E3 2017 – Glaring omission

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Very little interest in mobile gaming at E3.

  • E3 is the biggest trade show for the computer games industry but it still seems to be ignoring one of its most important segments: gaming on mobile devices.
  • Mobile gaming is radically different from gaming on PCs and consoles in three ways:
    • First: PC and console games are much more expensive and more complex.
    • Second: They require high-end PCs or dedicated hardware to run optimally compared to mobile games which run well on most smartphones.
    • Third: They are played for long periods of time whereas mobile games are played for a series of short periods.
  • This means that the software and hardware required to address this segment is completely different but that does not mean that there is no opportunity for the PC and console players in mobile.
  • This is because, I think that the hundreds of millions of users who play PC and console games also play games on their mobile phones.
  • These are different games, played in a different way with a different monetisation system but because the players are the same I see no reason why the big game communities should not be leveraged into mobile.
  • Sony, Microsoft and Valve have all spectacularly failed to leverage the multiplayer communities that they have on PCs and consoles onto mobile phones.
  • I believe that this is why the Digital Life segment of Gaming in mobile remains almost completely unoccupied.
  • This is very different to China where mobile gaming is dominated by Tencent with NetEase coming a distant second.
  • Hence, because Gaming is the single largest segment of Digital Life (30%), I think there is a big opportunity being left on the table.
  • This is the rationale for why I think Microsoft should be prepared to sell Xbox if the right offer comes along.
  • Someone with the ability to do with Xbox what Microsoft cannot should be willing to pay more for the asset than it is worth to Microsoft.
  • It is under these circumstances that I have advocated for its sale as it would generate more value for shareholders than remaining inside Microsoft (see here).
  • The same could be said for PlayStation but because it is such an important part of Sony, I seriously doubt that it would sell under any circumstances.
  • I can’t say the same for Microsoft which is continuing to do very well in dominating the Digital Work ecosystem but is letting its consumer ecosystem fade away.
  • Activision Blizzard looked to be making move on mobile gaming with its acquisition of King Digital but unfortunately, the mobile user numbers for King Digital have fallen by around 35% since the acquisition.
  • Hence, I think that this segment remains wide open creating a big opportunity for someone who has the skill and determination to do in mobile what Microsoft and Sony clearly do not.

ARM vs. Intel – Pause for thought.

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Intel shoots at Asia rather than at home.

  • With another attempt to replace Intel chips in PCs on the cards, Intel has moved to protect its position with a not so subtle reminder that its instruction set is covered by a large number of patents.
  • The 40th anniversary of the x86 processor is approaching and to celebrate, Intel has published an editorial extolling the innovation that has made x86 by far the dominant processor in both PCs and servers.
  • The problem has always been that the x86 was never designed to run on battery powered devices meaning that it consumes meaningfully more power than its ARM equivalent.
  • Consequently, there has always been a desire to allow battery powered PCs (laptops) to use the ARM processor as this would, in theory, meaningfully extend their battery life.
  • The first attempt to do this was Windows RT which involved adapting the Windows software to run on the ARM instruction set which failed miserably.
  • The current effort involves an emulator which takes the ARM instruction set and translates it into x86 so that the regular Windows software and applications can run with no modification.
  • However, this proposition already has question marks around implementation and performance (see here) and now Intel is muddying the waters further with its patent pool.
  • Intel has filed around 1,600 patents (533 families) on its x86 instruction set of which around 1,000 (333 families) I estimate are still enforceable.
  • It seems pretty likely that an emulator that makes use of the x86 instruction set will infringe these patents and hence would need a licence from Intel to operate.
  • There are two reasons why I think this warning is not aimed Qualcomm and Microsoft but rather others who may be considering taking a similar route.
    • First: Qualcomm knows and understands more about IP licencing than almost anybody and consequently I think that it will have foreseen this issue.
    • Hence, I think that, together with Microsoft, it will have sorted these issues out with Intel before officially announce its progress down this route.
    • Second: in its 8th June comment, Intel states that “there have been reports that some companies may try to emulate Intel’s proprietary x86 ISA without Intel’s authorization”.
    • At the time of writing, the co-operation between Microsoft and Qualcomm to use an emulator to get Windows running on x86 was not a report, it was an announced fact.
  • This combined with my view that Qualcomm is likely to have sorted the IP issues out in advance, leads me to believe that this warning is targeted elsewhere.
  • Hence, I do not think that this will impact the effort by Qualcomm and Microsoft which, in my opinion, remains completely dependent on the implementation.
  • Emulators have a very bad track record in terms of consuming extra resources which to date, has rarely resulted in any real benefit accruing to the user.
  • I still think that to succeed, these devices must perform at least as well as an Intel powered device at the same price point and have better battery life.
  • I think that this is the minimum requirement as without this, there is no incentive for a user or an institution to purchase the device.
  • This is what I think Microsoft and Qualcomm will be most concenred about but for the other chipmakers in Asia Intel’s comments will have given them pause for thought.

