Apple – Favourable Omens

RFM AvatarSmall






Signs point to scale making up for any gross margin weakness.

  • Apple has entered a new product category and is attempting to kick-start wireless payments but in the short term, financial performance will be governed by the iPhone.
  • All the signs are pointing to a very strong calendar Q4 for iPhone shipments as pre-orders look to have been the strongest for 2 years.
  • Furthermore wait-time on some versions of the device are now up to 4 weeks and both Apple and the biggest operators are reporting higher than expected demand.
  • This does not come as a huge surprise to me as both the iPhone 6 and 6+ address the long term problem of small screen size.
  • Screen sizes of 4.7” and 5.5” bring it into contention in the phablet space which Samsung created and has dominated to date.
  • This combined with the thinness and sleekness of the new models make them worthy competitors to Samsung on hardware alone for the first time for some time.
  • When I then also consider the superior quality of the iOS ecosystem compared to the others like Google, China etc., I can see why users may be tempted to switch.
  • I suspect that the vast majority of the iPhone 6’s that are sold will be to existing iPhone users, but I am also expecting that there will be some market share gain over the next few months.
  • Against this, I expect that the larger screen sizes are going to result in somewhat higher BOM costs than the market has become accustomed to.
  • As the pricing of the device looks largely unchanged, I can see slight gross margin weakness from this device compared to older versions.
  • While this may cause concern, I think that scale will more than compensate for any weakness.
  • Market share gains should lead to greater volumes meaning that the fixed costs of R&D and Sales and Marketing will be better covered.
  • Hence, I am not concerned that operating margins, net margins or cash flow will be negatively impacted.
  • To the contrary, I expect a strong calendar Q4 where operating leverage more than makes up for any shortcoming at the gross margin level.
  • Apple’s challenge is now to develop the exclusive Digital Life services that it needs to keep users paying over the odds for an iOS device.
  • This is the key to its long-term profitability but at the moment is lagging behind Google, Microsoft and even Yahoo!

Google – Method in the madness

RFM AvatarSmall






iOS still makes more money for Google than Android does.

  • Android may dominate the statistics when it comes to unit shipments and number of users, but iOS remains critical to Google’s revenues from mobile.
  • This is why it will continue to ensure that the user experience of its apps on iOS is as good as it can make it.
  • The latest is the announcement by Google of iOS sync which is part of its efforts to provide companies who use Google to run their companies, with an enterprise grade service.
  • This obviously flies right in the face of Android for work which is Google’s strategy to reform Android into an enterprise class platform for companies but there is method in the madness.
  • iOS sync allows companies to control the Google apps on iOS and to make document storage on Google drive seamless and secure.
  • This is all part of Google’s strategy to ensure that its ecosystem works just as well on iOS as it does on Android.
  • Of the 58 apps that currently make up the Google ecosystem, at least 17 are available for iOS and these are the main apps that make up its Digital Life offering.
  • Google has a love / hate relationship with iOS.
  • On the one hand it derives 52% (2014E) of its mobile advertising revenues from iOS devices but on the other it knows that Apple will wipe it from its devices as soon as it can afford to do so.
  • This is the biggest threat to Google’s current growth in my view as losing revenues from iOS would bring medium-term revenue growth to well below 10%.
  • All it can do is to ensure that Apple can never afford to remove it from its devices for fear of annoying its users and seeing them defect.
  • This is why Google will continue to develop its Digital Life service for iOS to the best of its ability.
  • If Apple can develop its own services to a point where users are happy to switch over, then it will be in a position to remove Google from its ecosystem but not before.
  • This is a very long way from happening but importantly Google is not resting on its laurels and continues developing to stay ahead.
  • Consequently, Google offers one of the securest growth stories among the ecosystem players and with Yahoo! and Microsoft, it remains top of my list.


Micromax – Bollywood beckons

RFM AvatarSmall






The home market is ripe for taking if Micromax is quick.

