LeEco – Electric millstone.

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I think, LeEco must exit automotive to survive.

  • It looks very much like LeEco is giving up its grand plans for a 12,000 employee eco-headquarters in return for hard cash in order to give the ecosystem strategy time to succeed.
  • Despite these radical actions, I still think that LeEco’s only chance is to give up its automotive ambitions and focus on its core business: the ecosystem.
  • LeEco has recently raised $2.2bn (see here) which I calculated would leave $622m free to support the fledgling ecosystem of products and services.
  • However, the sale of the 48 acres it purchased from Yahoo to Genzon Group, the Chinese real estate developer this increases my estimate of free cash for investment to $1.132bn.
  • This is because to reach the $622, I took off $250 for purchasing the land but this outflow is now an inflow of $260m, improving cash flow by $510m.
  • This will give the company time to develop its offering but I remain concerned that its automotive ambitions remain a major problem.
  • LeEco’s automotive strategy is centred on an electric vehicle start-up called Faraday Future in which its founder is the major backer.
  • It broke ground on a huge 3m square-foot factory in Nevada in April 2016 but because contractors have not been paid, work has since ground to a halt.
  • Furthermore, Faraday Future has now reduced the size of the planned factory by 80% to 600,000 square-feet, cut the number of models from seven to two and delayed the factory opening by at least 1 year.
  • Faraday Future’s problems do not end there as senior management turnover has been high in the last 9 months and there could be as much as $300m in unpaid bills.
  • As Apple (see here) and even Tesla have found, building cars is a difficult business that requires a lot of time and very deep pockets.
  • I am pretty certain that Faraday Future has none of these things making its chances of long-term solvency very slim.
  • This is why I think that LeEco’s best interests will be served by not having this millstone hanging around its neck.
  • Faraday Future clearly needs hundreds of millions of dollars of new investment which LeEco simply cannot afford if it is to have any chance at delivering on its ecosystem ambitions.
  • These ambitions begin with a media consumption strategy that needs both heavy investment in terms of content and attention to detail when it comes to software and the user experience.
  • Furthermore, management needs to be focused on delivering on these ambitions rather than being distracted by building self-driving cars.
  • RFM research has found that currently, the user experience in the automobile has no effect on the user’s decision on where to live his Digital Life and therefore building a car to deliver one’s ecosystem makes no sense at all.
  • This combined with the difficulties, cost and poor profitability of automobiles, is why I think that Apple backed off (see here).
  • Hence, I think that for LeEco to have the best chance of succeeding, it needs to extract itself from Faraday Future and forget about self-driving cars.
  • Building a thriving ecosystem is difficult enough and throwing in cash constraints and management distractions can only make it next to impossible.

 

Spotify – Patience pays.

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I think shareholders will see more value by being patient.