ARM vs. Intel – Silver bullet pt. II

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Implementation and performance will be everything.

  • The second lap of trying to get Windows to work on ARM processors is in full swing but the key to success will be the performance of the devices.
  • At the Computex trade show in Taipei, ASUS, Lenovo and HP have all announced that they will be producing Windows 10 devices that are powered by Qualcomm’s Snapdragon 835.
  • This is the final piece of the puzzle to get devices into the hands of users after Qualcomm and Microsoft announced that they would be giving Windows on ARM another try (see here).
  • ASUS, Lenovo and HP will be using Qualcomm’s Snapdragon 835 to provide both the horsepower to run the device as well connectivity to ensure and always on experience.
  • With its first attempt, Microsoft modified Windows 8 such that it would work on an ARM processor and in the process killed flexibility and backwards compatibility to legacy software.
  • The result was a platform that was shunned by both developers and users, completely killing any hope that ARM would gain penetration in Intel’s home turf of PCs.
  • This time the approach is completely different as Qualcomm and Microsoft have produced an x86 emulator that fools the software into thinking that there is an x86 chip present.
  • The net result is that any Win32 and Universal Windows Apps (UWP) will run on the device with no modifications being required by the developer.
  • I understand that UWP apps will run natively on the Snapdragon 835 but the emulator will be required for everything else.
  • This is where the success or failure of this venture will be determined.
  • The computing devices will lightweight, low cost with a long battery life making them ideal candidates to run Windows 10S (see here).
  • This device category is ideally suited for schools but for students who have their own devices, the appeal is less clear.
  • This is because the majority of the kind of apps that I think students will want on their PCs are not available as UWPs.
  • Students tend not to have a lot of spare cash and therefore will rely heavily on free software which if they are using Windows 10S needs to be on the store.
  • Taking the top free PC software as recommended by TechRadar, I found that 3 apps were available as UWPs compared to 10 that were not but of which, for 2 or 3 there was something similar.
  • Google Chrome, iTunes, Google Drive or any BitTorrent clients are available as UWPs, all which I suspect are pretty important for cash strapped students.
  • Therefore, the performance of the emulator will be critical as I think it will be heavily used in these devices.
  • On bench tests, the Snapdragon 835 is perfectly capable of running Windows 10, but there is a huge difference between performance in the lab and performance in the hands of real world consumer.
  • Furthermore, emulators always incur a performance overhead meaning that apps running via the emulator can never perform as well as those running natively.
  • The key questions are:
    • First: How well will Windows 10 be implemented on the ASUS, HP and Lenovo hardware to ensure the Snapdragon 835 can perform to the best of its ability.
    • Second: How much performance drag will the emulator incur?
  • The answers to these questions will only be apparent once the devices are available but I think it is quite easy to draw a line in the sand.
  • To succeed, I think these devices must perform at least as well as an Intel powered device at the same price point and have better battery life.
  • I think that this is the minimum requirement as without this, there is no incentive for a user or an institution to purchase the device.
  • I also think that always on connectivity is not a requirement for a Windows 10 device because all of the Digital Life activities that require this kind of connectivity have long since moved to smartphones.
  • Hence, I do not consider it to be a valid selling point of the devices.
  • The launch of these devices is obviously a negative for Intel but it is worth remembering that every attempt to dislodge Intel to date has been a miserable failure.

 

Microsoft – Breathing space

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Microsoft gives the PC makers room to breathe.

