Friday, 26 October 2012

Can Logitech survive in a Post-PC world?

Yesterday I started a new series on the move towards Post-PC architectures, laying out what I believed a Post-PC device was. In essence its a low-cost, mobile device that acts as a window into a cloud ecosystem, has a more integrated hardware design and is often sold with an upfront subsidy. Oh and you'll probably be owning more than one of them.

I want to move on now to consider the implications for the various business models across the industry. Like any good bully I'm going to start by picking on the easy targets, the incumbent business models of PC manufacturers, and point out some of the obvious stress points.

Watch Out Wintel!

Great book - but can Intel practice
what they preach?
Well actually quite a lot, if you have any sort of economic interest in the current PC era. The current PC value chain is dominated by two companies - Microsoft and Intel. With their cool 40% operating margins they skim off the lions share of profits, leaving DRAM vendors, hard disk manufacturers and PC OEM's fighting it out for single-digit margins at the bottom of the pile. Note its a common fallacy that PCs are a low-or-no-margin business. They are actually a massively high margin business, but only if you name starts with "Microsof-" or ends with "-ntel".

These two profit pools (Microsoft's Windows and Office licences and Intel's CPU sales) are most directly threatened by the shift away from PCs. The move to post-PC devices removes one of their great competitive moats, which is that (apart from the limited OSX domain) there was no competing ecosystem users could play in other than the Windows Desktop. In essence buying an Intel CPU or a Windows licence was an obligatory tax you had to pay before you could use a computer. No longer.

Now this moat, which is one of the great economic monuments of our time, does not vanish overnight. As I said - the sluggards of the enterprise world are likely to remain a great bulwark supporting their profits for years to come.

Also Intel have moved frighteningly quickly with the mobile SOC development. Having been caught napping by ARM, Medfield is now not only feature but battery-life comparable to ARM. With their fearsome execution engine Intel will only move ahead from here.

But the problem is that an ARM SOC sells for $20-30 versus $100 for a full-fat Intel processor. Both are sufficient to power a single device - the problem is the post-PC device is a lot cheaper. And even in high-margin enterprise servers - the ultimate fortress for Intel's horsepower, ARM are starting to get a foot in the door.

For Microsoft the launch of Windows 8 becomes ever more critical. By all accounts they've done a good job of executing on what is essentially a compromise between two worlds. Actually MSFT's execution over the last few years has been great (Courier notwithstanding). But the problem is that slick new products like Kinect, or Windows Phone 7 can't outweight the ballast of Office + Windows in their revenue mix. That's doubly clear if you break out the profit contributions:

Of course as I said, most the enterprise world is barely getting its head around the idea that they can move to Windows 7, let along Windows 8 or - god forsake - some untried and un-enterprise-grade Post-PC gig. Just so long as you remember though that nothing lasts forever...

Look Out Logitech!

As I write this Logitech's shares are down 15% on the Nasdaq after a tricky H2 guidance cut. The issue is a sudden softening in PC demand in Q3 (funny how these things are always sudden!). Logitech are pointing to the slower macro, exacerbated by a pause ahead of Windows 8. But I have long suspected that the underlying issues are more structural.

I briefly touched on Logitech the other week as a potential loser in the war between platforms. I want to flesh that out a bit. In essence Logitech are overwhelming exposed to the existing PC platform.

This chart shows their revenue mix on a LTM basis. As you can see by far the most important contributors are keyboards and mice. Mice are the single biggest category - but where do they fit in a world that's moving towards touchscreen devices? Microsoft are clearly pushing Windows - even PC versions - towards a more Metro and touch-focused interface. The mouse may be becoming an endangered species.

In a Post-PC world keyboards also move from being essential to being an optional extra. Now to their credit keyboard sales do include some contribution from iPad keyboard accessories (I make iPad accessories about $17m this Q or 3% of group sales). However the truth is the attachment rates of keyboards in a Post-PC world is going to be far below the 100% rate Logitech currently enjoys.

But the exposure doesn't stop there though. Webcams - they are also linked to PCs (Post-PC devices generally have webcams built in, and are too small to mount an external one). Speakers, docks and headphones are also tilted towards speakers for PCs or iPod docks (another category that's on the way out after Apple's move to the Lightning Connector).

In short if the world moves hard towards the Post-PC architecture, three-quarters of Logitech's revenues are at risk.

This is exacerbated by the fact that Logitech are overwhelmingly a consumer-focused company. Remember if there is any area that will resist the most to Post-PC it will be slow-moving corporates. However what little exposure they have to these customers comes either from their low-margin OEM business (which is declining at a c20% rate) or their LifeSize video-conferencing unit (which is under-scale and loss-making). So little comfort there.

Of course Logitech will argue that the Post-PC world opens up new opportunities, and that peripherals such as their Ultrathin Keyboard Cover will allow them to drive renewed growth in Keyboards. However there are a number of challenges there which may prove too hard to overcome.
  • The first is that the Post-PC peripheral market is brutally competitive. Like any growth market it attract any number of new entrants willing to have a go (the satnav market was very similar in the mid-2000s. Just look at the wide range of competitors Logitech faces in this group test. Now eventually there will be a shake-up as the market matures and Logitech will undoubtedly remain standing. However in the near term this means the market will suffer from pricing pressure and margins will remain capped.
  • The second more fundamental issue is that Post-PC devices are, by nature, less amenable to peripherals. As I pointed out in yesterday's post, because they are smaller, cheaper and run on a very quick (6-12 month) product cycle, their design tends to be more integrated and appliance-like. This limits the scope for peripheral makers versus, say, PCs which were designed from the outset to be modular and peripheral friendly. Also if mobility is the hallmark of a Post-PC device, this again limits the scope for peripherals.
  • Thirdly Post-PC devices are subject to significant platform risk. Apple's move to the Lightning Connector is a good example - at a stroke they've pretty much wiped out the market for iPhone docks and depreciated millions of dollars of current inventory. That doesn't mean you can't make good profits in the meantime, simply that you can never escape the risk you'll have a nasty shock further down the line. (e.g. what if Apple brings out the New iPad... With Keyboard Cover?)
The chart below show's Logitech's historic operating margin on a LTM basis. You can see clearly the fat, excess returns they earned in the 2000's when they had a dominant position in PC peripherals. Then you see the hit they took in the last recession, and their consequent recovery to 4% margins. The risk is that if the Post-PC world tips the desktop over the edge, even that may look generous.

PS And no, I don't have a position in Intel, Microsoft or Logitech shares. Just in case you were wondering.

Thursday, 25 October 2012

Welcome to the Post-PC era

(Another) big week in Tech

Surface: When is a Windows device not a PC?

This is the biggest week in the post-PC era so far.

For a start we've had Apple's latest iPad, taking everyone's favourite table to a lower price-point and a broader market.

