Apple’s Services Evolution

Posted: February 28th, 2019 | Author: | Filed under: apple | No Comments »

Growing Services

As I wrote about last month, Apple continues to evolve into a company that provides (and makes money off of) services. Last quarter, Apple pulled in a total of $84.3 billion. Apple’s services generated $10.9 billion in revenue, up 19% from a year prior. Apple’s services revenue comprised 13% of their total revenue. Although Tim Cook touts Apple as a services company, and many of their most recent moves back that up, they have a long ways to go to diversify their hardware revenue, especially non-iPhone revenue.

Even more importantly, Apple reported its margin in the services category, coming in at 62.8%. Much higher than Apple’s overall margins of 38%. And this is why investors love services – low spend, high profits.

As you can see in the chart below, Apple’s services’ revenue is much more consistent than the cyclical iPhone revenue. As a long term investor, I’m not that concerned about this, but Wall Street loves this consistency.

Google, the App Store, and Lazy Money

Apple’s services’ revenue is growing quickly, it’s consistent, and its margins are thick. The bad news is the bulk of the services’ revenue is coming from lazy money.

WTF is lazy money? Well, in one way it’s good. It’s money you don’t work for. Google, for instance, makes up approximately 20% of Apple’s services revenue by paying Apple for placement in the Safari toolbar. This is great although does come at a cost to the user. Apple could, as they normally do, remain laser-focused on the user experience and choose the search engine that offers users the best UX. With Apple’s privacy focus, DuckDuckGo appears to be an obvious choice for Apple. Instead, Apple gives this real estate to the highest bidder, the not-so-privacy focused Google. I’ll get back to the privacy issue later.

Apple also makes lazy money through the app store. Apple charges 30% to app developers for the sale of an app and/or the first year of a subscription. Apple takes 15% annually from app subscription revenue after that. Some of this revenue is earned. Apple sets guidelines and vets app to protect their users. The App Store also allows users to search and discover apps easily and quickly. But some of this is rent-seeking, such as attempting to take 15% of ongoing revenue from Netflix subscriptions. Netflix has decided they will no longer allow users to subscribe through the app. Again, Apple is arguably sacrificing the UX in order to make lazy money.

SaaS Money

Apple Music and iCloud are more textbook services. With these services, users are signing up for monthly subscriptions that they pay for. These services are sticky. Once a user creates their playlists in Apple Music or gets all of their images/files into iCloud, they become entrenched. But, this isn’t easy money for Apple. Apple will have to continue to maintain and improve these services in order to keep their users.

News, TV, Gaming and More!

The Apple services rumor mill is hot. The Apple News service appears to be coming soon. A TV/Movie service after that and potentially a gaming service down the road.

Apple is leveraging its distribution advantage of the iPhone, iPad, and (to a much lesser extent) AppleTV to launch services. As mentioned last month, this is a sound, but risk-averse strategy.

Apple Privacy

Tim Cook has been harsh on the other tech giants when it comes to privacy. Taking many opportunities to bash Facebook, Google, and others that use the information they have about their user to serve targeted ads. Furthermore, and perhaps their most overstepping behavior, Apple has insisted that every app in the app store disclose when they are recording a user’s behavior.

Although I commend Apple’s respect for user privacy, this is an example of why it’s hard for companies to change what they do. Apple has made money selling computers in many different form factors, but creating a best-in-class service is much different. Good product managers of a service let’s data be their guidance. Every major website we interact with is tracking how their users use it, and this data is used to improve the UX. SaaS 101. Apple’s attempt to take a moral high road will result in inferior services. So far, unlike Apple devices, Apple has yet to make a service that is best in class. Apple Music, Apple Maps, etc may someday have more users than Spotify or Google Maps on iOS devices but that will mostly be because of the value of default apps, not because of a superior service.

Bottom Line

I’m open-minded. We’ll see if I have to eat crow on my assertion that Apple is incapable of making a best-in-class service without sacrificing some privacy. I suspect Apple will eventually start to track behavior to improve the UX and collect information to enhance personalization.

Either way, Apple will make money from these services and the services’ revenue will continue to make up a larger slice of their revenue pie.


Risk-Averse Apple

Posted: January 30th, 2019 | Author: | Filed under: apple | Tags: | No Comments »

Good Enough for Warren

Apple is a hell of a company. So much so, the greatest investor of all time, Warren Buffett, has nearly $40B worth of Apple stock through Berkshire Hathaway.

Apple has become the perfect Berkshire Hathaway investment. It has a solid brand that has lasted the test of time. It’s a profit machine, the most in the history of a public company. It’s sitting on a giant pile of cash ($130B) and it’s putting that cash to use the way Warren likes. Apple provides a healthy dividend, currently a 1.85% yield, and consistently buys shares back. Finally, Apple is giant, which means Warren can park a lot of cash in it.

That’s the good news, the bad news is Warren likes to invest in boring, risk-averse companies.

There are other signs that Apple isn’t pushing the envelope. Tim Cook has been beating the “Services” drum, indicating Apple is morphing into more of a services company. This is a nice safe bet for Apple. Leverage the massive success with devices as a way to push services and make easy money. Apple Music, which is a giant success, is exhibit A. Furthermore, Services are cheaper for Apple to create, easier to go to market, and less risky than hardware. If Apple has a flop with hardware, the critics will have a field day.