  • Spotify is closing in on finally doing a deal with the record labels that I think will remove the last obstacle to the company going public.
  • Spotify and three of the largest record labels have been dancing around each other for a significant period of time without coming to any definitive agreement.
  • This is crucial because without the content from these three labels. Spotify would be unable to provide its current service.
  • I have long argued that as Spotify’s user base grows, so does its negotiating power and that the longer it took to arrive at an agreement, the better it is for Spotify (see here)
  • However, the time for Spotify to go public is approaching fast and I suspect that without a deal with Universal, Sony and Warner, any valuation that Spotify would achieve at IPO would be materially impacted.
  • Furthermore, with this hanging over its head, the stock would be very volatile in the public market as, in theory, the labels could wipe Spotify out at any time by pulling their music from its service.
  • In practice, this is never going to happen because with every month that passes, the labels need Spotify more than it needs the labels and I am pretty sure that if they were going to pull their music from Spotify, they would have done so ages ago.
  • This is because streaming is now the only source of growth in the music industry without which the labels would lose what has become their most important route to market.
  • Spotify is unique in that it is the only major platform to have a free-tier and adding in those users takes Spotify’s total user count well north of 100m.
  • This is hugely significant, as although these users do not pay Spotify directly, they generate vast amounts of data which can be used to improve and train its algorithms.
  • This is critical because it is those algorithms that allow Spotify to both understand the music it has on its platform as well as accurately match it to the users that it has.
  • In the long-term, I think that this gives Spotify the opportunity to cut the labels out completely which would have the effect of substantially enriching both artists as well as shareholders of Spotify.
  • I think that this is why Spotify is not keen to do a deal with the labels that limits the provision of music to free users as data collection and algorithm training would most likely be impacted.
  • The other side of the coin is that I suspect that Spotify has guided its investors to a time when it can IPO, giving existing shareholders visibility as to when they will see a return on their investments.
  • I believe that doing an IPO without a signed deal with all three of the biggest labels has difficulty written all over it which is why Spotify is considering caving in to some of the labels’ demands.
  • Although this will bring some short-term benefits to Spotify and its shareholders, I think that a deal in the short-term could delay Spotify’s ability to supplant the labels which I have long believed is where the real upside lies.
  • This is because I see that this is how Spotify goes from earning $0.30 on the subscription dollar to $0.50 or more.
  • Hence, I think that the best outcome for shareholders will be achieved by being patient and letting the IPO exit window slip for as long as required for Spotify to become powerful enough to dictate terms to the labels.
  • I continue to see only a minor threat from Apple Music as Spotify is still adding paid subscribers much more quickly and shows every sign of having better artificial intelligence with which to differentiate its service.
  • Whether Spotify can convince its shareholder of the merits of delaying their exit remains to be seen.

Facebook – Brainless video.

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Focusing on video first makes complete sense.

  • I think that Facebook is making the right choice in targeting video first as it already has traction and video-based services tend to have the lowest requirements for artificial intelligence to make them easy, fun and useful.
  • With the launch of a TV app being just the latest move Facebook has made in video, it is increasingly clear that Media Consumption is Facebook’s number 1 priority for 2017.
  • The TV app that is being launched is very simple in that it makes it easy for a user that does not have time to watch videos on Facebook during the day to easily to so at night on a larger screen.
  • This should enable a better video experience and begin to spread engagement across other devices but it will come with the added complication of multiple resolutions and bit rates.
  • On a mobile device the screen is small which means that lower resolution videos and bit rates are acceptable, but once these are played on a larger screen, their shortcomings quickly become obvious.
  • This move into TV comes hot on the heels of the addition of a tab at the bottom of the Facebook app which links to the top trending videos as well as videos that Facebook thinks that the user might like.
  • The TV app will initially be available on Amazon TV and Apple TV but I expect that it will quickly spread to Xbox, PlayStation and the other streaming TV devices that are available.
  • The one place I don’t expect to find it is Chromecast as Facebook’s video aspirations are clearly a challenge to YouTube.
  • Of the three new areas of Digital Life (Gaming, Media Consumption and Search) that I see Facebook targeting (see here), going for video first makes complete sense.
  • This is because Facebook already has a lot of traction in this space and also because it is the least demanding in terms of requiring intelligent automation.
  • The total number of video items that are present is very low compared to other things like music or searches and knowing who posted the video is a good indicator of its content and who will like it.
  • I continue to see Facebook as the laggard in AI (see here) and targeting video is sensible as it gives it more time to improve its AI before having to apply it to more difficult tasks.
  • Furthermore, the fact that video is a fast growing, but likely soon to mature, medium for digital advertising also means that the time to really address it is now.
  • I see the app on the TV as just the beginning and would not be surprised to see this being followed up with premium content taking it into the realm of Netflix, Hulu, YouTube and Amazon Prime.
  • That being said, I don’t think that Facebook’s offering in Media Consumption is anything like mature and so I think it will be some time yet before it becomes a real destination like YouTube.
  • Consequently, I still see a slow period of revenue expansion while its new strategies mature before revenues take off again.
  • As this reality sinks in, I think the valuation could unwind somewhat providing a better opportunity than now to invest for the long-term.

Twitter Q4 16 – No Trump card

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Trump card fails to win the trick.