  • Microsoft updated its Surface Pro at an event in Shanghai but left plenty of space for its partners to innovate within the fledgling tablet-PC category.
  • Microsoft has followed Apple in dropping the version number from the name and the new product makes incremental improvements which include:
    • Battery: Microsoft claims that despite looking very similar, the new product has 50% more battery life than the Surface Pro 4, clocking in at 13.5 hours under optimal conditions.
    • This will be well received by road warriors who spend a lot of time in airports and coffee shops looking for power sockets.
    • Fan-less: The new Surface Pro is fan-less in the m3 and i5 versions which is a meaningful saving both in terms of power and noise.
    • Microsoft is very late to fan-less computing and I see it as behind the curve as there are other devices (see here) available that run the same processors but are fan-less across the whole range.
    • I am assuming that as the i7 version also runs Intel Iris Plus Graphics 640, more heat may be generated under heavy load than the i5, necessitating the presence of a physical fan.
    • Going fan-less is a good opportunity to reduce thickness and weight but again Microsoft does not appear to have taken this route as it is keeping the same chassis for all versions.
    • Instead it is leaving this to other companies like Samsung, Huawei, Eve Tech and HP which has clearly been doing some work on its form factors.
    • Hinge: A new hinge has been created to enable what Microsoft calls studio mode.
    • This is where the device is almost horizontal but is slanted at the same angle as the workspace of an architect or illustrator.
    • This is very similar to the use case provided by the popular but expensive all-in-one PC Microsoft launched last year called Surface Studio.
  • Outside of these upgrades, the new Surface Pro is an incremental upgrade which leaves plenty of room for others to address this space.
  • I don’t think that it has ever been Microsoft’s intention to take market share away from its partners but more to show them the way forward
  • Historically, PC makers have really been starved of form factor innovation, having outsourced almost all of its to the ODMs.
  • However, there are signs of this coming back.
  • A good example is HP which as seen huge improvements its form factors with the Envy line of laptops finally living up to its name.
  • Most PC makers now offer a Surface Pro-like product which if marketed properly, still has the potential to change the nature of PC market.
  • A tablet PC with a separate keyboard and mouse offers a more productive, healthier and more ergonomic computing experience which I still think renders the laptop form factor obsolete.
  • However, PC makers and the marketing departments of Intel and Microsoft have been selling laptops for 40 years which has become a very difficult habit to break (see here).
  • I still believe that this has the potential to kick the PC market back to growth as old laptops are quickly replaced, but given that this is just a product cycle, it would only last for a few years.
  • This rising tide would float all boats but I would prefer to be aboard either Microsoft or Lenovo for this ride.

Microsoft – S for school.

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Windows 10 S great for schools but not for the Surface Laptop.  

  • For the education of children, Windows 10 S makes perfect sense but for college and everything else, I can’t see why anyone would want it.
  • Microsoft held an education event this week where it launched a new version of Windows 10 called Windows 10 S and a stunningly beautiful laptop called Surface Laptop.

Windows 10 S

  • The main feature of Windows 10 S is that it is locked to running apps that are available in the Windows store.
  • This allows a greater degree of security as each app will have been checked by Microsoft but also will run in its own container.
  • This has the effect of not bogging down the operating system as often happens as devices age and ensures that performance will always be crisp and quick.
  • This is ideal for the classroom where all devices should offer exactly the same performance and teachers can’t waste time waiting for the older laptops to boot or load.
  • Windows 10 S also allows the school to take complete control of the device just as enterprises do with the laptops within their organisations.
  • I see this as highly appealing to schools whose aim is educate the students rather than to offer them a good and fun user experience on the device of their choice.
  • Microsoft has also added a handy feature enabling the creation of a USB drive that can install all of the required apps, settings and permissions on a Windows 10 S device in one go.
  • This makes the set up and management of devices within a school much easier and faster.
  • The app limitations mean that Windows 10 S can run effectively on devices that compete with Chromebooks which is clearly what Microsoft is intending with this version of Windows.
  • However, outside the controlled environment of a school, I can’t see anyone willingly running this version of Windows.
  • This is because what is available in the Windows Store is a sad reflection of the wealth of software that is available for the PC.
  • If take the example of a student at university then this reality is put into sharp focus.
  • Students tend not to have a lot of spare cash and therefore will rely heavily on free software which is they are using Windows 10 S needs to be on the store.
  • Taking the top free PC software as recommended by TechRadar, I found that 3 apps were available compared to 10 that were not but of which, 2 or 3 had something similar in the store.
  • The Windows Store does not offer Google Chrome, iTunes, Google Drive or any BitTorrent clients, all which I suspect are pretty important for cash strapped students.
  • Microsoft refers to its refusal to install the software that the user wants as a “friendly popup” that directs you to something similar in the store but I suspect that almost all users who have paid for their own devices will find this utterly infuriating.
  • Hence, I think that to make Windows 10 S gain any traction outside of schools, Microsoft needs to dramatically improve the Windows Store.
  • This will take some time and hence I see virtually no traction for Windows 10 S outside of the controlled education environment for which it has mainly been designed.
  • The good news is that users can unlock the device by upgrading to Windows 10 Pro for $49.99 (free for students) but how well Windows 10 Pro will run on a $170 PC remains to be seen.