Apple seems hooked on “rent-seeking” activity. Taking an annual cut of Netflix subscriptions bought through the App Store, for example. This is the type of activity I expect from a more desperate company, not one that is focused on the long-term.

Watch and AirPods are huge successes. Each capitalized on Apple’s strengths, integration of hardware & software, and leveraged the success of the iPhone. Both were safe bets with relatively little friction.

Compare this to their original giant successes, the iPod and the iPhone. Those products also capitalized on Apple’s strength of integrating hardware & software but they were huge risks. They both required Apple to change the industries they entered. With the iPod, Apple was able to convince music labels to sell music via iTunes. With the iPhone, Apple convinced the carriers (only AT&T at first) to leave their bloatware off and to give Apple complete control of the user experience. These products had major friction to overcome, both were big risks, and both become massive successes.

R&D Spending

The good news is, as revenue has grown, so has Apple’s R&D spending, but they trail the Googles and Amazons of the world in this (with the percent of revenue)

“Speaking before this week’s results, he said Bernstein estimated that Apple spent 5.1 percent of its revenue on R&D which is less than its rivals. “Apple could double its R&D and be relatively inline with peers”.”

Amazon and Google

It’s not just the spending that makes me think Apple isn’t taking as many risks as their peers. Google has their “moonshots” and Amazon enters every business imaginable. Buying Whole Foods is an example of Amazon taking a large risk.

As much as I want Apple to take a larger risk, I don’t think they should follow Google or Amazon’s playbook. My beef with the risks that these companies take is many of them are not leveraging their core competencies. Google’s moonshots have so far fallen flat and have not born fruit, despite the heavy investment.

Amazon has surprisingly been successful in areas outside their core competency (i.e. Alexa) but have had flops in areas they had no business being in (i.e. Fire Phone)

Bigger Risks

So what type of risks would I like Apple to take? Apple should aim to develop a product with the following characteristics –

  • Requires the integration of software and hardware
  • Requires a significant change to an established industry
  • Requires a long R&D cycle to pull off
  • Is within a product category where Apple can make THE premium product
  • Has major profit potential ($5B+ / quarter)

Televisions, the only major screen people use that Apple doesn’t have a product in, is the first obvious choice, as many have written about before. Television is in the middle of a transformation, with cable subscribers shrinking (although slowly) and streaming services growing. Although streaming is growing their overall offerings fall far short of traditional cable.

Automobiles are the second obvious choice. Cars are becoming more and more reliant on software as automated driving becomes more mainstream. This may be a perfect time for Apple to pounce. Manufacturing a car, at scale, is no joke, as Elon Musk can tell you. This move would be orders of magnitude riskier than a TV but with higher profit potential.

Bottom Line

Apple is secretive with their R&D efforts. There is a good chance Apple looks risk-averse on the outside but is indeed working on products that are high-risk.

Apple’s current strategy is rock solid. It’s a little too safe for my taste, but growing services and making more peripherals to the iPhone can easily get Apple well above the height of their previous trillion dollar market cap.

We’re still a long ways away from peak apple, but as a consumer, I hope they swing for the fences.


To Buy Spotify?

Posted: December 31st, 2018 | Author: | Filed under: spotify | No Comments »

To buy Spotify or not to buy?

One one hand, it meets my general criteria for buying stock well. Here are my current individual holdings and my rubric for determining if a stock is worth the risk. SPOT compares well to my other holdings.

My Love

I use Spotify every day and have so for years now. It’s a part of my everyday life and has improved it. Spotify is easily worth the $9.99/month.

Leadership

Daniel Ek, the founder and CEO of Spotify, has shown great leadership (and I prefer founder-led companies). Daniel is product and tech first. Daniel has done a great job delaying gratification and continues to invest in the long-term.

PE

This is the biggest drawback. I prefer to invest in companies that make a profit.

Cash

Spotify isn’t quite making a profit yet but their cash burn is controlled and they are close to sustained profitability. The hoard of cash left over now should begin to grow and allow Spotify to acquire.

Potential

Considering the total addressable market of the entire world, Spotify’s potential is the sky. That being said, Spotify doesn’t have a 10 in this category because of its marginal costs.

Spotify’s potential is is close but not quite like Google, Netflix or Facebook because Spotify is not a complete aggregator.

What is an Aggregator?

As Ben Thompson defines it, an aggregator has the following characteristics –

  1. Direct Relationship with Users
  2. Zero Marginal Costs For Serving Users
  3. Demand-driven Multi-sided Networks with Decreasing Acquisition Costs

Unfortunately, Spotify doesn’t qualify as an aggregator as defined here. Spotify’s marginal costs for serving users music is around 52% per song.

Spotify is well aware of this and is working effectively to reduce marginal costs. As Spotify’s influence grows they gain leverage with the three major record labels. But more importantly, the marginal costs can be significantly lowered by signing deals directly with artists, as they have started to do.

But music is unique. Unlike news articles and TV, the backlog of music is as much, if not more, important than the new music. This gives the record labels a stronger position with negotiations and, at least currently, limits Spotify’s gross margin.