  • Despite becoming a major channel for the White House to communicate with voters, the realities of Twitter’s situation have continued to dominate its financial performance.
  • Q4 16A revenues / Adj-EPS was $717m / $0.12 badly missing consensus at $740 / $0.23.
  • Monthly active users (MaU) also remained stagnant coming in at 319m up 4% YoY which reflected the anaemic revenue growth which was just 1% YoY.
  • Daily active users did manage to grow 11% indicating some increase in engagement with the service, but it was not nearly enough to convince advertisers to spend more money on the platform.
  • This reality was reflected in Q1 17 guidance where Adj-EBITDA will be $75m – $85m well below consensus at $188m which I think reflects stagnant revenues as well as higher investments in media consumption.
  • I continue to believe that the lack of growth is caused by the fact that Twitter has already fully monetised its segment and in order to grow revenue further it has to address the other segments of the Digital Life pie.
  • In this regard, Twitter has opted to go for Media Consumption which would add another 10% points to its coverage, bringing it to 28%.
  • This is why its progress with its streaming of NFL games and partnership with Bloomberg, Buzzfeed News and PBS is so important.
  • If Twitter can develop this offering into a fully-fledged Media Consumption service with real engagement, then I could see Twitter increasing its revenues to over $1bn per quarter giving annualised revenues of $4-5bn.
  • However, it is still very far from challenging YouTube or Facebook Video which is why I need to see far more than just NFL streaming and a bit of news in order to become confident that Twitter has a media consumption offering that it can monetise.
  • With $196m in cash flow from operations in Q4 16 and $763m for FY2016, Twitter is very far from any existential danger but I see the fair value of the company with no growth being way below where it is today.
  • Consequently, I see nothing in 2017 that is going to drive Twitter back to growth which will put further pressure on the share price.
  • I continue to see Twitter as a potential acquisition target but would expect to see the shares touch $10 before real interest is triggered.
  • I see no reason whatsoever to go bargain hunting as there is no bargain to be had.

Facebook Q4 16 – In focus

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Facebook intends to kill the YouTube star.

  • Facebook reported good results and highlighted that while 2017 would be much slower, video is the current priority to drive the next leg of growth.
  • Q4 16A revenues / Adj-EPS were $8.81bn / $1.41 nicely ahead of consensus at $8.51bn / $1.31.
  • Mobile was once again the main driver of revenues making up 81% of revenues and growing 61% YoY, echoing the strong numbers reported by Alphabet.
  • Facebook reiterated that growth in 2017 would slow markedly, as it has fully monetised the traffic that it already has, but it is well advanced in seeking other avenues.
  • In the next 3 years, the priority is clearly video and I can see Facebook evolving to become more like YouTube or Netflix.
  • These developments are already underway with the latest innovation being the addition of a tab at the bottom of the Facebook app that has top trending videos as well as recommendations for the user.
  • This makes Facebook video look far more like YouTube which I see as an encyclopaedia of video which Facebook clearly intends to emulate.
  • If Facebook can establish itself as a real rival to YouTube, this will bring its content consumption offering to maturity and I will be comfortable increasing its Digital Live coverage from 36% to 46%.
  • I think that it is still too early to call Facebook a real destination for video, but it is steadily moving in this direction.
  • In Gaming and Facebook M its efforts are far more nascent and I see these two appearing in Facebook’s 5 year strategic horizon.
  • While the long-term outlook for Facebook remains good in terms of Digital Life coverage, artificial intelligence remains a big concern.
  • Facebook has made some big hires in this area but its algorithms remain basic at best and deliver an awful user experience.
  • RFM research indicates that almost every time Facebook tries to use intelligent automation, things go badly wrong leaving Facebook having to fall back on humans.
  • While this is not a huge problem today, if Facebook continues to rely on humans to customise the user experience for its users, OPEX will start growing much more quickly than sales.
  • My concern is not that Facebook can’t fix it but that it will take it a very long time, leaving it still behind its rivals who are already miles ahead and investing heavily.
  • This is why I think that Facebook will end up having to make a lot of acquisitions in this space over the next 3 to 5 years.
  • With a slower outlook for 2017 and the share price back to its all-time high, I can not get excited about the stock as there are challenges that need to be overcome before the next leg of growth materialises.
  • I continue to prefer Microsoft, Tencent and Baidu for capital growth and Apple for income.