Then we have Microsoft playing their game of How Windows 8 Launches Can We Confuse You With At Once (I count RT, Pro and Windows Phone so far, although that's not forgetting Windows Phone 7.8 and whatever enterprise/server variants of Windows 8 Pro they come up with).

And to round off the fesivities we'll have we've got Google on Monday lifting the lid on their latest Nexus phone and (allegedly) another attempted at a 10" tablet (don't hold your breath. Four words: Still No Tablet Apps).

What do you mean by the Post-PC era?

I'm been thinking a lot about the post-PC era in the last few months. It's clearly going to cause seismic shifts in the industry, not only in terms of devices but in terms of the underlying economics.

For two decades the WinTel monopoly has hoovered up the overwhelming majority of industry profits, leaving mere scraps for the PC OEMs to live off. Over the next five years this is likely to change.

Like "Cloud Computing", "Big-Data" and "Web 2.0", the "Post-PC era" is the sort of buzzword that is abused far more often than it is used. In essence it is the shift from the thick-client desktop PC or notebook as the primary compute hub, to multiple thinner-client mobile devices (for the moment, smartphones and tablets) accessing services hosted in a remote computing hub.

To me the the Post-PC era evolves from three key trends in the technology world.

  • First the shift to cloud computing, which I have documented elsewhere. Rather than running discrete apps like Word or Media Player on a desktop, the opening up of broadband pipes makes it more efficient to offer them as a services (e.g. Google Docs or Youtube) down the broadband pipe.
  • Second the rise of mobile broadband networks (hey we're actually getting LTE in the UK this year!) and the ubiquity of wi-fi, which means that devices which utilise these services no longer need to be tied to a plug or a network socket.
Wing Commander 2: A game that primarily revolved around
killed evil space cats with space ships. And sold millions
of new PCs to boot.
  • Thirdly the trend for fast-moving consumer cycles to drive rapid evolution in the quality of devices and services. A good example is how cutting-edge video games drove the increasing power of desktop PCs between 1990-2005 - that Wing Commander 2 sold a damn sight more 486s than Word 2 ever did. While enterprise computing is very slow, governed by 5-6 year upgrade cycles (11 year-old Windows XP still powers 4 out of 10 corporate PCs!), the 6-12 month cycles in the ultra-competitive smartphone world has driven startling improvements over the last five years.

What does a Post-PC device look like?

These three trends have given rise to a range of post-PC devices such as smartphones and tablets which share the following charateristics:

  • The device is primarily a window into a cloud ecosystem: More and more, vendors are not selling you a phone, they are selling you an ecosystem. You buy an iPad over an <insert pointless Android tablet here> because it kicks ass with a range of third-party apps. You buy a Kindle Fire because Amazon Prime gives you more media content than you can consume in a lifetime. You buy an Android phone because you run your life on GMail, Google Calender, Google Tasks and Google Docs.
  • The device is smaller and more mobile: Because more processing is done in the cloud and delivered via broadband, you only need a thin, mobile client. This dictates a smaller and more portable device. Thankfully the rise of the ARM SOC and the relentless improvements in fabrication processes driven by Moore's Law have given us precisely the right hardware to power such devices.
The ultimate post-PC appliance! :-p
  • Devices are more like appliances: Another result of a smaller, thinner device being built to a 6-12 month product cycle is that it tends to be more tightly integrated and closed. Whereas traditional PCs are built to last 5 years and be upgradeable, cheaper post-PC devices are only meant to last until next Christmas. This means the form-factor becomes more appliance like in terms of integration and lack of expansion (cf the latest Macbook Airs with their non-upgradable storage).
  • There are multiple devices, rather than just one: You don't have just one post-PC device. Because each is only a window into a centralised hub of services, and because they are smaller and cheaper, it makes sense to have different devices for different use-cases. Again this ties into the appliance point mentioned above - rather than having one general-purpose device you have a smartphone for accessing services on the fly and a tablet for sitting on the couch and watching movies.
  • The device is often subsidised up-front: The traditional PC value chain was always very fragmented, with your PC being purchased separately from your broadband, the DVDs you played on it and the apps/games which you ran on it. This meant each vendor was paid individually. In contrast the post-PC devices is merely a window onto a cloud ecosystem, and the business models of the vendors are much more integrated (AAPL being the prime example...). This means the hardware is often subsidised - either explicitly (by way of a two-year handset contract), or implicitly (e.g. Google and Amazon selling your tablets at cost and recouping the money via ads/product sales later).
Free... Provided you buy a matching diamante 24 month contract costing $960...

In a nutshell you get a cheaper, better looking and more mobile devices, subsidised up front. Heck you can even play Wing Commander 2 on it!

What's not to like?

Well quite a lot actually. Come back tomorrow as I start to delve into some of the trickier economics of the post-PC era!

Wednesday, 24 October 2012

The (Mobile) Gospel According to Zuck

Facebook ups its game

The shift to mobile has been the biggest overhang for Facebook's share price since its IPO. In a nutshell, users are shifting to mobile but up until this year Facebook never advertised on mobile, so a mobile user was a lost user in economic terms. In Q2 it made tentative steps, with sponsored stories on mobile delivering $0.5m /day in ad revenue. But at the same time Zynga was painting a grim picture of his its mobile ARPUs were half than on the desktop.

To their credit things were rosier last night. Facebook delivered $1.26bn of revenue and 12c of EPS vs. consensus of $1.2bn and 11c. But what was more important was the quality of that revenue. Despite Zynga-driven sluggishness in Payments, Advertising revenue which is the real growth engine showed accelerating from 28% YoY growth last Q to 36% in Q3. ARPU's also ticked up from $1.28 /user to $1.29 as Facebook struck gold with promoted posts in users News Feeds. Ad pricing was +7%, having grown 9% in Q2.

Mobile is showing signs of life

Most importantly though was a marked improvement in mobile. As I highlighted recently, mobile users continued to grow in the mix, but for the first time Facebook seemed to be making real money from them.

Facebook impressed with two data points - firstly mobile ad revenues were $150m in the quarter (from zero six months ago), or 12% of group revenues (for reference 60% of FB users access it on mobile, and maybe 12-13% access it exclusively on mobile). That implies a $600m /year mobile business.

Secondly on the conference call they disclosed that sponsored stories on mobile newsfeeds were running at a rate of roughly $3m /day at present. That implies the mobile business is ramping up to more like $1bn+ (versus group revenues of c$4bn).

Now bear in mind that isn't all new revenue - inevitably it involves some cannibalisation of desktop advertising. But it makes a strong case against the perception coming from Zynga that mobile is an unrelenting negative.

I think that's doubly impressive because - to be frank - Facebook's ad targeting has been lamentable, both on desktop and mobile. My wife is still getting ads for mid-market CRM system on her news feed (she's a PhD student!) on the dubious assumption that a friend of hers once "Liked" Salesforce and so she must like it. If they can up their game on how to target users (which should be the easy bit for them...) there is clearly more upside here.