Macro View – Competitors

You don’t have to be an aggregator to be a great business but Spotify has other existential threats. Daniel Ek wasn’t the only person who recognizes how big this streaming opportunity is.

All of the big dogs are in the game. Apple, Google, and Amazon. And many smaller but unique threats – Sirius, Tidal, iHeartRadio, and Soundcloud.

Apple, Google, and Amazon all have deep pockets and distribution methods for their streaming services.

Apple distributes Apple Music by pre-installing it on every iPhone it sells. Pre-installed apps have a leg up over many competitors simply due to the friction of downloading another app. Google and Amazon have numerous ways to distribute their streaming services, with their hit smart speakers being their most successful.

The others all bring something unique to the game as well. Sirius has much more original content, a more radio-like experience, and has a solid car distribution strategy. Soundcloud is doing a great job capturing the young, upcoming artists.

Focus

As of now, despite my bullishness, I’m standing on the sidelines with buying $SPOT. The waters are too bloody for me, too much competition with too many threats.

But that may change. Unlike Apple, Amazon and Google, Spotify is not a small side product for Daniel Ek and company. Spotify’s greatest strength against these top dogs is to stay laser beam focused on creating the best streaming music experience for listeners and creators.

If Spotify continues that mission while getting their marginal costs down through leverage with record labels and signing artists directly, I’ll start piling up the stock.


Spotify, One Product, Two Models

Posted: November 30th, 2018 | Author: | Filed under: Product, spotify | No Comments »

Spotify is awesome.

As a consumer, having a giant library of music spanning hundreds of years available at your fingertips is a pleasure.

As an investor, Spotify is addressing a universal human problem. How can a person listen to any music any time they want? Music is ingrained into our DNA. Everyone loves music. Spotify’s total addressable market (TAM) is the entire world. Google, Facebook, and Amazon. Those are the businesses that scale the best.

Beyond the giant TAM, Spotify is attractive as an investor for its business modal. Spotify has a diversified revenue stream. The much-criticized targeted ad model and the much-beloved subscription model.

As a product person, on the other hand, having one product with two business models is a nightmare. Making product decisions that can satisfy both business models is a hell of a challenge.

Ads

Spotify uses ads to monetize their 109 million ad-supported users. In Q3 of 2018, Spotify pulled in 143 million euros from ads. This breaks down to 1.31 euro per ad-supported user. Ad-supported tech companies is nothing new. Facebook and Google make over 90% of their revenue from ads.

That being said, ads are a lightning rod for criticism. In order to serve the most effective ads, data of users must be harvested to allow targeting. This harvesting of data can be perceived as creepy or worse, can be exposed in a breach, damaging reputation. This has most recently played out with Facebook and its stock price is suffering.

Furthermore, many like to think that in an ad-supported business model, the user IS the product. The user’s attention is being sold to advertisers.

That sentiment is extreme but has a grain of truth. The company’s interests can become less aligned with the users’ interest in an ad-driven model. Users may tolerate an ad, perhaps even benefit from it, but it’s not something a user would opt in to. The key here as a product manager is to match the best ad to the user and to find the sweet spot of ad inventory that doesn’t alienate the user.

Spotify is using their self-serve Ad Studio to power their ad business. Like Facebook before it, Spotify is allowing customers to target specific users based on data. An advertiser can target a user based on their age, gender, location, activity, and music taste.

This set of targeting options pales in comparison to Facebook’s. The limited targeting options and the mostly audio-only ad inventory is reflected in Spotify’s Average Revenue Per User (ARPU). Facebook pulled in $6.09 per user in Q3 2018 compared to Spotify’s $1.48 ad-supported ARPU.

Subs

Ad-supported business models are more controversial than subscription business models, which tends to better align the company and user.

The good news for Spotify is their 87 million premium subscribers generated the vast majority of their revenue. Nearly 90% of revenue in Q3 came from subscriptions.

Strategy

With the risks of an ad-supported business model and 90% of revenue coming from subscriptions, the strategy to focus first and foremost on the subscription business appears clear.

Spotify can appeal to everyone and therefore it’s important for Spotify to always have a free tier. This free tier, supported by ads or not, should be treated like other freemium models – as a way to give people a taste of the product and to entice them to upgrade to the premium tier.

Unlike Facebook, who only has an ad-supported tier, Spotify should treat their ad-supported business model as a second-class citizen. Spotify should never sacrifice the product to make more ad money. Spotify should optimize the free tier to entice users to upgrade. Unlike most ad-supported models that are finding the sweet spot of ad inventory and user alienation, Spotify needs to purposefully alienate the free users enough that they will be enticed to upgrade, but not leave Spotify for a competitor.

 


Sinking Snap

Posted: October 31st, 2018 | Author: | Filed under: snapchat | No Comments »

 

A 6,000-word memo, Q3 earnings, the first desktop app, and an all-time low stock price. Snap has had a busy October!

The strong product/design-minded founder in Evan. The young user base. The LA location. The numerous hit products that have influenced many others. There is so much to love. But like any investment, there are many reasons to be concerned.

Identity Crisis

As a product manager, I appreciate focus. I prefer working for a leader that is capable of understanding what the company is, and what it isn’t. A mission that is inspiring and provides direction. This is one quality that has drawn me to Snap. Unlike Amazon, that does a little bit of everything, or Microsoft, that has its fingers in many cookie jars, Snap is focused. Snap has one app with a limited amount of functionality.