Surface Laptop

  • Microsoft also launched a beautifully designed laptop that has looks and power but with the price tag to match starting at $999.
  • Every detail has been attended and it is refreshing to see a device maker show such care and passion for a product that it has created.
  • For high end users, who are not fans of the tablet form factor, this is a great option but in that regard, it has no business whatsoever being launched with Windows 10 S.
  • This product has clearly been designed to appeal to users and hence I suspect that almost every device will be shipped to users who have paid for it themselves.
  • Furthermore, the vast majority of schools, will not be buying this product for their students but rather something much cheaper.
  • Hence, I think that to create the best possible demand for this product Microsoft should offer the option for the device to ship with a regular version of Windows at no extra charge.
  • This is because I suspect that almost everyone who buys this service will not want to be bound by the limitations of Windows 10 S.
  • I think that after paying up to $2,200 for this device being forced to pay another $50 just to run the apps that the user wants will really stick in the craw.
  • Microsoft have launched the Surface Laptop as a hero device to encourage the adoption of Windows 10 S on much cheaper devices but it makes absolutely no sense for the device itself to run this version.

Take Home Message.

  • The end result is that I like Windows 10 S for school as it will take the fight to Chromebooks which dominate the education landscape in the US.
  • This is especially the case because Office is a far better option for content creation than Google Docs but where Google has an edge is in text books.
  • Google has spent a lot of time building up a huge library of e-text books for schools and this is something that Microsoft will have to quickly replicate in the store if it wants schools to switch.
  • Furthermore, if Microsoft can win students over to Office when they are young it sets Microsoft up nicely to continue its dominance with Office as these students enter the workforce.
  • Microsoft looks better positioned in education with this release which to me looks like a very long term, but worthy investment.
  • I continue to like Microsoft which is doing very well in the enterprise and fortunately the valuation does not demand excellence in consumer, where I continue to see indecision and slow decline.

 

Google – Meaningless milestone

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Android’s success shows up Google’s deficiencies.

  • Android has surpassed Windows as the No.1 platform for accessing the Internet globally, highlighting just how bad Google is at monetising Android as it remains only a small percentage of total revenues.
  • I think that this could be a growth opportunity if Google can fix the many problems that exist within the system that it created and in many cases controls.
  • According to StatCounter, Android devices now make up 37.93% of all Internet access devices very slightly ahead of Microsoft Windows at 37.91% with iOS a distant third at around 13%.
  • Furthermore, with most users spending more time on smartphones and tablets than PCs, it is clear that the PC is rapidly becoming a device used in the enterprise and by content creators.
  • This is a major reason why RFM does not consider PC usage as a contributor to Digital Life when assessing the addressable market for a digital consumer ecosystem.
  • Consequently, it would be natural to assume that Android is a big part of Google’s revenues but in reality, it is not.
  • RFM estimates that in 2016 just 19% of advertising revenues came from Android devices compared to PCs and Macs which generated 60% of advertising revenues.
  • A further 19% of revenues came from iOS devices despite the fact that there are 2.9 Android devices for every 1 iOS device.
  • This tells me that the PC is a much better platform for advertising monetisation but it is also a clear indication that Google is doing something very wrong when it comes to making money from Android.
  • I have long argued that while demographics plays a role, the endemic fragmentation of Android and Google’s inability to update software on its own devices severely hinders the usage of and loyalty to, the Android platform (see here).
  • I believe that this is a major reason why an Android device generates less than half the revenues that an iOS device does which is also meaningfully less than a PC or Mac.
  • While this is a real black eye for Google, I also see it as an opportunity.
  • RFM estimates that in Q4 16A each iOS user delivered $3.37 in revenues for Google compared to $1.47 on Android.
  • If Google could fix the problems with Android, then I think that there could be meaningful upside to this number.
  • For example, if Google was able to increase monetisation of its own Android devices to $2.00 per user per month, this would increase revenues by $6.4bn on an annualised basis.
  • As smartphone user growth and usage both slows, Google will need to look for growth elsewhere and I see this as an obvious place to start.
  • I am hoping to see signs of this at Google i/o (in May) but in the preview of Android O (see here), I was disappointed.
  • Without these kinds of actions I think that Alphabet remains fully valued and would prefer the shares of Microsoft, Tencent and Baidu.