 

Twitter – Event horizon

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Sale of Fabric collapses Twitter’s horizons. 

  • With the sale of Fabric to Google, Twitter has essentially given up all hope of becoming an ecosystem and its growth will be totally dependent on its ability to create engagement around media consumption.
  • This means that a blue-sky scenario for Twitter will see it with 28% coverage of the Digital Life pie up from 18% today.
  • In this instance, RFM estimates that the best possible revenue outcome for Twitter would be annualised revenues of around $3.9bn, growing 6-8% in the long-term.
  • Twitter first unveiled Fabric in 2014 as a developer platform by which developers could create other services and then tightly link them to Twitter.
  • The idea was that this would allow Twitter to collect data in other areas of Digital Life and thereby improve its addressable market when it came to monetisation.
  • However, the fact that it has now sold this to Google is a sign that it has given up on trying to develop this avenue of expanding its business and is doubling down on media consumption.
  • When it comes to monetising microblogging, Twitter is best in class but because it is present in such a small niche of Digital Life, growth has ground to a halt causing a major problem for both management and shareholders.
  • This is why Twitter has been trying to develop a media consumption offering and why the live casting of NFL games over its service is such a big deal for the company.
  • The response to the live streaming over Twitter has been quite good with Twitter adding 0.25m to the NFL’s regular audience of 15m or so but there is a very long way to go.
  • However, it is still very far from challenging YouTube or Facebook Video which is why I need to see far more than just NFL streaming in order to become confident that Twitter has a media consumption offering that it can monetise.
  • This is crucial because now that Fabric has gone, this is Twitter’s only real hope of extending beyond Microblogging and Instant Messaging.
  • The narrowing of its horizons means that, while Twitter could increase its revenues to a new level (and hopefully make some profit), revenues of $8bn-$10bn look hopelessly out of reach.
  • The company currently has an enterprise value of $10bn which looks much too high if the blue-sky scenario now returns maximum annualised revenues of around $4bn.
  • Hence, I still think that the shares could test $10 per share at which point it becomes an attractive tuck-in acquisition for any of the big ecosystems to complement their existing offerings.
  • Google, Facebook or maybe Tencent would be at the top of that list.

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.

VR / AR – legions of limitations

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

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

LeEco – Priced to go.

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LeEco’s real disruption is price. 