  • Micromax is the latest of the new generation of handset makers from Asia that are starting to make an impact on the global stage.
  • Top of this list is Xiaomi which is now the No.1 smartphone vendor in China and whose phones are used more than the iPhone. (see here)
  • Hot on its heels is Micromax which earlier this year beat Samsung into the No 2. Slot in its home market, India. (Counterpoint).
  • As of Q1 14A, Micromax is the global No.4 feature phone manufacturer with 6.2m units shipped (Counterpoint) and is now arguably the most important smartphone manufacturer in India.
  • India is like China in that it is a big enough market to support a local handset manufacturing industry on its own.
  • When it comes to smartphones, penetration is going to end up being much lower than US, Europe or even China but because the market itself is so large this is less of an issue.
  • RFM estimates that the middle class, which could afford a smartphone in India, is at least 300m which is not far off the population of Western Europe.
  • Consequently, there is a very large addressable market for Micromax even it chooses just to remain at home.
  • Micromax is not resting on its laurels and has commenced operations in the Russian market earlier this year.
  • Micromax is like Xiaomi in that it is very good at offering devices that have a pretty good specification at very low cost.
  • For example its recent Canvas Nitro A310 device offers an octa-core 1.7Ghz processor, 13MP camera, a 5inch 720p screen, 8GB storage and 2GB of RAM for $214.
  • The device runs Android 4.4 KitKat but has little other than hardware and great pricing to differentiate it from its competitors such as the Moto G and Xiaomi Mi3.
  • This is where Micromax needs to focus. Xiaomi (see here) has done a great job at capturing the use of smartphones with consumer content and I believe the same opportunity is available in India.
  • India has a massive film industry which also drives its music industry.
  • This content is very specific to India and I think that the market for delivering this to users is fragmented and not very well developed.
  • If Micromax can have some impact here, it will have the beginnings of an ecosystem from which it can branch out into the other important Digital Life services.
  • Without an ecosystem, Micromax will only be able to compete on price meaning that its margins will remain in low single digits in the best instance.
  • The Indian Digital ecosystem market is almost non-existent today and there are no obvious large contenders like Baidu, Alibaba and Tencent like there are in China.
  • This gives Micromax a good opportunity but it will have to move relatively quickly before everyone else cottons onto this opportunity.

Amazon – Fire damage.

RFM AvatarSmall






The damage to the Fire phone has already been done.

  • Amazon has cut a massive $200 off the price of its Fire phone with the 32GB version at AT&T (2 year contract) going from $199 to 99c and the 64GB version going from $299 to $99.
  • The device still comes with 1 year Amazon Prime for free making it an excellent deal for heavy shoppers.
  • All of the indications are that shipments to date have been dire (see here) and the Guardian has calculated that just 35,000 have been shipped since launch. (see here).
  • Having looked at its calculations, I can see no fault with its logic and in fact, 35,000 could even be on the high side.
  • Initial expectations were for 2-3m to ship within the first year of launch and I suspect that Amazon has made commitments for something like 1m units.
  • Assuming that all of the 1m units are shipped, then Amazon’s losses on this project have just jumped by another $200m.
  • If they are not, then losses could be greater as unsold inventory will have to written down.
  • Consequently, I think that next quarter will be marred by a write down of Fire phone inventory not unlike (but smaller than) Microsoft’s write down of the Surface.
  • This project and Amazon’s entire ecosystem strategy suffers from two major problems.
  • First: Image.
    • The incredibly poor start for this device has been widely reported in the media.
    • This means that consumers are aware of the issue and this is likely to have a large and deleterious effect on the purchase decision even if the deal is “too good to be true”.
    • This is the nature of the handset industry in that bad press can have a serious effect on market share.
    • Consumers have tended to steer clear of the devices from companies that they see faring badly regardless of how good the offer is.
    • Nokia, BlackBerry, Motorola, HTC and many others have all struggled with this problem and so far have failed to recover from it.
    • Consequently, I think that shipments of the Fire phone are likely to remain dismal despite the price cut.
    • I see a heavy write down in next quarter’s figures.
  • Second: Ecosystem
    • Amazon’s approach to the ecosystem continues to be inconsistent with very little to pull it all together.
    • Amazon’s ecosystem is tiny as RFM forecasts that it had 21.1m registered users at the end of calendar Q2 14A.
    • This is miles short of the 100m which RFM believes is needed for critical mass and hopelessly adrift of the magic 300m needed to make some real money.
    • Having a credit card relationship with Amazon does not make the user part of its ecosystem but it does give Amazon an opportunity.
    • Amazon needs to maximise that opportunity by making its ecosystem compelling and then release a handset not the other way round.
    • The acquisition of Twitch (see here) and the pricing strategy behind Amazon Prime (see here) both need to change before Amazon has any real hope of being anything other than a minnow in this market.
  • The net result is that Amazon’s ecosystem strategy continues to look like a haphazard series of expensive experiments and acquisitions.
  • Until there is some cohesion, loses are likely to continue.
  • Investor patience is already wearing thin. Mine is non-existent.