ARM vs. Intel – Silver bullet?

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Last time it was software. This time its emulators 

  • Qualcomm and Microsoft have announced that Windows is once again coming to the ARM processor but this time the approach is completely different to the disaster that was Windows RT.
  • In Windows RT, Microsoft modified Windows 8 such that it would work on an ARM processor and in the process killed flexibility and backwards compatibility to legacy software.
  • The result was a platform that was shunned by both developers and users, completely killing any hope that ARM would gain penetration in Intel’s home turf of PCs.
  • The fact that Intel has cut its lower end Atom line of products that aimed to compete with ARM in Android tablets has left space in the market for these products to grow into.
  • This time the approach is completely different as Qualcomm and Microsoft have produced an x86 emulator that fools the software into thinking that there is an x86 chip present.
  • The net result is that any Win32 and universal Windows app will run on the device with no modifications being required by the developer.
  • The net result is hoped to be cheaper, fan-less, always-on, mid to low end PCs that have longer battery life than their counterparts powered by Intel.
  • Qualcomm and Microsoft have also promised that Adobe Photoshop, Microsoft Office and Windows 10 games will all run on these products and it is here that I find the big caveat in this strategy.
  • This caveat is performance.
  • Intel processors may be power hogs but they offer blistering performance in real world devices as well as in benchmark tests.
  • ARM has been able to match some of the benchmarks but has never been able to come close to Intel in real devices.
  • This is why the mention of Photoshop, Office and games is so important as these three are well known to be very processor intensive.
  • Their requirements are so high that the software is written directly to the processor (written to the metal) to avoid any lags created by going to the processor via the operating system.
  • This is where the problem will occur as processor heavy apps will no longer be written directly to the metal but instead will be going through the emulator.
  • The emulator process is as follows:
    1. Translate requests from the x86 programs sitting on top of it into the RISC instruction set that ARM understands.
    2. Execute the request on the ARM processor.
    3. Translate the results back into the x86 instruction set so that the app can run.
  • Consequently, the emulator will incur additional processing overhead as well as consume power.
  • The big questions are how much will it consume and will it have an impact on the overall user experience?
  • For Intel, this is a critical question because if there is no impact it could see its market share in the mid-range PC market (most of the volume) come under serious threat.
  • In Q3 16A Intel reported non-GAAP gross margin of 64.8% compared to Qualcomm at 58.9% but if I remove the profits from licencing, I estimate that Qualcomm’s chip gross margin is around 40%.
  • Consequently, if Qualcomm’s Snapdragon chipset plus the emulator can match Intel’s performance, Intel will have to cut its prices to stay in contention.
  • This could see its gross margin come under sustained pressure as the first real challenge to its monopoly finally hits home.
  • History is on Intel’s side as emulators on battery powered devices have always impacted the user experience so much that the experience failed to win over users.
  • In order to put pressure on Intel, the Qualcomm powered Windows 10 devices will have offer the same level of functionality and performance, better battery life as well as a cheaper price.
  • These are my three criteria for Qualcomm to really challenge Intel and success will come down to the quality of the emulator that it has created.
  • Qualcomm will also need to work closely with the device makers as there are endless hardware configurations for Windows 10 PCs and clumsy integration could easily make a complete mess of the elegant product that Qualcomm and Microsoft have created.
  • The first devices will be available early 2017 (launch at CES 2017 looks likely) and it is by these that Intel’s outlook will be judged.
  • This is obviously negative for Intel but it is worth remembering that every attempt to dislodge Intel to date has been a miserable failure.

Microsoft – Wood for the trees.

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Microsoft is so focused on the future that it misses the opportunity in the present. 