  • LeEco launched its assault upon the US market with a glitzy but confusing press event where the real standout was the prices of its new devices.
  • LeEco is a Chinese media streaming company that is hoping to build upon its media heritage by creating an open ecosystem powered by the cloud and delivered through the phone, TV, VR, Bicycle and the car.
  • It already has some traction in China with its media assets and it is this heritage that it is attempting to leverage into the US market.
  • The company has correctly identified that no one is really able to make different device categories work together in a seamless and fun to use way.
  • This, it hopes to fix with its LeCloud platform which drives the EUI user experience on all the devices the company offers.
  • Here the degree of data integration and the AI that it has running its recommendations as well as look and feel will be critical to driving engagement.
  • To get the ecosystem into the hands of users LeEco launched a series of devices including phones, TVs, bicycle, VR and a car.
  • However, the ones that really matter are a high end Android device (LePro3) coming at $399 and an 85-inch (uMax85) TV coming at a staggering $4,999.
  • These prices can be reduced still further by signing up to be part of LeEco’s UP2U membership program which gets the user $100 off the device and $1,000 off the TV.
  • The idea of UP2U is to drive engagement with its media consumption assets and to use the data generated to improve the quality of its service as well as to define its future roadmap.
  • This combined with limiting itself to selling over the Internet in the first phase of its development is how it hopes not to lose vast sums of money from selling these devices at such low prices.
  • LeEco is following the Amazon model of almost giving the devices away with the hope of making a return by selling content and services over its platform.
  • In this regard it has added an interesting twist which is allowing its platform to be open such that anyone can sell their content and other device makers can make use of it.
  • This completely rules out any chance of ever making a return on the hardware as the ecosystem will never be exclusive to LeEco devices but there is an opportunity in the ecosystem.
  • However, it is here in the ecosystem where LeEco’s vision falls short.
  • The average user in developed markets spends just 10% of his time engaged in media consumption meaning that LeEco is ignoring 90% of the opportunity.
  • Furthermore, the TV is not a driver of the user purchase decision when it comes to selecting an ecosystem which is why LeEco has to sell this product at such a good price and encourage engagement with further discounts.
  • LeEco has a reasonable line up of launch partners for its media consumption offering including Lionsgate, Netflix and Showtime but there are a notable number of exceptions.
  • This means that purchasers of the TV and the phone will still need to go outside of its ecosystem to get access to things like YouTube, Facebook video, HBO and so on.
  • RFM research indicates that to have a viable ecosystem in its own right LeEco will need 100m users outside of China and 300m to make real money.
  • However, if it manages to generate real engagement with those that buy its devices then these numbers could be lower as it will be supplementing the network effect through the revenue share that it will get from selling content.
  • This is going to be a tall order as developed markets are already well penetrated with media consumption offerings meaning that EUI will need to be compelling to create the stickiness from which LeEco can earn a return.
  • This is why the key metric to watch is not necessarily the number of devices it sells but whether those users engage with its software and content assets.
  • This is where RFM’s 7 Laws of Robotics will be crucial as a good score against these measures will give a good indication as to whether users will like the service.
  • This is where Xiaomi has fallen over as engagement with its ecosystem is weak meaning that users buy its products in China and then use the ecosystems of the BATmen.
  • LeEco has given users plenty of incentive to try the service but whether it can get them to stay is another matter.
  • Hence, the real beneficiaries of these launches are Google, Netflix and Qualcomm.
  • Google and Netflix benefit by having more capable hardware in the hands of more users and Qualcomm benefits as it has supplied most of the hardware differentiation that LeEco is using.
  • Whether LeEco can also benefit remains to be seen but it is certainly putting its money where its mouth is in pulling out all the stops to get users to try its products.

Amazon Music – Table stakes.

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40m tracks and a search box does not a service make. 

  • Amazon has plugged an obvious hole in its push to create a consumer ecosystem with the launch of a music service that brings its catalogue into line with that of Apple Music, Spotify and so on.
  • The new service called Music Unlimited costs $9.99 per month ($7.99 for Prime members) and features the now standard 40m tracks and a search box.
  • In addition, Amazon is also clearly reacting to the very real threat posed by Google Home by offering the music service for just $3.99 a month on the Echo.
  • For $3.99 the service is only available on the Echo and I see this as Amazon attempting to compensate for the fact that Google’s Assistant is far brainer and more useful than Alexa (see here).
  • I also suspect that Amazon had a very easy time licensing the music as I see the labels being keen to democratise music streaming as much as possible.
  • This is because the writing is on the wall for the music labels as the music streaming companies will soon be able to distribute music from artists much more effectively than the music labels can.
  • Furthermore, once the artists have figured out that distribution via streaming can be just as good, if not better and they get to keep far more of the revenues, then an exodus will begin.
  • However, the more the labels can keep the market fragmented, the less power each service will have to replace them slowing their inevitable obsolescence.
  • Consequently, I think that it is easier than ever to licence all the music a service needs which will hasten the commoditisation of music streaming.
  • This is why I have long believed (see here) that the music itself is incidental and what really matters is the data that the service generates and the algorithms that make sense of it.
  • This is what allows a music streamer to understand its subscribers and match them with great accuracy to the bewildering 40m items that are available for them to listen to.
  • This also allows the addition of innovative features to be deployed on top of the service which is becoming an important area of differentiation.
  • On this front, I do not see Amazon doing very well.
  • The Alexa digital assistant underperforms Google, Cortana and Siri indicating that a vast amount of work is required to improve it.
  • This is a major reason why I think that as long as Google executes well, it should be able to dominate the segment that Amazon has created.
  • The net result that Amazon is a me too service that will have some attraction for existing Prime members but is not going to cause Spotify or Apple Music to lose much sleep.
  • Hence, I see no change to the landscape where Spotify is adding subscribers at double the rate of Apple Music despite Apple Music being installed on over 1bn devices.