Since the IPO roadshow and the renaming of the company from “Snapchat” to “Snap”, Evan has insisted that Snap is a camera company. Evan’s 6,000-word memo continues this narrative. The first line of the memo is “We are a camera company.”

This line is followed up by –

“We contribute to human progress by empowering people to express themselves, live in the moment, learn about the world, and have fun together.”

This is an identity crisis. Evan’s stubborn attempt to label Snap a “camera company” is a leap. This may be his attempt to shake the “social media” label, which I commend, but it’s clear to me that Snap is a communications company. One that does an especially good job of allowing people to communicate through pictures and videos.

Later on, Evan says

“We’ve been working hard since the redesign to solve the problems that we created and continue making Snapchat the fastest way to communicate.

And sets the 2019 OKRs as follows

2019 OKRs

  • Make Snapchat the Fastest Way to Communicate
  • Find Best Friends for all Snapchatters
  • Achieve Full Year Profitability
  • Lead the Way in Augmented Reality
  • Spread Positivity

Camera or fast communication. What is Snap? Can it be both? What should Snap be?

Fastest Communication

Striving to be the fastest way people communicate is a noble goal that addresses a basic need for everyone on earth. From Western Union to AT&T to Tencent, many companies have been built by focusing on improving the speed of communication.

If Evan wants to make Snapchat the fastest way to communicate, what are the best ways? A picture tells a thousand words. In this way, Evan’s stance that Snap is a camera company makes sense. But peer-to-peer digital communication is largely a text game that Snapchat isn’t concentrating on.

Text-first apps like WhatsApp, Facebook Messenger, Hangouts and Tencent own the fast communication space.

These products are much different than Snapchat. They’re multi-device (PC and mobile). They’re multi-platform (iOS, Android, web). They have “light” versions to reach those with low bandwidth access.

There are some things that are slow to change. No matter how much mobile keyboards improve, users are still quicker at typing on a laptop/desktop keyboard. To be the go-to communications app, it’s important to have everyone’s friends on the app. Without a low bandwidth version, you will not accomplish that goal.

Beyond distribution, these Snpachat is a different experience than the leading messaging apps. Snapchat opens up to the camera, the others open up to a text box. Snapchat is ephemeral with no option to save your history. For Snapchat to become the fastest way for me to communicate, they’d have to move away from their camera-centric approach and greatly invest in their text-based communication.

One-on-One, One-to-Many, One-to-Newsfeed

ICQ, AOL Instant Messenger, WhatsApp, Messenger. These apps had/have a lot of users, with high engagement. But they also never made money.

One-to-Newsfeed products like Facebook, Twitter, and Instagram have shown to be highly profitable. Not many digital ads convert better than a native ad in a newsfeed.

One-to-one or one-to-many chat experiences, on the other hand, have rarely found a sustainable business model. Tencent *may* be the exception but WhatsApp and Messenger’s inability to monetize in the US shows there is still work to be done in this space.

Although I like Snapchat’s focus on fast communication I worry about its ability to monetize. Snapchat Stories, which is a One-to-Newsfeed type of model, is very monetizable (but now a crowded space). Facebook has started monetization with WhatsApp and Messenger by allowing businesses to communicate to customers. Facebook is in the process of rolling out paid tools for businesses but has not yet meaningfully monetized the largest communication apps in the United States.

Bottom Line

Evan needs to decide if he wants Snap to concentrate on cameras or communication. Despite monetization concerns, the “fastest communication” play is Snap’s best bet. Snap should invest in bringing Snapchat to different platforms (web, Apple TV, Amazon Fire), improve their text-based chat and create a low bandwidth friendly version. These steps will allow Snap to empower the world to communicate as quickly as possible.


Facebook Founders Fly The Coop

Posted: September 30th, 2018 | Author: | Filed under: facebook | No Comments »

Instagram, WhatsApp, and Oculus. These are the three prize acquisitions of Facebook and, as of last week, these three units no longer have their founders. For years Facebook has been praised for acquiring companies and, for the most part, allowing these companies to stay independent. As time went on, that independence eroded and the founders eventually left. Critics of Facebook are jumping all over this alleged change. Did Zuckerberg mismanage this situation? Will founders be less likely to sell their companies to Facebook going forward? Is Facebook a terrible place to work?

Gruber and Acton’s Take

Let’s start with Gruber’s take (of DaringFireball)

Parmy Olson, writing for Forbes:

For his part, Acton had proposed monetizing WhatsApp through a metered-user model, charging, say, a tenth of a penny after a certain large number of free messages were used up. “You build it once, it runs everywhere in every country,” Acton says. “You don’t need a sophisticated sales force. It’s a very simple business.”

Acton’s plan was shot down by Sandberg. “Her words were ‘It won’t scale.’”

“I called her out one time,” says Acton, who sensed there might be greed at play. “I was like, ‘No, you don’t mean that it won’t scale. You mean it won’t make as much money as… ,’ and she kind of hemmed and hawed a little. And we moved on.” […]

When Acton reached Zuckerberg’s office, a Facebook lawyer was present. Acton made clear that the disagreement — Facebook wanted to make money through ads, and he wanted to make it from high-volume users — meant he could get his full allocation of stock. Facebook’s legal team disagreed, saying that WhatsApp had only been exploring monetization initiatives, not “implementing” them. Zuckerberg, for his part, had a simple message: “He was like, This is probably the last time you’ll ever talk to me.”