  • Microsoft has moved even further away from the consumer with its Creators Update for Windows 10 and the launch of the Surface Studio complete with the Surface Dial accessory.
  • At the same time, Microsoft continues to ignore the huge opportunity presented to it by the obsolescence of the laptop form factor which I find strange as it claims to be all about creating new product categories.
  • Microsoft unveiled two new innovations as well as an incremental update to the Surface Book.
    • First: Windows 10 Creators update
    • In addition to a host of other incremental improvements, the Creators Update focuses on enabling 3D objects on the PC as well as in both AR (HoloLens) and VR, gaming and easier connections and sharing with close contacts.
    • None of this is desperately new except that the degree to which content now works across different devices is far superior to anything else that has been launched to date.
    • Microsoft hopes to include the mobile phone in this range of devices but how well it can do that on Android and iOS remains to be seen.
    • These platforms are now critical as Windows Phone is rapidly losing all of its remaining users.
    • Also key to this update is the focus on content creation as the upgrades in this update are aimed at improving functionality for those that draw, write, broadcast and so on rather than those that consume.
    • This is a tacit admission that the battle with iOS and Android for content consumers has long been lost.
    • However, it also shows Microsoft aggressively acting in both software and hardware to keep the content creator users and corporates on its platform.
    • Second: Surface Studio.
    • This is very high specification all-in-one PC with a 28” monitor that can transform to become a work surface exactly like the drafting table used by anyone that draws or designs for a living.
    • Surface Studio comes with the Surface Dial which is designed to go in the non-pen hand to alter characteristics such as ink colour, brush size, opacity and so on.
    • The Surface Dial works both on and off the screen and is backwards compatible with all Surface products.
    • This device is clearly aimed at professionals and it is priced accordingly at $2,999.
    • Third: Surface Book.
    • The top end i7 model has been upgraded to offer double the graphics capacity than its predecessor as well as 30% more battery life.
    • Microsoft now claims that the device can provide 16 hours of battery life.
    • However, the single biggest failing if this product has been carried through into the next version as the keyboard stops working as soon as the screen is detached.
  • The net result is an update to the Microsoft Windows proposition that is aimed at keeping content creators and corporates on its platform.
  • In that vein, this is a good update with nice looking and relevant products but I still think that Microsoft is missing the wood for the trees.
  • I have long argued that the laptop form factor is obsolete as having the keyboard, mouse and screen permanently locked together offers a substandard user experience that is both uncomfortable and unhealthy (see here).
  • This is why the Surface Pro line of products is a game changer as it enables a desktop like user experience to be enjoyed from anywhere.
  • This works by allowing the screen to be at the correct height and distance from the eyes with a wirelessly connected mouse and keyboard to be in the most comfortable and ergonomic position.
  • However, this does not work with the Surface Book as the minute the screen is detached from the keyboard, the keyboard ceases to function.
  • I think it would cost Microsoft less than $1 per unit to put this right and it would enable it to really push a whole new use case for content creators out of the office.
  • I have long believed that this could lead to a huge replacement cycle where ageing laptops are replaced with PCs in the tablet form factor which could even kick the PC market back to growth for a few years.
  • However, this failing indicates that Microsoft has still not realised the opportunity that lies before it.
  • Intel and the PC makers are equally guilty of this oversight but these companies have not taken it upon themselves to re-imagine computing.
  • I suspect that the main issue here is that these companies have been selling laptops for over 30 years and it is very difficult to break out of that mindset.
  • It would also require a big marketing campaign as laptop users are also so ingrained with this form factor that they have not realised that there is something much better on offer.
  • The net result of this event is a software and hardware update that goes a long way to keeping content creators faithful to Windows but continues to ignore the possibility to create a large replacement cycle in its core product.
  • Fortunately, Microsoft’s valuation does not demand this vision to come true in order to be attractive which is why I continue to like it alongside Tencent and Baidu.

Lenovo Q1 17A – Heavy weather.

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I see opportunity but not without risk. 