Android – Fragmentation fix.

RFM AvatarSmall






Google and China likely to completely take over their versions.

  • The latest report from OpenSignal strongly implies that Android fragmentation is getting worse but I suspect that the reverse is true.
  • The latest study shows that within a sample of 682,000 devices upon which the OpenSignal App. has been installed, there are 18,796 different Android devices.
  • This is a significant increase on last year where 11,868 different devices were found within the same sample size.
  • This does not mean that there were 18,796 different versions of the software but there are that many different handsets in the market.
  • This is both a blessing and a curse.
  • Greater diversity has made it possible for the cost of Android devices to be substantially lower than that of iOS and Windows Phone.
  • This has been a major factor behind Android’s rise to around 80% of smartphones shipped in Q2A.
  • The ability to buy a smartphone for less than $100 has enabled Android to penetrate huge markets such as China, India and Africa where cost is the single biggest concern of the consumer.
  • At the same time, it has meant that handset makers have had to make huge compromises when designing and building the devices.
  • This includes the removal of many hardware components as well as using older versions of the code which are much cheaper to implement.
  • This has also meant that, in many cases, very little is spent on optimising the standard Android code to run on stripped down hardware.
  • This has meant that third party applications either don’t run or behave erratically on different handsets from the same manufacturer.
  • No one is immune from this problem as RFM’s research has found multiple instances from app developers where their app behaves differently on different models made by Samsung.
  • This is why everyone develops for iOS first.
  • By developing for iOS a developer knows that he is targeting a much more consistent group of devices as well as targeting a higher demographic in the market.
  • This problem is endemic to Android and there is very little that is likely to improve unless something changes.
  • However, I see that change is coming.
  • RFM research reveals that both Google and the Chinese ecosystem players are working on addressing this issue.
  • The only way that this issue can be addressed is for those that are writing the code to take more and more control of it.
  • This is exactly what I see Google doing with GMS.
  • GMS is Google’s proprietary, non-open code that sits on top of the open Android software which contains all of the Google services that users are keen to have.
  • I see Google slowly expanding the scope of GMS to include more and more of the device’s functionality until the open piece is nothing more than a kernel.
  • This will mean that Google will have effectively created its own proprietary OS and in doing so it will be able to control the fragmentation that keeps it behind iOS in terms of quality of experience and security.
  • I see the Chinese players doing exactly the same despite the failure of Aliyun which it appears that Google was successful in blocking a couple of years ago.
  • In the long term, this is likely to result in Android becoming nothing more than a kernel upon which ecosystem players run their proprietary systems and experiences.
  • The end result will be less fragmentation within devices within a single ecosystem but much greater fragmentation between the different ecosystems.
  • Currently, there is nothing visible that will prevent Google from succeeding in this strategy and the end result is likely to be more and more user data being captured by Google on its servers.
  • This will be instrumental in maintaining its market share in mobile advertising and it will also help increase the relevance of the adverts that it sells.
  • This combined with strong user demand for its services is why I do not see any other ecosystem challenging its dominance anytime soon.
  • This is likely to mean growth in revenues above 10% for the next few years making the stock still look interesting despite its strong run over the last few years.
  • Google along with Yahoo! and Microsoft are still the most interesting places to look when considering an investment in the mobile ecosystem.