The (mobile) Gospel According to Zuck

What was most interesting was Zuckerberg articulating the clearest case for mobile that I've heard him make. He made the following arguments

  1. Mobile reaches more people than on desktop.
  2. Mobile users check their devices more often than desktop ones.
  3. Mobile ads are higher quality and more interactive than desktop (or traditional TV ads).
  4. Mobile ads can be more integrated into the device than on the destkop.

This is the first time I've heard him make this case - and a contrast to the somewhat rabbit-in-headlights approach adopted on their maiden conference call. It is a powerful case, but not an overwhelming one. I would make the following points:

Mobile reaches more users: Yes mobile reaches more users than on the desktop, but bear in mind a lot of the incremental news mobile-only users are likely to be those in poorer countries who don't have a computer/internet connection at home. So new mobile users are lower yield.

Mobile users check their devices more often: This is a definite positive. Also mobile ads can only come in the news feed (due to limited screen real estate) which makes them more memorable. My wife's spam is a good example - I may not like it but I certainly remember it.

Mobile ads are higher quality and more interactive: In theory this is true. In practice though Apple's iAds fiasco has shown more interactive is not necessarily better. Mobile ads are different, but whether they are better is yet to be proven.

Mobile ads can be more integrated into the device: This is the biggest issue because it runs into the issue of Platform Risk. In theory Facebook (and its ads) can be much more integrated into the device than on mobile. Zuckerberg game the example of Mobile-App-Install Ads which push the user towards an app (from the advertiser) on the Android or iOS app store. In practice though there is one big problem with this.

The coming battle over platform risk

The problem is that Facebook does not control the platform. Facebook's mobile apps sit on top of iOS/Android/Amazon &tc. This means it can only be integrated into the device as much as the ultimate platform owner feels like allowing them to be.

This is exacerbated by the fact that at least one of the platform owners - Google - is Facebook's biggest competitor in advertising. It is highly unlikely that Google will allow Facebook to make hay with mobile ad integration at its own expense.

Its been interesting actually how much Facebook has been cosying up to Apple (my enemy's enemy is my friend, right?) with more direct FB integration coming into iOS and OSX in recent updates and Facebook re-engineering its iOS app first. Apple's iAds platform (as I've already highlighted) has had limited traction - in contrast of Facebook's Q3 success. But ultimately Apple too will be thinking about its own interests.

In short on mobile, much more than desktop, Facebook has a real challenge related to Platform Risk, a topic I recently wrote about. Much as Zynga was beholden to the Facebook platform (from which it was quite spectacularly thrown under a bus on last night's conference call), so Facebook is ultimately beholden to iOS and Android.

The best case scenario for them is that this limits the excess returns they can make on the mobile platform. The worst case scenario is that one day Google and/or Apple cut them out of the loop.

Zuckerberg was asked about this issue late on the call and did not give a convincing answer, instead falling back on his script that a) mobile = more users/facetime/monitisation, and b) pointing out that Facebook isn't running apps on its mobile platform its connecting other people's (which isn't going to be much use if one day Apple cut's the phone lines).

To be fair some of these conflicts are still some way in the future. Apple certainly is enjoying something of a love-in with El Zuck. The platform war with Google though is a more immediate threat.

Monday, 22 October 2012

Organising chaos - A Blog Recap

This blog has been running for just over three months now, so apropos of nothing I thought I'd put up a recap of some of the key posts.

I tend to write posts in a series, but this tends to get lost in the chronology of the blog archive. So I thought readers might find a quick recap quite useful.

Anyhow here are the key issues I've written about so far. Lot's more to come!

Bloomberg & Cloud Computing

I'd wanted to talk about Bloomberg for some time. A lot of the analysis here I haven't seen elsewhere - partly because of their extreme secrecy but partly because no-one was thinking about them as a cloud computing company. Of course as part of this I needed to set out what a cloud computing company was - hence a mini-series on cloud before getting down and dirty with Bloomberg.

Apple, iPhones, iOS6 and Maps

Of course no self-respecting tech blog can ignore the big AAPL. What I've tried to do is put its business into the context of a wider war between competing platforms, rather than about what shiny boondoggle they will come up with next. In particular I've written extensively on Maps as I've got a fair bit of background in that area.


Facebook was an obvious topic to write on - not only because its at a make-or-break point in its evolution, but because as a relatively new public company surprisingly little analysis had been done about it. I'm looking forward muchly to picking apart their results tomorrow!

Connected TV & Appliances

The evolution from Appliance to Compute Device is one of the most powerful, but least-talked about, disruptions you see in consumer land. Most importantly the biggest appliance => compute device shift is about to take place in your very own living room. All hail the connected TV!

Technology business models

While its fun talking about shiny boondoggles, what fascinates me as an analyst is how you connect the boondoggle to the cashflow - i.e. the business models which tech companies use to monitise their products. In terms of growth, capital intensity and rapid change I think these are absolutely extraordinary. And it also presents lots of opportunties for investors to make money..

Nothing in particular

Sometimes something interesting catches my eye. Normally I try to make it vaguely tech or business related. Sometimes I don't succeed. 

Thursday, 18 October 2012

How much will Apple pay for TomTom?

Yesterday I set out the strategic rationale for Apple to acquire TomTom. In a nutshell 1) it helps them fix iOS maps, 2) it gives them longer-term muscle in the mapping business and 3) is a do-able deal.

Today I want to focus on the third point - how would the deal come about and how much would Apple have to pay. My key takeaways is that the deal is very do-able, but Apple will need to pay a decent premium to the current share price.

TomTom: A potted history

TomTom: Rise and Fall
Before I lay out my case I want to provide some background on TomTom. This is partly for entertainment value (its certainly been been one of the more eventful companies I've covered in my time as an equity analyst), but mainly because to understand this deal you have to understand where the founders are coming from.

TomTom began as a software shop by a bunch of former employees from Psion's Dutch arm, notably Harold Goddijn and his wife Corinne Vigreux (who still lead of the company today). The outfit - called Palmtopsoftware - originally wrote apps for Psion PDAs. I remember with some affection using their ZX Spectrum simulator on my Psion Revo back in the day (it let you play Defender of the Crown in the college library. 'nuff said). They then moved onto writing apps for Windows CE-based devices such as dictionaries and nagivation apps.

Harold's current yacht
Then engineer (and co-Psion refugee) Mark Gretton struck gold with the idea that rather than kludging their software onto Windows CE boxes, they should build their own dedicated device. This was a classic case of a dedicated appliance pioneering a new technology. TomTom happened to be at the right place at the right time, and smart enough about branding their devices to build a big lead in the market. IPO, riches and acclaim followed. Harold and Corinne bought a yacht.

Then it all went wrong.