Gruber’s response to this quote  – “Sounds like a delightful place to work.”

The WhatsApp founders are presenting themselves as benevolent product people who want to empower people to communicate. By contrast, Acton is presenting Facebook as greedy, immoral capitalists that want to make a buck at all costs. As usual, the truth is somewhere in the middle.

Facebook acquired WhatsApp four years ago, on February 2014 for $19 billion, yes billion with a “B”. Over the last four years, Zuckerberg and the rest of Facebook have let WhatsApp run independently. So far WhatsApp has made Facebook a whopping $0. It appears clear to me that Zuckerberg’s patience was up and he was pushing Acton and the rest of WhatsApp to start monetizing. For the leader of a public company, this is the right thing to do. Four years of no monetization and focusing on the user/product is very fair, now go make some damn money.

Was Acton against monetization? No, but he appears to be against Facebook’s preferred approach of monetization – Ads. His quote in the interview is great for eyeballs but did he actually believe Facebook would want to use a metered-user model? How long would it take for this metered-user model to make back the $19billion Facebook spent?

Facebook doesn’t make money this way. Facebook wants their products available to everyone, and for free, supported by ad revenue. Note to all founders – if you sell your product to Facebook (or Google) it will be supported by ads someday.

The second part of Acton’s quote, “You don’t need a sophisticated sales force. It’s a very simple business.”, also shows a naive understanding of Facebook’s business. Facebook’s long-term approach is a self-serve ad model. Facebook is implementing a “very simple business” monetization approach to WhatsApp, and one that they know very well.

Ads are Bad

What exactly is Acton’s beef with serving ads in WhatsApp Stories? Is this really as “evil” and “creepy” as Acton and many journalists believe? Are serving the most relevant ads to users to support a tool many people benefit from every day more “evil” than charging the same people? This is the narrative I have trouble understanding despite the amount of ink spilled about it.

The main fear is that Facebook’s drive for targetted ads forces it to act as a surveillance organization, not that dissimilar than the NSA. Some believe this information can be used against you. Does Facebook have enough personal/private information to cause harm to you? That’s in the eye of the beholder.

If the root of the fear against ads is not in the ads themselves but with the surveillance that comes with targeting ads, is there a way to improve this fear? How much less money would Facebook make with no targeting at all? 10x less? Could Facebook modify targeted ads to be opt-in, including what information is available for targeting? It’ll be interesting to see how Facebook addresses this issue in the long-term.

Sounds like a delightful place to work.

Gruber’s accusation that Facebook is a terrible place to work is laughable. Yes, Zuckerberg appears to have a ruthless side to him. I’d imagine all CEOs running a company of that size has this side to them. That being said, by all accounts, Facebook appears to be an excellent place to work.

Facebook is #1 in Glassdoor’s “Best Places to work” category and Zuckerberg consistently ranks high in the “Best CEOs at large companies”. He currently ranks 18.

But, but, the Instagram and WhatsApp founders quit! This must surely mean there is a problem!

Not quite. Founders leaving a company after being acquired is inevitable. The fact that the Instagram founders stayed for six years and the WhatsApp founders stayed for four is astounding. Most founders have zero desire to work for a large company, which is why they’re founders. Most companies work quickly to monetize and make their mark on their new baby, but Zuckerberg allowed these companies to run independent much longer than most, which kept their founders around longer than expected.

What this means for the future of Facebook Acquisitions

If there ever was a myth that you could sell your company to Facebook, get rich and never have to monetize, that myth is now exposed. But, I don’t believe this was ever the case. Every founder knows every deal has strings attached.

As Ben Thompson put it

Controlling one’s own destiny, though, takes more than product or popularity. It takes money, which is to say it takes building a company, working business model and all. That is why I mark April 9, 2012, as the day yesterday became inevitable. Letting Facebook build the business may have made Systrom and Krieger rich and freed them to focus on product, but it made Zuckerberg the true CEO, and always, inevitably, CEOs call the shots.

Perhaps Systrom, Krieger and Acton were all too naive to understand this but it’s unlikely. Their treatment and resentment of Facebook may cause founders in the future to take a closer eye at a Facebook offer but unlikely to deter them. Facebook’s pockets are deeper than ever, and these deeper pockets can make up for any goodwill lost here. The impact on these departures is hard to predict and even harder to measure but keep your eye out for more high-profile Facebook acquisitions, they’re not done yet.

 


Trillion Dollar Apple

Posted: August 30th, 2018 | Author: | Filed under: apple | No Comments »

Not So Peak Apple

When Steve Jobs returned to Apple in 1997, Michael Dell, CEO of Dell, was asked what he’d do if he were in Jobs’ shoes, Dell said:

“What would I do? I’d shut it down and give the money back to the shareholders.”

In 2006, when the Apple smartphone rumors started building steam, Ed Colligan, CEO of Palm had this to say

“We’ve learned and struggled for a few years here figuring out how to make a decent phone,” he said. “PC guys are not going to just figure this out. They’re not going to just walk in.”