HPQ Q3A – Gentle drift

RFM AvatarSmall






HPQ is drifting from one quarter to the next with no direction. 

  • HPQ reported good Q3A revenues as market share was gained but weaknesses in the high margin businesses kept any gains from hitting the bottom line.
  • Revenues / EPS were $27.6bn / $0.89 compared to consensus at $27.0bn / $0.89.
  • The stabilisation in the PC market that helped both Intel and Lenovo was also felt by HPQ but HPQ also managed to gain share in PCs to 18.3% just behind Lenovo on 19.4%.
  • Unfortunately Enterprise Services, Software and HP Financial Services all saw declines in revenue
  • These are the areas where HPQ needs to grow most as it is here where there is value to be added and good margins to be earned.
  • The result of these declines was lower margins which wiped out both benefits from the revenue beat in PCs and benefits delivered from the cost reduction program.
  • Guidance for Q4E was in line with expectations with EPS of $1.03 – $1.07 compared to consensus at $1.05.
  • These results are indicative of the malaise that currently besets HPQ.
  • The company is cruising from one quarter to the next with no real strategic direction which is showing through in the financial results.
  • The improvements delivered through streamlining and cost cutting are being eaten up by weaknesses in business that should be growing and badly need to be set to rights.
  • HPQ needs to decide where it wants to go as a company and make its assets all pull together in the same direction.
  • This is the only way that the company can return to growth because as things stand at the moment, the next time the PC market dips, HPQ’s earnings will go with it.
  • Lenovo, Asustek, Microsoft and Intel remain far better ways to gain exposure to theme of a recovery in the PC market.

Facebook & friends – Internal affairs

RFM AvatarSmall






Facebook’s messaging mess highlights a problem for everyone.

  • The number of attempts Facebook is making to crack the millennial messaging market is growing fast and with it the bill for shareholders.
  • Facebook’s travails also highlight a very significant problem faced by all of the ecosystem contenders when it comes to developing their Digital Life offerings.
  • Many contenders are using M&A to grow their way around the Digital Life pie but unfortunately the reality is much more complicated.
  • Facebook seems to be desperately trying to win back the younger part of its user base by trying to address the success of Snapchat.
  • Following its failure to create a clone, it then tried to buy the original and when that failed, it returned to trying to copy it.
  • Its first attempt called Poke failed after a couple of months, Slingshot has suffered a similar fate and now Facebook is trying again with Bolt.
  • Bolt is a standalone app. that is derived from Instagram that effectively replicates the functionality of Snapchat.
  • So far the signs are quite good but it has only been launched in New Zealand, Singapore and South Africa.
  • These efforts also go hand in hand with the Facebook chat app. and the WhatsApp acquisition to make a very confusing messaging strategy.
  • It looks like Facebook is trying to hang onto the younger generation of users many of whom have been put off the main service by the arrival of their parents onto the system.
  • Facebook now has at least three separate messaging strategies for a single service that are all separate and distinct from one another.
  • The value to Facebook of messaging would be many times greater if all of these services were able to interact with each other.
  • Unfortunately, the agreements made at acquisition seem to ensure that the acquired entities remain separate and continue to operate independently.
  • If this remains the case then Facebook will never be able to take WhatsApp into gaming or integrate it with its other services.
  • In my mind this is the only way in which Facebook can have a hope of earning any return on the $19.6bn of shareholder’s money that it invested in acquiring this company.
  • This is the most striking example of a major problem that besets all of the digital ecosystem contenders.
  • To generate value to its full potential, a Digital Life offering needs to have all the services integrated and aware of one another.
  • This way the services work better and the owner of the services can gain a much deeper profile of the user.
  • This is critical to selling value added advertising as well as providing a deeper and richer service to the user.
  • So far only Google has come close to this ideal and this is a major reason why I believe it is by far the most successful at monetising the mobile internet opportunity.
  • Yahoo!, Microsoft, Apple, Amazon, Twitter, Facebook, Sony, Tencent, Baidu, Alibaba and so on must all get on top this issue if they are to really succeed.
  • Almost all the deals struck to date state that the acquired service or app. will continue to operate independently of the acquiring company.
  • I believe independence is the only way in which acquiring companies can entice hot new services and apps to allow themselves to be purchased.
  • Many acquirers believe that once the acquisition is closed, the problems are over but I suspect that the reverse is true.
  • The acquirer has a fiduciary duty to its owners to earn a decent return on the money it invests and without integration, this is very unlikely to happen.
  • Only a very few of the ecosystem players understand this problem and Facebook is not among them.
  • Consequently I see Facebook’s attempts at expanding outside of social networking remaining stillborn and continue to believe that it will run out of growth as soon as the social networking piece is properly monetised on mobile devices.