Two things (almost) killed TomTom. First they grossly overpaid to buy Tele Atlas funded by far too much debt. Then both debt market and the satnav market crashed.

Actually buying Tele Atlas was a smart strategic move. At the time it was one of only two vendors (along with Navteq) which had a full digital map for Europe and North America (Google has since built its own third map) and thus had genuine scarcity value. And the market for a dedicated appliance matured, it made sense to diversify into higher-margin software. The fact that I am now writing about Apple wanting to buy TomTom - principally for Tele Atlas - is in some ways a vindication of the deal. Unfortunately they made the mistake of getting into a bidding war with rival Garmin which meant they ended up paying €3bn, funded by debt.

They might have survived that but then the global economic crisis hit just as the satnav market went ex-growth. With revenues from its main profit-driver falling at a 20-30% rate TomTom simply could not meet its debt covenants and the shares which had peaked at over €60 fell to less than €3. This culminating in a near-death experience and a rather messy refinancing mid-2009. To their credit Goddijn and Vigreux put their money where their mouth was, putting their personal wealth back into their company via the rights issue. They also brought on-board friendly local investors Janovo and Cyrte who put in €100m for a 10% stake. The current shareholder structure looks like this:

Since then its hardly been an easy ride. In particular Google's bombshell in October 2009 of free turn-by-turn on Android (a move finally followed by Apple this year) was the beginning of the slow death of Satnavs as a mass market proposition. Yes there remains a market for them for holidaymakers or professional users (I actually bought one this year to help navigate us on our honeymoon!), but since then Satnav revenues have declined steadily, such that TomTom no longer even tells us how many devices they have sold each quarter. To her credit CFO Marina Wyatt has done a good job defending margins and keeping the company profitable (the pressure of debt covenants does help focus the mind), but it can't have been much fun in recent years.

But at least they still have the map.

How much is TomTom worth?

There are two questions here. First how much TomTom is worth as a standalone business. Second how much is it worth to Apple.

Actually the first question doesn't matter a vast amount (I know, I know. Any value investors please leave the room now). It gives us a starting point for valuation but everyone at the table will know the real point is how much Apple is prepared to pay. For what it's worth, here's a bog-standard DCF I knocked up on TomTom's business:

Key assumptions are highlighted in blue. I'm not going to claim its a work of art, or indeed that its going to be particularly accurate. Basically IF you assume satnav declines (and therefore revenue declines) bottom out this year AND IF you assume TomTom can sustain a 10% margin then it implies a valuation price a smidge over €4 /share or about €900m for the equity (not far off the current price). . At the DCF valuation TomTom would be trading on roughly 1x EV/Sales and a 10-12.5x forward P/E multiple, consistent with a stable low-growth company. Of course that does assume that Satnavs don't die a death, and that competition doesn't crush margins - as I said its not a work of art.

This isn't particularly useful in figuring out M&A valuation - but at least it gives you a starting point for both sides.

How much is TomTom worth to Apple?

Now we get to the M&A valuation, which is much more interesting but more frustrating. I'm not going to apologise for the fact that the numbers I'm going to talk about here will have little grounding in intrinsic value or sane investment valuation. The sad fact is that most M&A is value destructive, and so the key question is not what an asset is worth but what some mug is prepared to pay for it.

The economic rationale of the deal is simple. TomTom has an asset (its digital map + associated expertise) which it is unable to fully monitise through its existing lines of business (selling satnavs and licencing the map to third parties). However plug that into Apple's front end and distribution and you can suddenly monitise that asset across hundreds of millions of iOS users. Therefore the cash generating potential of that asset is much higher for Apple than for TomTom.

That's the theory. In practice figuring out how much extra value Apple can create over the next 5... 10... 15... 50 years is anyone's guess. At the end of the day it boils down to how much the sellers reckon they can get out of Apple, and how much will make them feel good about themselves. i.e. its an exercise in psychology as much as mathematics.

As with any negotiation, what you need do is put yourself into the shoes of everyone gathered round the table.

Apple: To best honest, they don't particularly care. With $82bn of cash in the bank whatever they pay for TomTom isn't really going to ruin Tim Cook's day. I would say they won't want to pay stupid money for TomTom, and by that I would mean the demonstrably silly €2.9 - 5.7bn price tags which Tele Atlas and Navteq sold for during the last bubble. I would say those levels would be the hard lines which Apple would not want to approach.

Apart from that you can slice the valuation every which way. For example how much more would an iOS user theoretically pay to replace Apple Maps with a decent mapping app? If you assume $5 and multiply that by a 410m iOS installed base you get $2bn (but then again Google Maps is free, and its more about the value of Apple/TomTom maps to future iOS users than existing ones). How much did Apple's share price get whacked by the maps fiasco? $30bn according to some (hint: don't believe everything you read in the papers) so by that reckoning any price tag is good value (the fault in that logic, btw, is that you are making an assumption that TomTom DEFINITELY will make Apple maps as good as Google; it might not).

Another way to think about it is how much would it cost for Apple to build the map from scratch. The short answer is that it took both Tele Atlas and Navteq about $500m of capex to build their US + Western Europe maps back in the 1990s. You could undoubtedly do it for less now (for a start you could buy a TomTom to help your mapping trucks navigate the roads...). But there's a catch - it would take you several years to do this - so whats the opportunity cost of giving Google another few years to forge ahead? Tricky...

We can play these games all day. I think Apple would be willing to pay up to the €3bn level Tele Atlas went for before (they can console themselves that they're getting TomTom's other assets thrown into the deal) which gets us to €13 /share. But I'd assume they'd want to pay far less.

How much will the insiders sell for?

Janovo/Cyrte: This is the easy one. Dutch private equity houses Janovo and Cytre invested €100m in the 2009 refinancing, and hold a 10% stake in TomTom. Doing the math, that means they're currently sitting on a c15% loss on their initial investment. What would be a sensible financial return for them? I think they would want to show their investors at least a 15% CAGR return, and preferably a nice round 20%. Compounding that over three and a half years that would point to a €1.63 - €1.89bn valuation, or roughly €7.4 - €8.5 /share.

In practice though these guys are "friendly" investors for the management. If the founders take an offer they are likely to. And if the founders reject it, the deal is dead anyway.

The Founders: At the end of the day, its whether the four founders Goddijn, Vigreux, Geelen and Pauwels will take a bid. They control 48% of the equity and will have to support any acquisition given TomTom has a poison pill in place to prevent a hostile takeover.

At the very least I think they will want to see a decent return on the €4.21 /share at which they bought back into the company in the 2009 rights offering. It is important to understand the psychology behind this (which is why I gave the potted history above). The founders had nurtured their baby, seen it blossom into a giant and then seen it crash. In 2009 they had the option of walking away and let it get taken over by their debt holders, or putting their money where their mouth was and buying into the refinancing. To their credit they took the latter option, and the company is still around today. But I think the final vindication would be if they could walk away from that investment with a profit.