In 2007, when Apple was on the verge of releasing the iPhone, Steve Ballmer, CEO of Microsoft had this to say

“Now we’ll get a chance to go through this again in phones and music players. There’s no chance that the iPhone is going to get any significant market share. No chance. It’s a $500 subsidized item. They may make a lot of money. But if you actually take a look at the 1.3 billion phones that get sold, I’d prefer to have our software in 60% or 70% or 80% of them, than I would to have 2% or 3%, which is what Apple might get.”

Beyond those infamous quotes, there has been an onslaught of “Peak Apple” predictions and articles from every corner. Below you can see the Peak Apple articles themselves hit a peak in October 2011, when Steve Jobs passed away.

Google Trends graph for “peak apple”

 

Fast forward to 2018 and a lot happened. Dell shrunk and had to go private. Palm was acquired and is out of the smartphone game. Microsoft is out of the smartphone game and Ballmer retired. But one thing has remained the same, Apple continues to grow.

How it Got to a Trillion

Apple’s march to a trillion starts off with Steve Jobs’ integrated approach to creating products. Unlike Dell, who focused on the hardware, or Microsoft who focused on the software, Apple focused on both. During the 80s, 90s and early 2000s, this integrated approach to building PCs was great but not as great as a business as Dell’s and Microsoft’s specialziation strategy. Dell and Microsoft made more revenue during this era but Apple was building an expertise – building hardware and software that worked in harmony.

In 1997, Steve Jobs returned to a down-and-out Apple as CEO. Apple had lost its way and Jobs immediately cut down the product lines to establish focus. This focus enabled Apple to be ready for the next big opportunity, the iPod in 2001. The iPod was the first modern device Apple made that leveraged its competitive advantage of building integrated products to take advantage of a macro trend, in this case the rise of MP3s.

The focus, the integrated product approach and specifically the iPod set Apple up to take advantage of perhaps the biggest product opportunity ever – the smartphone. As wireless broadband, ARM processors, lithium batteries and touchscreen technology reached a point of maturity, Apple was ready to pounce and exploit its expertise to fill an enormous demand for smartphones. And pounce they did, creating the iPhone that has been the main revenue driver that allowed Apple to become the first publicly traded $1 trillion company in the US.

What’s Next For Apple?

Is this it for Apple? Is this the peak? I sure as hell won’t make the mistake of attempting that prediction.

The iPhone will continue to be a money maker for Apple for some time. Despite experiencing a plateau with total iPhones shipped, the iPhone continues to grow in revenue by moving more high-end and adding more tiers. Furthermore, Apple has opportunities to ship more units as India and China’s middle class grows, time will tell if we’ve reached peak iPhone shipments. The services revenue and peripherals (Watch, AirPods) will continue to grow revenue for Apple.

But keeping the status quo is not the company Steve Jobs wanted to build and it’s not the company he left behind. Like Walt Disney before him, Jobs established a company of values and conviction that can survive and thrive well after his death. Perhaps the best part about speculating Apple’s future is how tight-lipped they are with future plans. Will Apple ride the VR wave? Will Apple be a player with autonomous cars? We don’t know the answers to that yet but you can bet Apple won’t rest on its laurels. Apple will, for the most part, avoid increasing revenue through acquisitions and will instead invest heavily in creating products that allow Apple’s integrated approach to shine.

 

 

 


Growing Facebook, Inc.

Posted: July 31st, 2018 | Author: | Filed under: facebook | No Comments »

FB Growth

It’s been a wild ride for Facebook’s stock in 2018. It was punished by “Cambridge Analytica” in April but had a big ramp up from May-July resulting in an all-time high market cap of ~$630 billion dollars.

But that changed when Facebook released its earnings last week. The stock dropped over 20% and the current market cap is closer to $500 billion. Wall Street is spooked about Facebook’s guidance for slowing growth.

Our total revenue growth rates will continue to decelerate in the second half of 2018, and we expect our revenue growth rates to decline by high-single digit percentages from prior quarters sequentially in both Q3 and Q4.

– Facebook CFO Dave Wehner

Is the market acting rationally? Was the earnings report “abysmal” like many hot takes have labeled it?

Financial Fundamentals

In Q1, FB’s revenue grew 49% yoy. In Q2, FB’s revenue grew 42% yoy. This new guidance puts FB’s Q3 growth greater than 32% and Q4 growth greater than 22%. Although this guidance is lower this is incredible growth for a company of Facebook’s size. Apple, Google, and the all mighty Amazon have all averaged growth under 30% yoy the last decade. Even with Facebook’s revised guidance, it is ahead of the pace of its peers. With its P/E at 23, this gives FB a PE/Growth (PEG) of well over 1. According to value investor Peter Lynch, Facebook is cheap from a fundamental perspective.

It seems difficult to label this earnings call as abysmal. The fundamentals are strong with few attacks on its current business model. But does this make Facebook a value stock instead of a growth stock?

#DeleteFacebook

The height of #DeleteFacebook was in April and any ramifications were reported in the earnings last week. US & Canada were flat with both DAUs and MAUs, which means few followed through with deleting their account. European users saw a decrease in DAUs which Facebook is attributing to GDPR rollout, not towards #deleteFacebook.