  • Lenovo is hanging on in the difficult markets that it serves, but I think there is an opportunity for it to be as creative in PCs as it has been in handsets.
  • Q1 17A revenues / EBIT were US$10.1bn / $245m nicely ahead of estimates of $10.0bn / $167m.
  • This was mostly driven by good profitability in PCs which chalked up 5.3% EBIT margins despite a 7% decline in revenues.
  • Handsets increased their losses compared to Q4 16A as sales and marketing expenses have been increased ahead of the new models from Motorola (Moto Z and Moto Mods).
  • Here, I am hopeful that these products will be reasonably successful as the Moto Z offers a lot of phone for a very reasonable price and Moto Mods is the most interesting iteration of modularity I have seen for a very long time.
  • Motorola has crammed an Android device into a very thin package leaving space for a series of backs that magnetically attach to the device offering a range of functions such as camera, projector and high quality speakers.
  • If these devices ship reasonably well, there should be a corresponding improvement in profitability that should be further augmented by steady cost reductions.
  • All of Lenovo’s end markets are having a difficult year but Lenovo is continuing to do a good job at making the best of them.
  • However, I think it could do more and I would like to see some of the creativity in Motorola spread to the other parts of Lenovo.
  • The softest target is PCs where Lenovo’s strategy is to differentiate by addressing certain segments where there is growth such as tablet PCs, Gaming PCs and Chromebooks.
  • Unfortunately, its tablet PCs are nothing more than laptops where the keyboard comes off and then instantly stops working.
  • What Lenovo needs to do is to go further than even Microsoft and Huawei have gone and make the most of the fact that the laptop form factor is now obsolete.
  • Having the keyboard and the screen physically separate allows for the vastly superior, much healthier desktop PC experience to follow the user out of the office.
  • I have long argued that this offers the potential to create a 3 to 4 year replacement cycle where laptops are replaced with something that is just as powerful but offers a vastly superior user experience.
  • The problem is that the PC industry has been selling laptops for 40 years and seems incapable of accepting the notion that there is now something much better on offer.
  • This is the opportunity for Lenovo but it is not without risk, nor will it come cheap as users are even more oblivious of how the tablet PC can improve their portable computing experience.
  • Consequently, I do not expect Lenovo to do down this road, but I believe that if it wants to see a return of growth and better than commodity margins, this is where it must go.
  • Of all the PC makers, I find Lenovo to be one of the best run and most pragmatic, even if it is a little unimaginative.
  • I would back it against almost any of the others.

Microsoft FQ4 16A – Finnish with a flourish

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Good results restore optimism in strategy 

  • Microsoft reported good FQ4 16A results supported by signs of stabilisation in PCs and excellent performance in the cloud.
  • FQ4 16A revenues / adj-EPS were $22.6bn / $0.69 compared to consensus estimates of $22.1bn / $0.58 and RFM on $21.9bn / $0.59.
  • Microsoft’s strong results were driven by a very good performance by Azure which continued to grow by over 100% and some signs of stabilisation in the PC market.
  • This was slightly offset by gross margin pressure triggered by the increasing mix of revenues coming from cloud and Office 365.
  • This is completely normal as cloud revenues have lower gross margins than perpetual software sales but they are longer lasting meaning that they deliver more profit in the long term.
  • I would continue to expect to see gross margin decline steadily over the next year or two as this transition continues.
  • Stabilisation in PCs has been echoed by a number of other companies in the supply chain which have also seen some signs of stabilisation in the PC market this quarter.
  • I have long been believer that the PC is very far from dead but it is in fact suffering from a portion of its users continuing to defect to other platforms.
  • These users are the ones that I refer to as content consumers who have historically used a PC to do nothing more than browse the internet, email, shopping and so on.
  • These users have very little reason to own a PC as a smartphone or tablet running iOS or Android can do the job just as well and much more conveniently.
  • I think that other users such as content creators and companies will long have need of the PC and while I don’t think it is going to grow, I don’t see a precipitous decline either.
  • This is why I think that Microsoft’s legacy OS revenues are likely to stabilise as the OS tends to be sold as part of the PCs overall and therefore is likely flatten in line with the market.
  • The same cannot be said for Office but Microsoft is doing an excellent job at converting traditional Office sales into Office 365 subscriptions and there is every sign that this will continue.
  • Consequently, the outlook for the next fiscal year is good with steady revenue growth and tight control of the cost base.
  • However, the issue around the consumer assets remains unanswered.
  • Microsoft is increasingly becoming focused on prosumers and the enterprise and where assets like Bing, Xbox fit and Skype fit into that remains very unclear.
  • The good news is that Microsoft’s valuation does not demand any real action around integrating these assets to create a fully-fledged enterprise and consumer ecosystem.
  • Hence, I can still see these assets being sold off at some point which still gives me a valuation for the shares of around $62.
  • This is still nicely above current levels ($55) leading me to remain positive on the outlook.
  • I would also add Baidu and Samsung into this group of stocks to look at for the balance of 2016.