Another pointer would be stories about a potential de-listing which circulated earlier this year, when the shares were languishing around €3. If they were true (and, to be honest, who bloody knows?), then that would imply the insiders believed the shares were materially undervalued at that level. So what, at least €4 /share perhaps?

But its not just the money. After all in any scenario Apple would have to offer a reasonable premium to the current share price. As I said its important to remember for the founders that TomTom is their baby. So the quality of the offer is as important as the level.

By this I mean if, say, an offer came in from a private equity house which wanted to break up TomTom, fire the employees and sell off its assets it would get very short shrift.

But if an offer came from say a world-beating tech company, famously entrepeneur-led which would allow TomTom to take its navigation vision to another 410m users... Well that would be another story.

And if that gave the founders an opportunity to flourish on a bigger stage. Well...

Somewhere over the rainbow...

As I said, its as much about the psychology as the valuation.

So where have we come out at? I think Apple could pay up to €13 /share, but would want to pay less.

Janovo/Cytre would be looking at in excess of €7.4 /share. The founders would want more than €4.21 /share. The stock is currently trading at €3.86 /share. Standalone fair value (for what its worth) is probably around €4 /share (in my humble opinion).

Oh and one more piece of market nous - when you make a bid you want it to be a "knock-out bid", i.e. not a low-ball offer which makes shareholders hold out for more. In my experience a knock-out bid comes at a 30%+ premium to the share price, preferably a 40%+ premium. Yeah I know - Benjamin Graham would be turning in his grave. But Bruce Wasserstein wouldn't.

That's what they meant when they said valuation is an art, not a science.

Put a gun against my head and I'd say €5.5-8 /share, probably towards the lower half of that range. The key thing would be to get the founders on-board, at whatever price  it takes.

That's all.

Afterword: A few thoughts on deal mechanics

Timing: Given cash resources, and the fact it would be an agreed deal, I think this would be a relatively straightforward transaction. All that would be required would be a public tender for the remaining free-float. Provided there was a knock-out bid (In excess of 40%-ish to the current share price) I don't think there would be much push-back from the other shareholders. I reckon if they did this tomorrow it would easily be wrapped by end-Q1.

Counter-bids: There isn't an obvious counter-bidder out there either. Microsoft and Google already have their maps sorted out. The other big consumer ecosystem players - Facebook and Amazon - don't has as direct an interest in location-based services. I doubt the business would attract a counter-bid from a financial buyer as it already has a reasonable debt load, and has shown in the past that its model isn't amenable to high levels of gearing.

Regulatory hurdles: The only stumbling block I can think of would be regulators. On the mapping side given Nokia/Microsoft and Google are such powerful and well capitalised rivals I doubt there would be a viable challenge. If there's one thing we're not lacking in smartphones at the moment its competiton! Garmin could potentially mount a challenge on the satnav side, but given Apple has no use for the hardware busineses I think they'd be very happy to divest it. Possibly to Garmin.

Oh and by way of disclosure, no I don't hold any shares in TomTom or Apple. The forecasts (for what they're worth) are my forecasts and the opinions are my opinions. You heard it here first.

Why Apple should buy TomTom

Edit (19-Oct) - I've topped off this mini-series by writing a second piece on the valuation issues around a potential deal. See the new post here.

Happy anniversary

It's been a long month for Apple

Tomorrow marks a month since the release of iOS6, along with its universally derided mapping app. I have written extensively about why this was a retrograde step and what exactly is wrong with the app.

In the meantime Apple has made its apologies, gone on a mapping recruitment drive and begun fixing some of the more egregious errors. However I don't think that is enough. The key message from my analysis was that there were fundamental issues with the data and the engine couldn't be easily fixed. Also this is only the presenting issue.

The underlying problem Apple is grappling with is that mapping is simply a harder, messier business than they thought. Particular when their biggest competitor is going from strength to strength, and the third guy in the room is no slouch either (at making maps I mean. damn useless with phones though!).

In short Apple is under pressure both to accelerate the patching of the existing maps, and acquire some heavy duty mapping expertise.

Which is why Apple should buy TomTom.

What does TomTom offer?

The thing to understand is TomTom isn't just about the digital map. The map itself is, of course, useful. It's a database containing vector-based information about roads locations as well bunch of other  datapoints (e.g. one-way systems, available turns at junctions, traffic frequency at different times of day etc.). The basic database for the US + Western Europe is a few gigabytes in size and would fit nicely on a microSD card.

But the value goes deeper than that. After all if it Apple already licence this map data. But TomTom owns much more than that.

As important as the map is the network of relationships behind it. What most people don't realise is that the majority of digital mapping isn't done with cars - its done by getting the underlying GIS data from thousands of government agencies, utility companies and transportation companies and integrating it together. The hard bit about building a map isn't actually driving the roads - its about getting that data. It is noticeable that Google built out its US map much more quickly, because it could start with a core set of federal data rather than having to go to multiple providers. In contrast its build-out in Europe has been much slower as its been dealing with a much more fragmented market and much tougher regulator landscape. TomTom of course has had all these relationships for years, and this represents significant hidden value.

TomTom's Mapshare Reporter
As important as the relations is the people. Again although TomTom has seen swingeing job cuts of late it still employs hundreds of experienced mapping experts. These guys don't simply grow on trees; to assemble a comparable outfit from scratch would take years. This represents a significant asset.

Finally there are is a raft of software and services which TomTom has built on top of Tele Atlas. In particular the database of Points of Information (PoIs - everything from service stations to restaurants and hotels), its Mapshare portal for crowdsourcing map updates, the routing algorithms to map out a journey and HD Traffic, its live traffic offering.

I think about it like this - just licencing the map is like buying an MP3 of the White Album. But acquiring TomTom is like acquiring the original score, with the Abbey Road studios thrown in to boot.

Note I am pretty much ignoring TomTom's (still significant) satnav hardware business. That's not to say its go zero value, but it has zero value to Apple.

The map is what matters.

Three reasons why Apple should do the deal

So why should Apple buy TomTom. I think there are three big issues to consider.

1) It accelerates the improvements to the current map

In my previous post I outlined identified three problems with initial release of iOS6 maps. a) wrong or incomplete map and PoI data, b) distorted or missing 3D images/textures and c) poor quality traffic routing or search queries. I also concluded that this isn't something Apple is going to be able to fix overnight, either because they are pretty fundamental engine issues or because it will take time to crowdsource the necessary data.

I don't think TomTom will help much with the 3D image/texture issues - that lies more with getting the right satellite data from DigitalGlobe or improving/changing the 3D engine from C3. However I think owning TomTom could significantly accelerate fixing the other problems.