The good news from the earnings report is that there is no mass user exodus. All “Peak Facebook” predictions have fallen flat. That being said, user growth of Facebook.com may move closer to internet growth in general. But should Facebook’s growth potential be evaluated based on Facebook.com’s user growth? Or should Wall Street start paying attention to the new number rolled out these earnings –

For the first time today, we’re also releasing how many people use at least one of our apps, Facebook, WhatsApp, Instagram or Messenger, and that’s 2.5 billion people each month.

-Mark Zuckerberg

WhatsApp, Instagram, and Messenger can all continue to grow for years to come. Since Facebook provides a way for advertisers to target users on any of their apps, it doesn’t quite matter which of these apps the eyeballs are on. Therefore, revenue growth is no longer as tied to Facebook.com’s user growth as it has been in the past.

Areas of Growth Opportunity

Stories

The biggest place Facebook has work to do is in monetizing Stories. After paying $22 billion dollars for WhatsApp in 2014, Facebook finally has an opportunity to make some of that dough back. WhatsApp has 450mm DAUs on WhatsApp Status (their stories format). Add another 400mm for Instagram stories and 150mm on Facebook stories and you have a lot of eyeballs to monetize.

Like the mobile monetization before it, I expect Facebook to easily capture value with Stories. In Facebook’s early days as a public company, many doubted its ability to advertise effectively on mobile. Today, it accounts for 91% of Facebook’s advertising revenue

Mobile ad revenue was $11.9 billion, a 50% increase year-over-year, making up approximately 91% of total ad revenue.

Similar doubts exist about Facebook’s ability to monetize Stories. These doubts will go unfounded as time goes on. The uncertainty around monetizing mobile ads were more founded than Stories since no other mobile app was monetizing ads at scale when Facebook started that journey. But with Stories, Facebook (and Wall Street) has Snap to use as a model. Snap is pulling in ~$1.20 per quarter per user from Stories monetization (and growing 35% yoy). With over 1 billion DAU Stories users, Facebook can easily make another $1 billion per quarter from these ads (and I expect much more as time goes on).

Marketplace, Workplace, and Occulus 

Like Google before it, Facebook continues to attempt to diversify its revenue streams but so far all attempts are dwarfed by the mega success of their advertising products.

“Payments and other fees” brought in $193mm, which is 1.5% of total revenue. This means that Marketplace, Workplace, and Occulus are not producing significant revenue. Although this is an area of opportunity this is also an area to keep expenses down. Facebook remains more focused than Google and Amazon, but can Facebook make the tough decisions? Can/will Facebook shut down a major effort if it underperforms?

Based on its low PEG, you can make an argument that Facebook is a value stock. But its growth days aren’t over as last quarter has shown. When you consider the revenue growth and user growth potential of products under the Facebook umbrella, it becomes clear that Facebook is a growth stock with fundamentals that appeal to a value stock investor.

FB will reach a new all-time high before 2018 is over. The $1 trillion market cap is still less than five years away. Facebook’s growth isn’t over yet.

Disclaimer – I own $FB and am biased AF

 

 

 

 


Facebook is F*cked, Long Live Facebook

Posted: June 28th, 2018 | Author: | Filed under: facebook | No Comments »

In March, in the thick of the Cambridge Analytica and #DeleteFacebook “movement”, I wrote a piece defending Facebook.

It’s now June and time to reflect. Zuckerberg has been dragged in front of Congress and the European Parliament. The Cambridge Analytica headlines have slowed. #DeleteFacebook is no longer trending. Facebook released earnings results which showed user growth, not users leaving Facebook. Furthermore, Facebook’s stock has reached an all-time high, over $200 a share and a near $600B market cap.

Facebook Nevers

MG Siegler remains a top 5 tech writer in my book but I disagree with his Facebook analysis. After seeing #DeleteFacebook was a complete joke, MG has turned his rationale for Facebook’s inevitable decline…”Facebook Nevers“.

 The fall of Facebook was never going to be people quitting the service en masse — it’s too interwoven into the fabric of the way many of us use the web these days — it was always going to be the people who never really use the service in the first place. Kids.

MG compared Facebook to Cable. It’s not that people will quit en masse but youngsters won’t sign up. He acknowledged that probably wasn’t the case –

But again, Facebook is so integrated into so many lives that in many cases you’re basically forced to sign up. Even the kids in many cases. Just as they must sign up for an email account. It’s a rite of passage, in a way. Your entrée onto the internet. So perhaps “never” is a bit harsh of a word here.

Anecdotally, what MG says in the last quote is what I’ve experienced. All of my younger cousins are on Facebook but don’t post to it much (it’s unclear how often they lurk). MG’s analogy to email is spot on here but he missed the larger arch. Young people will sign up for both email and Facebook early but won’t use either…until they become adults. They’ll use email when they go to college and much more when they enter the workplace.

Facebook is awful when you’re finding yourself as a kid. But it’s awesome when you’re stuck at home raising two young children. Sharing your children grow with people around the world is amazing for parents. Facebook will have less use in the 13-25 demo but once people enter parenthood, their behavior will change in many ways, including how they use social media.

$100B Instagram

According to “Bloomberg Intelligence”, whatever the hell that is, Instagram is now worth $100B. That number may as well be right but something is worth how much someone is willing to pay for it, not based on what data or some analyst says. That being said, Instagram is killing it.