Lenovo Q1A – Breathing space

RFM AvatarSmall






Improvements give Lenovo more space to invest and execute.

  • Lenovo reported good Q1 results as its handset business and PC business both grew share.
  • This gives the company more breathing room when it comes to turning around the loss making Motorola Mobility that it is about to acquire from Google.
  • Q1 revenues and net income were $10.4bn / $213m compared to consensus forecasts of $9.9bn / $201m.
  • Lenovo saw a 15% increase in PC shipments despite a stagnant market and also registered a 16% increase QoQ in smartphone shipments against a market that grew by just 4.6% QoQ.
  • Market share in PCs has hit an all-time high of 19.4%, nearly 1% clear of HP while smartphone share has reached 5.1%.
  • Including Motorola, smartphone share is now at 7.6% making it comfortably number 3, although it now has Xiaomi snapping at its heels.
  • EBIT margin has inched up to 2.7% from 2.5% in Q4 but the revenue increase has driven Q1A operating profit to $283m.
  • This combined with the fact that EBIT Losses at Motorola almost halved in Q2 to $99m (Google Q1 10Q) gives Lenovo much more room to effect its strategy.
  • Additionally, the IBM server business is more profitable than the Lenovo group which should also help keep the company in the black when the two transactions have closed.
  • Lenovo has $5.5bn in the bank much of which will be spent on the transactions to come.
  • However, this combined with the improving fundamentals gives Lenovo enough space to give its strategy to become a major player a proper chance.
  • That being said, this will not be easy. I have long believed that at least 10% market share is needed before any scale related benefits start to kick in leaving Lenovo 2.4% adrift.
  • This means that heavy investments are going to have to be made which could easily push Lenovo into loss making territory.
  • Furthermore, sooner or later Lenovo is going to have to contend with the fact that all the value in its industry is migrating to the ecosystem for which it has no answer.
  • It claims to have a stake in the digital ecosystem with its SHAREit application but this is merely a tool for transferring content between different Lenovo devices and is not a Digital Life service in its own right.
  • Hence Lenovo continues to get a 0% score on the RFM Digital Life Pie analysis but I can see it starting to think about being a contender.
  • Historically, I have been concerned regarding Lenovo’s strategic depth but I have to admit that in the last three months it has surprised me.
  • Lenovo remains one to watch but I still think that the new strategy will make a dent in earnings and the valuation before it can hope to come good.

Zynga Q2A – Chalk and cheese

RFM AvatarSmall






Bad results show the difference between consoles and handhelds.