  • Integration is the key to a digital map
    When it comes to wrong or incomplete map data, a lot of the problem wasn't that Apple didn't have the data, rather it wasn't integrating it correctly. Often the underlying TomTom map had the correct data, but Apple have overlaid incorrect information from third party sources. Owning TomTom will help this process along - as I pointed out earlier the raison d'etre of a mapmaker is exactly that - to correctly integrate data from a number of different sources.
  • Faster map updates: Owning TomTom's map also accelerates the process of updates. If Apple use TomTom as a third party licencee they will always have to wait on TomTom to provide an updated dataset. If they own the company they can put updates straight through as soon as TomTom gets them.
  • Crowdsourcing: TomTom also has a mature crowdsourcing portal called Mapshare. A bit part of Apple's ongoing fix is to get users to report problems and fill in the gaps - TomTom has years of expertise in managing this process and figuring out what user updates should filter through to its final map.
  • Routing: Another area of mirth have been the routing snafus provided by Apple's turn-by-turn engine. To a degree these were inevitable (Google's turn-by-turn had similar problems in its initial versions). But an easy fix would be to throw in TomTom's mature and proven turn-by-turn engine. 

Bear in mind TomTom is not a magic bullet. These are all issues that Apple can likely fix on its own. The issue is one of opportunity cost. If Apple can fix these all in three months then none of them are a compelling reason to buy TomTom (especially given the transaction would take some time to complete). However if (as I suspect) they will take much longer to fix then Apple need to consider the opportunity cost. Every extra month with the embarrassment of iOS6 Maps hanging round its neck is another month for Google to make hay and take mindshare amongst users.

2) It seriously bulks up Apple's mapping chops

But let's be clear - Apple wouldn't buy TomTom just to help fix the current iOS Maps. They're not that stupid. Actually the bigger reason to acquire TomTom isn't as a mapping elastoplast. Rather its to acquire lasting mapping expertise.

As I said the jewel in TomTom's crown isn't its map database. Its the people and the processes it has build up over the years. Although Apple are pushing hard to hire mapping experts, there simply aren't that many people out there with the necessary expertise. In contrast TomTom has hundreds of mapping experts and a stable, mature mapping organisation.

Also bear in mind that TomTom has genuine scarcity value. With Navteq now in the hands on Nokia/Microsoft, and Google highly unlikely to play ball, TomTom is the only major reservoir of mapping expertise on the market.

I think a good analogy is SAP's acquisition of Sybase back in 2010. What SAP ostensibly bought was a fairly ratty old relational database and a bunch of interesting BI technologies. What it actually bought is the brains and know-how of thousands of irreplaceable database experts. At the time Sybase was the only large standalone database vendor left - if SAP wanted bet its future on data, it had to bet on Sybase.

As this editorial in trade rag Directions Magazine points out - that is why Apple needs TomTom. This is an asset that money can't build, but it can certainly buy.

3) The deal can be done quickly and smoothly

I want to talk about the mechanics and psychology of the deal in a separate post (hopefully tomorrow). But I want to make the simple point that this is a deal which could be done quickly. TomTom's founders hold 48% of the company and "friendly" insiders Janivo/Cyrte hold another 10%.

So Apple will essentially be negotiating with the founders (and their egos). If you are a leading tech entrepeneur there is no one your would rather sell out to than the House That Jobs Built. Harold Goddijn, Apple Senior Vice President (Maps) would do nicely.

Get them onboard and its a done deal.

I think there would be minimal regulatory issues given Apple can point to Google and Nokia/Microsoft as large an significant competitors in the industry; Garmin might pipe up but I doubt they will have much sway.

And it goes without saying that with TomTom currently valued at $1.1bn and Apple's cash pile at $82bn (give or take vendor commitments) money won't be an issue. So far this maps kerfuffle has cost Apple a lot more than that!

Potential stumbling blocks

Before I finish a few notes concerning the case against. Why wouldn't Apple do this deal?

  • Apple think they can fix maps quickly: If Apple think they can address the issues with Maps by Christmas, this takes away a big rationale to do the deal. As I said using TomTom to accelerate the Maps fix this isn't the only reason to buy TomTom, but its certainly a significant reason, IMHO.
  • Apple think they can build mapping expertise themselves, or don't need it: If Apple think they can hire the mapping know-how themselves, or simply believe its not a high priority then they will not do this deal. I think the advantages of acquiring TomTom's scarce mapping know-how speak for themselves, and Apple are clearly pushing deeper and deeper into cloud services which means location MUST be a priority. However Apple may Think Different.
  • This isn't a very "Apple" deal / Apple don't buy other brands: Apple's M&A has traditionally revolved around acquiring smaller companies for their technologies (e.g. Siri Inc for Siri, SoundJam for iTunes) and then throwing it down their broad marketing and distribution maw (what M&A bankers call a "top-line synergy). In the past they have rarely acquired more mature tech companies, especially not those with their own standalone brands. I think its dangerous to say though that "Apple never do x" (didn't Steve Jobs say he'd never do a smaller iPad?). The strategic landscape has changed, and Apple is now much bigger. I think to say Apple will never acquire a larger branded company is foolhardy. TomTom seems as good a place to start as ever.
  • Endangered species?
    Apple don't need the hardware business: 
    Apple is unlikely to want to get into the satnav business. If they acquire TomTom the hardware business is likely to be sold off (perhaps back to the founders). I don't see this as a stumbling block to the deal. Garmin would be interested at the right price (it would give them a virtual monopoly on automobile navigation), or at the end of the day they could simply shut it down for a minimal loss.

In summary I believe the problems underlying iOS Maps will take longer to fix than the market believes, and people underestimate the hidden value in TomTom's asset portfolio. To me Apple acquiring TomTom makes absolute sense.

That's all for today. Come back tomorrow, where I will sketch out some more thoughts on the valuation of a TomTom acquisition and how a deal will be executed.

Friday, 12 October 2012

How to profit from platform risk

Platforms and sinkholes

A rather literal example of Platform Risk...
I wrote a brief post Wednesday on platform risk (in a nushell, when you building a gigantic mansion and then discover the land you've stuck it on is a giant sinkhole). There were two big takeaways.

The first is that platform risk  is more prevalent and you think, and doesn't just affect small software devs. The day Microsoft rolls out its own-label Windows Phone, is the day Nokia finds it suddenly has an awful lot of platform risk.

The second is that that platform risk isn't the real problem. It is merely a symptom which arises when you have an unstable relationship between the platform owner (e.g. Facebook, Apple, Google) and the "platform rider" which works on top of the platform (e.g. Zynga).

I want to expand on the second point, and show how looking at different types of platforms can guide your investment decisions.

