difficult.

 

 

 

 

 

 

Intel – Dull, but right

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The floundering challenge of ARM reduces pressure for Intel to do anything radical.

  • Intel has announced the appointment of Brian Krzanich as CEO of Intel following the retirement of Paul Otellini.
  • Mr Krzanich has been COO since January 2012 and is a 30 year veteran of Intel having started in 1982 as an engineer in the New Mexico Fab.
  • His speciality is chip manufacturing and he was mostly responsible for managing the move towards foundry business.
  • Mr Krzanich has been chosen over a raft of external candidates most interesting of which was Sanjay Jha, ex-CEO Motorola Mobility and ex-COO Qualcomm.
  • This choice speaks volumes about how things have changed in the last 12 months.
  • In the last year, the threat to Intel has diminished markedly and to me this is what makes an internal candidate a dull, but correct choice.
  • Firstly, ARM has made no meaningful impact into the computing market.
  • In fact, so bad is Windows RT, that I expect most manufacturers to pull their offerings any time now.
  • I think that the only hope for ARM in this space is complete harmonisation of Windows 8.
  • What I mean by that is that from a user perspective there should be no difference when it comes to buying a Windows 8 device.
  • It will take time for all the third party software to become compatible but there is no reason why the core of Windows 8 should be harmonised.
  • The user’s choice should be made on performance, battery life and price alone and he should not have to worry about a locked desktop etc etc.
  • The powers that be inform me that this will be very difficult to achieve, but until it is I firmly believe that ARM is going nowhere in this space.
  • Secondly, Intel has improved.
  • Its latest round of chips for mobile devices is actually pretty good.
  • There are Intel powered mobile devices that run Android at $400 that compete effectively at that price range.
  • While there is still a gap when it comes to power consumption, I think that Intel has gotten over the worst of its issues as its devices can now go from morning to night on a single charge.
  • This is a key criterion as almost all smartphones need to be charged while the user sleeps if they are not to run out of juice the next day.
  • Hence, I think that Intel is right to focus on manufacturing as its future as the pressure for a huge change in strategic direction has been lifted for the time being.
  • Intel has its best friend Microsoft largely to thank for that.

Apple vs. Samsung – Lessons in futility

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The only winners are the lawyers. 

  • Yet another round of tit for tat was launched this week with the date of yet another trial being set for November 12th 2013.
  • The purpose of this trial is to argue the value of the award that was set at the 2012 trial where Apple was awarded $1.049bn in damages, which was subsequently reduced to $598m.
  • By the time all this jumping and down is finished I would not be surprised to find that Samsung has spent more than the current award in legal fees.
  • At the height of its war with Nokia, Qualcomm was spending $300m a year and this was nearly 7 years ago.
  • The real problem here is that the life cycle of a mobile phone these days is shorter than the legal cycle.
  • This basically means that by the time one has succeeded in getting a product banned for patent infringement, it will no longer be shipping.
  • Hence the only recourse that one has is one of back royalties and punitive damages and these issues can be argued endlessly ending up in fights that go on for years.
  • This one is a classic example.
  • The heart of the matter is that it is rapidly becoming in Apple’s interest to settle this case.
  • That way it will at least receive some royalties and the cripplingly expensive legal expenses can be stopped.
  • The onus is on Apple because it is Apple that is losing out as a result of the Samsung Galaxy products shipping in huge numbers and at very healthy margins.
  • Unfortunately, the late Steve Jobs had a very pugnacious attitude when it came to seeking redress against those that he deemed to be copying his innovations and this still seems to be the order of the day.
  • The longer this carries on, the more pointless it all seems and the less scope there is for either side to end up winning anything meaningful.
  • Hence it is in the interest of both Samsung and Apple to settle their claims and get back to the business of making products.
  • I would like to believe that both of these companies have some degree of pragmatism and as a result I hope to see them settle their differences this year.
  • It is their job to enrich their shareholders not the legal profession and the sooner they remember that, the better. 

Dell – Don’t be Greedy

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Those holding out for $15 may be disappointed.