  •  Zynga reported weak Q2A results and cut its 2014E guidance as new revisions of its flagship games will take longer than expected to reach the market.
  • The key metric for Zynga is bookings which is the value of virtual goods sold during the quarter.
  • Q2A bookings and EPS were $175m and $0.00 compared to consensus at $191m and $0.00 respectively.
  • Only aggressive cost management enabled Zynga from slipping into negative territory.
  • On this front, it looks very much as if Zynga is cutting in the muscle of its creative machine as crucial new products such as Poker and Words with Friends will now be delayed.
  • The result is that the outlook for the rest 2014E has been cut hard.
  • Q3 bookings are expected to be $165m-$175m with EPS at LOSS$0.01 – $0.00.
  • This is way below consensus at $212m in bookings and EPS of $0.01.
  • Booking for the full year 2014E will now be $695m-$725m which is a meaningful reduction on the $770m-$810m that was forecast in April.
  • The one bright spot was cash. This remained almost unchanged at $1.15bn compared to $1.14bn in April.
  • This gives the company time to turn itself around despite the fact that aggressive cost cutting has meant that everything will now take longer than originally planned.
  • Zynga’s business is now focused on bringing its existing and new titles to mobile in a new and exciting way.
  • Unfortunately, the edge that it once had in social gaming has long since been competed away.
  • Gaming is a brutally competitive space and Zynga seems to lack the innovation that will allow it to regain some of the lustre that it has lost.
  • Mattrick has been in charge for a year and I suspect that he is finding it much more difficult than he expected.
  • There is a big difference between console gaming and casual based gaming in that user loyalty and stickiness is much lower.
  • This means one has to wow users with something that is really out of the ordinary to keep them coming back for more.
  • Against the juggernauts of Clash of Clans (Supercell) and Candy Crush (King), Zynga still has no real answer and its pipeline is not exactly encouraging.
  • Dominance in this industry can change very quickly which gives Zynga the opportunity.
  • However, it will have to come up with something pretty special to breathe new life into the financials.
  • Of this there is currently no sign.


Samsung vs. Apple – Hint of sanity

RFM AvatarSmall






The glacial creep towards a settlement continues.

  • Samsung and Apple have agreed to drop all litigation against each other that is taking place outside the US.
  • No licencing terms have been signed and both companies will now focus their efforts on pursuing their fight in the US.
  • This is similar to the agreement between Apple and Google in May 2014 where both companies dropped their suits and walked away. (see here).
  • It is known as a second class settlement and does not prevent hostilities from being re-opened should either wish to do so.
  • However, I think that this is very unlikely and believe that both companies are beginning to realise the futility and crippling expense of this long running and increasingly pointless war.
  • Events have shown that Samsung does infringe some of Apple’s IP but they have also shown that it is very difficult to force Samsung to pay for it.
  • Furthermore, the value of Apple’s portfolio took a massive blow when it was awarded just 5.4% of what it asked for at trial (see here).
  • Combine this with the legislative agenda moving against the use of standard essential patents in US and EU, and it is clear that the whole landscape is becoming very difficult for both sides.
  • For both of these companies, the US is their biggest market in terms of revenues and I suspect that they will use the outcome from this market for a global agreement.
  • This gives me hope that there is some pragmatism and rationality growing in both camps as this war has already cost both sides more than either is ever likely to earn or pay in royalties.
  • Apple’s approach has historically been more emotional in that it did not want others to use its innovations and sought to keep them from the market.
  • While well within its rights, it has proven to be impractical and I am hopeful that Apple is beginning to realise that it will have to do a deal of some description with Samsung.
  • This deal is likely to involve a net payment by Samsung to Apple but the ending of crippling legal fees is likely to mean a profits increase at Samsung.
  • I remain optimistic that a deal will be reached this year.
  • This issue is increasingly irrelevant for Samsung which is struggling with the profitability and growth of its smartphone business.
  • Now that it ceded control of the ecosystem to Google there is nothing to prevent margins falling to 11% over the next 3 to 4 years. (see here)
  • The result is a 25% decline in group EBIT and a share price very likely to underperform.