Understanding platform risk

As a rule of thumb, in earlier stage and/or higher growth platforms, the balance of power sits more with the platform owner (think Facebook's pretty much arbitary power over its platform), while in more mature platforms (where the legacy ecosystem matters more) the platform riders have more say (think the lower growth Windows desktop market). In essence there is a trade-off between growth prospects and stability. Ideally there is a tension here, where the platform is growing handsomely, but the platform owner isn't being too greedy. However its when this tension falls out of balance that platform risk arises.

I believe there are four types of platform, which demonstrate this various degrees of this tension:

The four evolutions of the Platform
  1. Closed Platforms (Facebook, iOS, Windows Phone): These are owner-dominated platforms where there is significant platform risk. The trade-off for the platform rider is that these are also high growth platforms. The bottom line is that there is often nice growth that lifts all boats, but a small but material chance of platform risk.
  2. Open But Bominated Platforms (Android, These are growing platforms where the platform owner doesn't quite has as much dictatorial power. This can be for structural reasons (e.g. Android's open-source nature which means that platform-riders retain the nuclear option of forking, something we are seeing with the Kindle Fire or Baidu Yi), or because the platform owners are not big enough to drive growth on their own (e.g. Salesforce is relying on its ecosystem on to fill in some of the gaps in its application portfolio).
  3. Mature Platforms (Windows, Linux, OSX): These are older platforms which offer a large market opportunity, but one that isn't growing as fast. Because a lot of the attraction of the platform comes from the existing ecosystem, the platform vendor is unlikely to break backwards compatibility with the platform riders in a major way (e.g. Microsoft ensure Windows 8 includes a kludgy legacy desktop mode).
  4. Burning Platforms (Symbian, RIM): These are dying platforms which present massive risk of platform decline. Thankfully by this point any platform rider with two brain cells has already left the building by the nearest fire exit.

The economics of platform risk

So what does this mean for the vendor and, more importantly, the investor? (this is a blog about finance, as well as tech after all). Here are a few thoughts on who profits:

Closed platforms

  • Platform owner: Excellent for the platform owner, as they have both control. They benefit from growth and their control gives them either the ability to extract excess rents, or a competitive moat to defend them if the market starts to change. The one downside is that in the early-stages closed platforms are less profitable due to start-up costs (Windows Phone, I'm looking at you...)
  • Platform rider: This is a satisfactory place for the platform rider to be, as they benefit from the rising tide of growth. However there are two big caveats - 1) the coolest platforms attract the most competition (as thousands of failed iOS devs have found out), 2) there is occasional, but massive, PLATFORM RISK.
  • Investor: Buy into the platform owner, but avoid investing in platform riders. If the platform is successful, the majority of profits accrue to the platform owner anyhow. If the platform rider is big enough to be worth investing in, there is a greater chance they would have drawn the attention of the platform owner and be vulnerable to platform risk.

Open but dominated platforms

  • Platform owner: The economics are good for the platform owner. Although they don't have the optionality they get from being a dominant position, they benefit from good growth. More importantly, platform riders are more likely to want to play in their garden because of the lower platform risk, and thus do more of the legwork in terms of driving growth for the ecosystem (translation: Platform owner might get a higher ROIC).
  • Platform rider: This is the ideal platform to work on as they benefit from growth but have only limited platform risk.
  • Investors: Buy into both the platform owner and any investable platform riders. Both should benefit from rising volumes and favourable pricing, which will help defend profitability.

Mature Platforms

  • Platform owner: Economically speaking, this is the best position. While you don't have the explosive growth, a mature platform generates incredibly high cashflows (viz Warren Buffet's comments on Microsoft back in 1997) for minimal new investment. That is pretty much the ideal business model under any economic conditions.
  • Platform rider: This is a good place to be in if you already have an established position and franchise, given the minimal platform risk. However the one caveat is that competitive pressures are likely to be higher, particularly if you lack a killer USP. In the absence of growth and differentiation, your competitors will find the only tool they have to compete with is price.
  • Investors: It makes sense to hold shares in the platform owners as a long-term holding/dividend play. Over the course of time you will make an enormous cash return. One safety warning though - such stocks are often under-valued by the market (particularly in tech which has the strange obsession that more expensive growth stocks are more valuable. In reality they are more expensive, but not always more valuable!), so don't expect to make a quick profit.

Burning Platforms

  • Platform owner: Bad for the platform owner. Doubly bad as the temptation for them will be to double down in an attempt to turn things round (translation: burn a few more barrowloads of cash) rather than admit defeat.
  • Platform rider: Has already left the building.
  • Investor: Short the hell out of the platform owner. And stay short (give or take dumb-acquirer M&A risk).

... And shifting platforms

Of course the juiciest investment opportunities come when platforms change - that's when you have the cataclysmic shifts in industry economics which are one of the most fascinating features of tech (something I've touched on before here and here).

By far the most common example is of platform decline. A good one going on at the moment is the shift from PCs towards tablet. This imperils the whole Windows 8 ecosystem (at least on the consumer side - enterprises are much more resilient). This puts a lot of platform riders in a very uncomfortable situation, both on the software and the hardware side. Normally they should be running for the exits but sometimes they weight of their legacy business means they can't (two words: Innovator's Dilemma).

AMD/ATI (which had a cute warning last night) is a good example of this - first the shift from desktop to notebook brutalised ATI's market for discrete CPUs, then as the world shifts towards low-power and tablet they have again been caught short. Logitech's keyboard/mouse business may also be caught in the same trap.

Apple (and Google's) moves towards the world of a connected TV (which I wrote a series on earlier in the year) is another example of a potential platform shift.

That's all. Enjoy the weekend!

An entirely unrelated form of Platform Risk

Wednesday, 10 October 2012

The joys of Platform Risk

I've written in the past about why I love platforms. Putting on my investment analyst's hat, owning a platform is one of the greatest assets a company can have. It gives them a deep competitive moat to protect pricing (and ultimately margins), and the prevalence of platforms is one of the standout features of the tech industry versus other sectors.

I want to expand on this across a few posts and think about the flip-side of this, looking at things from the perspective of the companies which operate on top of platforms, rather than platform owners. For these they face one enormous peril - platform risk. Investors should also be aware of how this offers both threats, and opportunities.

Zynga's platform problem

I've been thinking this week about platform risk. It was Zynga's profit-warning zinger last week which reminded me of this, particularly this comment:
At the same time, we are continuing to invest in our mobile business where we have one of the strongest positions in the industry. These actions support our strategy to transition from being a first party web game developer to a multiplatform game network. [italics are mine]
This is Zynga's dilemma. They are overwhelmingly exposed to one platform for their revenues (Facebook, and specifically Facebook on the desktop), and customers are unwilling to engage with them on other platforms (such as mobile). The platform which was previously lifting their business like a magic carpet, has now turned into a falling stone.

That, in a nutshell, is platform risk.