  • The exit of Blackstone has little to do with PC forecasts and everything to do with a bidding war that was increasingly likely to end in disaster.
  • I suspect that Blackstone realised that paying “more than $14.25” was effectively giving shareholders a far better return than they were entitled to given the risks involved.
  • Dell is at a strategic dead end and in my calculations a fair price for that is around $12 per share.
  • To see a higher price, substantial risks need to be taken to derive and implement a new strategy which could fail leaving Dell far worse off than it is today.
  • Hence offering shareholders $14.25 or more a share is offering them a greater return than they are entitled to.
  • This is because they are unwilling to take the risk of a strategic turnaround and if the deal was to fall through, I suspect the shares would be rapidly marked back to around $12.
  • Hence, to me the Dell / Silverlake offer of $13.65 is a pretty good price for shareholders.
  • The problem now is that I understand that even Silverlake is getting cold feet and it will cost it a fortune ($750m) to walk away.
  • Greed and fear remain as alive today as they have ever been.
  • However, I think that Silverlake is wrong to get cold feet. At $13.65 a share there is a lot of money to be made if execution is solid as the PC market is far from dead.
  • At that price, Silverlake and Michael Dell will need to raise around $19bn in debt to make the deal happen.
  • I strongly believe that the plan is to split the company up and sell off the PC business.
  • The idea here is that the valuations of the server, software and services business are being heavily polluted by the PC business.
  • Get rid of the PC Business and Silverlake will find itself with a range of business with some growth potential that can now be properly valued.
  • The key to this is that Silverlake and Dell must sell the PC business for $19bn or more.
  • That way they can get rid of all the debt raised leaving them with a large stake in a growth business acquired at a low price.
  • $19bn requires the PC business to sell at 0.7x EV/Sales, some 40% higher than HPQ which is on 0.5x EV/Sales.
  • To get that 40%, the PC business will need to be turned around or at least put on a clear and credible strategic path.
  • Here lies the risk, as Dell’s competitive edge as long since been eroded and very little has been done to find a new one.
  • Despite the risk, Silverlake are pretty savvy bunch in my experience and I am pretty confident they can come with something innovative given a chance.
  • However, Carl Ichan is still hovering in the wings and seems to be willing to pay $15 a share for a very substantial stake.
  • Shareholders voting for Carl Ichan had better make sure it is their shares that he buys as I seriously doubt those left behind will ever see $15 again should he get in the driving seat.

 

GOOG Q1 / MSFT Q3 – Have and Have not

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Google looks steady while Microsoft continues to chase its own tail.

  • Sift through the details of Google and Microsoft’s earnings announcements and you will see clear signs of the old and the new.
  • How consumers interact with machines and the internet is radically changing and Microsoft is struggling to remain relevant in that segment.
  • Google reported revenues / EPS that beat expectations with $11.0bn / $11.58 compared to forecasts of $11.2bn / $10.68.
  • The EPS beat was mostly due to a one time R&D tax credit.  
  • Motorola Mobility was once again a thorn in the side of shareholders with another thumping loss of $179m (-18% EBIT margin).
  • Microsoft defied gravity with enterprise and server software making up for the slump in consumer.
  • Microsoft reported revenues / EPS of $20.5bn / $0.72 compared to forecasts of $20.5bn / $0.68.
  • Good cost control allowed margins to expand producing the better than expected EPS.
  • The Windows division was weak with revenues of $5.7bn compared to forecasts of $5.9bn but clearly the market was braced for worse given the 14% Q1 decline in PC shipments.
  • Essentially, 25% of PC users have no real need of an advanced operating system as they only use the PC to browse, communicate and consume content.
  • It is this 25% abandoning the PC that is causing the much weaker than expected PC sales.
  • It is Android and iOS that are picking up the majority of these users and given a 4-5 year replacement cycle for PCs, I would expect this weakness to continue for a while yet.
  • The remaining 75% are content creators and I do not think that they are likely to abandon Microsoft.
  • However, many of them (including me) are finding that Windows 7 is plenty good enough for their needs and see no reason to upgrade yet.
  • This is where the Microsoft marketing machine needs to be woken from its stupor of “build it and they will come” because it has been built but no one has turned up.
  • These users need to be shown what Windows 8 really has to offer because right now they seem to have no clue.
  • Users with no clue will not be buying Windows 8. They will either stick with Windows 7 or go for iOS and Android.
  • Rapid prosecution of this problem could stop the rot and prevent some of the 25% from deserting Windows but at the moment Microsoft is showing neither the will nor the ability to do anything about it.
  • Google, on the other hand, is well placed and is actively investing in its services to keep users inside its ecosystem.
  • It knows what it wants, where it is going and how to get there.
  • The result is likely to be further steady growth in advertising revenues as well as user numbers in the Android ecosystem.
  • This is why Google is on 16.7x 2013 PER and Microsoft is on 10.4x 2013 PER and I see no reason for this to change anytime soon.