In March, I said –

Few will #DeleteFacebook and those who do will come back or increase their Instagram use.

This appears to have come to fruition. Instagram now has over 1 billion users with 400 million users using Instagram Stories daily. That’s a shitload of engagement. For some reason Facebook is not releasing time spent on Instagram so attempts to compare it to Snap is apples to oranges.

Who knows if Instagram is worth $100B but it’s safe to say it’s not being factored into Facebook’s valuation reasonably. With Facebook’s PE hovering around 25, the market isn’t expecting much growth from a product now responsible for over 15% of FB’s revenue (and growing rapidly).

Facebook to A Trillion in Five Years

Now that the media cycle has passed and the Facebook bears have went into hibernation, we can talk about where Facebook is going. Five years ago Facebook’s market cap was ~ $60B. Many thought that was absurd but here we are, five years later and $FB is worth 10x more.

Facebook is ~$400B (1.7x growth) away from the elusive $1 trillion market cap. With revenue growth at 47% in 2017 and PE at a reasonable 28, it’s hard to see this locomotive slowing down anytime soon. To get to $1 trillion dollars, FB needs to average a paltry (for Facebook) 12% market cap growth a year.

Facebook growth with 12% yoy market cap growth per year

How does it get there? Can Facebook continue to grow its user base past 2 billion? Although there are another 6 billion people to go in the world, Facebook can reach $1 trillion through ARPU Growth.

ARPU Growth

Over the past seven years Facebook has averaged 26% growth in revenue per user. Continuing this trend alone will push Facebook past the $1 trillion mark with ease. User growth, monetization of WhatsApp, Oculus revenue etc is icing on the cake.

Facebook’s demise was media hype. Instagram will continue to grow its user base and monetization. Facebook proper will continue to be Facebook, serving 2 billion people a day content and ads. ARPU will continue to increase. In 5 years, $FB will be worth $345/share at a $1 trillion market cap.

There are dozens of reasons why these predictions may not happen, but I’m putting my money on Zuckerberg and Facebook. Easy money!

Disclaimer – I own $FB and am biased AF


Smart Speaker Wars

Posted: May 31st, 2018 | Author: | Filed under: amazon, apple | No Comments »

Kind HomePod

Like the Apple Watch and AirpPods before it, many think the HomePod is a flop. There are common criticisms and rationale behind this sentiment. In the end, the HomePod will play out like the Watch and AirPods. It’ll be the most loved and most profitable product in its market.

The “Smart Speaker” category is just getting started. Amazon, with their Echo family of speakers owns 70% of the market. Google owns 25%. But, only 20% of US Adults own a smart speaker. From the iPhone to the Watch this is one of the least mature industries Apple has entered in awhile.

Apple’s foray into Smart Speakers is the same playbook they’ve followed for decades. Apple is never the first mover, they’re always “overpriced” and “under featured”. The HomePod is all of these to the T yet those who follow Apple closely believe this time is different. That Amazon has an insurmountable lead.

The HomePod’s strengths compared to the competition is voice recognition and sound quality. Siri may not be as accurate and robust as Alexa but the HomePod is most likely to hear your command. The price point is much higher than Amazon’s and Google’s products but the sound quality is arguably the best. Smart Speakers largest use case so far is to play music. Apple is making sure they nail this.

Ben Thompson believes HomePod’s sole native integration with Apple Music is an example of Apple’s strategy of squeezing more out of current customers. He cites Apple’s iPod’s interoperability with Windows as a clear difference in Apple’s strategy with HomePod. Ben forgets the first generation iPod was only MacOS compatible. Time well tell if Apple provides better support for Spotify and Amazon Music.

Apple continues to follow Apple’s strategy since its inception –  ensure Apple products work best within the Apple ecosystem first and foremost. Airplay from an iPhone, using Siri to play Apple Music – make sure these experiences work 99.9% of the time before rushing to support other systems.

Amazon’s strategy is much different. Amazon is focused on creating cheap devices. They’re on the lower end of sound quality and the price point implies the margins are slim or non-existent. Amazon doesn’t announce their strategy but there are two strategies that make sense when selling something at a loss. The first is to ensure market share and slowly but surely raise the price until you’re profitable. The second is to make money off of the device in other ways. Microsoft famously lost money on every Xbox but made it up on licensing from games sold. Google doesn’t make money off of Android but off of Google Searches on Android phones. Amazon believes those with an Alexa device in their home will buy more stuff from Amazon. Will this be true? So far there is evidence of correlation but not causation.

Beyond price, Amazon’s Alexa is a better voice assistant than Apple’s Siri.  But…both leave a lot to be desired. Despite the majority of people having access to voice assistants on their phone, only 46% have used them once. Of those who do use it, only 39% found that voice assistants accurately respond to their commands most of the time. Imagine if Google Search was only 39% accurate? Voice assistants aren’t quite ready for prime time.

Apple is behind on market share. HomePod is expensive. But HomePod is the best at what people use Smart Speakers for – playing music. The price point will drop, the HomePod will support more third party devices/streaming apps and Siri will catch up to Alexa and Google Assistant. Ultimately the HomePod will never have the most market share but they will own the most profit in the category.