Introducing platform risk

Platform risk is when you wholly or largely dependent on someone else's ecosystem, and that ecosystem moves suddenly against you. It could be the ecosystem starts failing (being a Symbian app developer would be a good example of this), or it could be that the platform you are working on starts competing against you. For example, for sellers of turn-by-turn navigation apps once Apple started to build it into iOS Maps 6 (okay, in this case they probably have another year or so before Apple gets it right!).

Technically speaking, a failing ecosystem is platform decline, and the platform owner turning round and competing with you is subsumption risk. Zynga currently has a rather nasty case of platform decline.

Note this should not be confused with the burning platform, so memorably popularised by Stephen Elop. A burning platform is when the platform you own and run is going down (and taking your P&L down with it). Platform risk is when the platform someone else owns (but you depend on) turns round and screws you. Platform risk for Nokia would be, for example, if Apple suddenly used its cash pile to buy up all the telcos and banned Nokia handsets from the networks.

Platform risk is everywhere

Modern dependency culture?
I blame the tech stack!
Platform risk occurs in other industries (one word: Betamax), but is particularly prevalent in the tech sector, particularly in the world of software. This is because much IT architecture looks like a stack, where each layer cannot function without all the layers underneath it. This is fine when you have a choice of vendors for your dependent layers (shall I buy an Apple or a Dell laptop to run my software on?) but it is dangerous when you have only one choice (Facebook is the only place where Zynga can find mugs willing to spend 99c on a virtual pink cow).

You only have to look around to see this isn't an uncommon problem. For example:

Dealing with platform risk

Platform risk is a nasty bug to catch, and in most cases prevention is much better than cure. Effectively platform risk is a symptom, not a cause. It generally arises where there is a competitive imbalance between the platform owner and the ecosystem which operates on the platforms. Either the platform owner is too weak (in which case their platform is going down), or they are too strong (in which case they think they can make arbitrary changes to the platform or start competing with the ecosystem).

The best solution is to operate on a platform where this imbalance does not occur. Typically you want a mature, open platform where the owner is making money but isn't incentivised to rock the boat. However there is a big catch - these tend to be the lower-growth platforms. The ones where you can double your revenues every year, or tap new and exciting markets - they tend to be the newer and more closed platforms.

Hmm. Do you really want to be playing this game?

So what you are left with is a sort of perverted Russian roulette. You have a pistol to your head; the platform owner on the other side of the table is equipped with an M1 Abrams. Get your choice wrong and you pretty much unlimited downside (see that car in the picture above? that's you). Get it right and he might offer you a lift on his little tank.

Which is where I will leave it for today. In my next post I want to outline the sort of platforms that exist in more detail, and suggest how tech investors can benefit.

PS One last thing - there is of course a whole bunch of businesses which thrive on subsumption risk - and that is start-ups who's main aim is to eventually be bought out by one of the platform giants (for example Facebook buying out facial recognition shop In fact often startups target this as a key exit strategy - after all in a world of technology behemoths very few startups have the wherewithal to play the long game (hat tip to Mr Zuckerberg). Most of them just take the money and run.

Friday, 5 October 2012

The snake in Facebook's garden...

Turning away from Bloomberg and Apple for the moment (rest assured, I still have many thoughts to post on both; I am particularly intrigued by Bloomberg's Polarlake acquisition and how it pushes it towards to world of Big Data), some more thoughts on the shifting platforms of Facebook-land.

Some interesting data-points in this arena over the last couple of days.

A million users's isn't cool. Do you know what's cool?

Facebook announced yesterday that as of 14th September it had hit a billion monthly active users. Extrapolating that forward it implies 1,009m MAU's at quarter end, up from 955m in Q2.

What was more interesting however was the underlying in the appendix.

Look closely and there a snake in the garden. Well actually, three of them:

Firstly, although user numbers continue to grow, growth rates continue to slow:

That's not that surprising. It's the inexorable law of large numbers, but its also a reason why large companies tend to attract lower valuations than smaller ones.

The second thing is that they mentioned in the appendix that mobile users hit 600m. This means mobile users are now a stonking 59% of the mix (they didn't disclose the more interesting mobile-only users in this release; for context this was 11% of MAUs at Q2).

Remember mobile users are lower revenue than Facebook, and judging from my experience, Facebook haven't figured out how to drive this up. My wife continues to be spammed daily by adds for, and I remain unconvinced that a soil mechanics PhD student really needs a mid-market on-demand CRM system.

Thirdly, and most interestingly though Facebook disclosed the median age of its user base as of Q307, Q308, Q310 and now (the points where it hit the 50m, 100m, 500m and 1bn user milestones). I may be wrong, but I think this is new disclosure. What's fascinating though is that if you have the age of the given user base at any point in time, you can figure out the average age of new users:

Median age for Q309 and Q311 not provided, so this is interpolated, weighted by (reported) MAU user growth.

This is curious. I would have thought as Facebook became more mature and extended beyond its campus-origins, the average age of new users would have gone up. Instead it's actually fallen consistently from 26 in the early years to 20.4 in the last twelve months.

Remember Facebook's big challenge is to increase ARPU - but if you're new users are getting younger this is a headwind because younger people tend to have lower disposable income. Yikes.

But there's more.

I suspect the real reason for younger and younger users is that at Facebook reaches maturity in (richer, older) developed markets, new users are coming from (poorer, younger) emerging markets. The table below shows the mix of quarterly net adds by region (and yeah the funny bit on the right is because US & Canada MAUs were negative in Q212):

But there's more.

Are you've no doubt realised, emerging markets are poorer markets. So lets use regional GDP/capita to figure out the average GDP/head for new Facebook MAUs:


So in summary, Facebook's volume growth is slowing, is shifting towards lower ARPU mobile customers and its new customers have less money to spend.

Are you sure this is the kind of stuff you want to issue a press release about???

A zinger from Zynga

The other fun fact yesterday was Zynga's Q3 profits warning. Basically they reported a Q3 revenue and EBITDA miss and cut guidance. The chart below says it all (remember this thing was meant to be a hot growth story):

NB I've estimated Online Game Revenues (the core growth driver) by
assuming that (previously growth) Ad Revenues were flat in Q3.

Remember Zynga accounted for 10% of Facebook's revenues in Q2 (though now highly likely to fall in Q3!) so the presenting issue is that this is (yet) another revenue growth headwind for FB.

However this is only the presenting issue. The underlying issue is a more fundamental problem of Platform Risk. This is something I touched briefly on in August and I want to write more about next week.

Zynga is dependent on the Facebook desktop platform for a large chunk of its revenues. Users (as we saw above) are shifting away to a mobile platform where ARPU is drastically lower. Zynga do not control the platform users are on, and do not control their destiny.

This is an issue for Facebook on two levels. On one level Facebook are also exposed to mix shift to lower ARPU.

But on a deeper level think about it like this:

Facebook is dependent on the Android, iOS and Windows platform for a large chunk of its revenues. Facebook does not control the platform users are on, and does not control its destiny.