Reports of Facebook’s Death Are Greatly Exaggerated (Paraphrasing Mark Twain)

Reports of Facebook’s Death Are Greatly Exaggerated (Paraphrasing Mark Twain)

On July 26, 2018 Facebook set a record for the most value lost in one day by a single company.  An astonishing $119B of market value was destroyed as the shares sank more than $40.  For many investors, it was the sky falling.

As most of you know, I’ve followed Facebook closely since it went public in 2012.  And, I’ve long been an admirer.  I said buy it at the IPO, and I’m saying buy it now. Click on the title of any of the posts to read the full content.

To summarize, Facebook may be under attack, but it is barely wounded.  And it is not in the throes of demise.  The long-term trends all favor the social media’s ongoing growth, and higher values in the future.  Below I’ll offer some of my previous blogs that are well worth revisiting amidst the current Facebook angst.

FANG (Facebook, Amazon, Netflix and Google) investing is still the best bet in the market.  They have outperformed for years, and will continue to do so.  Why? Because they are growing revenues and profits faster than any other major companies in the market.  And “Growth is Good” (paraphrasing Gordon Gekko.)  If you have any doubts about the importance of growth, go talk to Immelt of GE or Lampert of Sears.

Don’t forget, for years now Facebook is more than Facebook.com.  It’s smart acquisition programs have dramatically increased the platform’s reach with video, messaging, texting and eventually peer-to-peer video.  Facebook’s leadership has built a very adaptable company, able to change the product to meet growing user (and customer) needs.

Facebook is on a path toward significant communication domination.  Facebook today is sort of the New York Times, Washington Post, Los Angeles Times and about 90% of the rest of the nation’s newspapers all in one.  Nobody is close to challenging Facebook’s leadership in news distribution, and all news is increasingly going on-line.

For all these reasons, you really do want to own Facebook.  Especially at this valuation.  It’s getting a chance to buy Facebook at its value when the year started, and Facebook is that much bigger, stronger, and adapted to changing privacy regulations that were still a mystery back then.

Oh, one last thing (paraphrasing Steve Jobs.)  Facebook actually isn’t the biggest one day drop in stock valuation, despite what you’ve read.

Stocks are priced in dollars, and dollars are subject to inflation.  So we should look at historical drops in inflation adjusted dollars.  Even though inflation has been mostly below 3% since the 1990s, from 2000 to today the dollar has inflated by 46%.  So inflation-adjusted, the biggest one day value destruction actually belongs to Intel, which lost $131B in September, 2000.  And Microsoft is only slightly in third place, having lost $117B in April, 2000.  So keep this in mind when you think about the long-term opportunity for Facebook.

PS – keep your eyes open for my new ebook on Facebook.  It should be available for download in a couple of weeks

Apple’s Installed Base – Foundation for Success, or Curse?

Apple’s Installed Base – Foundation for Success, or Curse?

The last few quarters sales growth has not been as good for Apple as it once was. The iPhone X didn’t sell as fast as they hoped, and while the Apple Watch outsells the entire Swiss watch industry it does not generate the volumes of an iPhone. And other new products like Apple Pay and iBeacon just have not taken off.

Amidst this slowness, the big winner has been “Apple Services” revenue. This is largely sales of music, videos and apps from iTunes and the App store. In Q2, 2018 revenues reached $9.2B, 15% of total revenues and second only to iPhone sales. Although Apple does not have a majority of smartphone users, the user base it has spends a lot of money on things for Apple devices. A lot of money.

Statista Apple Aftermarket ShareIn a bit of “get them the razor so they will buy the razor blades” CEO Tim Cook’s Apple is increasingly relying upon farming the “installed base” of users to drive additional revenues. Leveraging the “installed base” of users is now THE primary theme for growing Apple sales. And even old-tech guys like Warren Buffett at Berkshire Hathaway love it, as they gobble up Apple shares. As do many analysts, and investors. Apple has paid out over $100B to developers for its services, and generated over $40B in revenues for itself – and with such a large base willing to buy things developers are likely to keep providing more products and working to grow sales.

But the risks here should not be taken lightly. At one time Apple’s Macintosh was the #1 selling PC. But it was “closed” and required users buy their applications from Apple. Microsoft offered its “open architecture” and suddenly lots of new applications were available for PCs, which were also cheaper than Macs. Over a few years that “installed base” strategy backfired for Apple as PC sales exploded and Mac sales shrank until it became a niche product with under 10% market share.

Today, Android phones are the #1 smartphone market share platform, and Android devices (like the PC) are much cheaper. Even cheaper are Chinese made products. Although there are problems, the risk exists that someday apps, etc for Android and/or other platforms could become more standard and the larger Android base could “flip” the market.

The history of companies relying on an installed base to grow their company has not gone well. Going back 30 years, AM Multigraphics an ABDick sold small printing presses to schools, government agencies and businesses. After the equipment sale these companies made most of their growth on the printing supplies these presses used. But competitors whacked away at those sales, and eventually new technologies displaced the small presses. The installed base shrank, and both companies disappeared.

Xerox would literally give companies a copier if they would just pay a “per click” charge for service on the machine, and use Xerox toner. Xerox grew like the proverbial weed. Their service and toner revenue built the company. But then people started using much cheaper copiers they could buy, and supply with cheaper consumables. And desktop publishing solutions caused copier use to decline. So much for Xerox growth – and the company rapidly lost relevance. Now Xerox is on the verge of disappearing into Fuji.

HP loved to sell customers cheap ink-jet printer so they bought the ink. But now images are mostly transferred as .jpg, .png or .pdf files and not printed at all. The installed base of HP printers drove growth, until the need for any printing started disappearing.

The point? It is very risky to rely on your installed platform base for your growth. Why? Because competitors with cheaper platforms can come along and offer cheaper consumables, making your expensive platform hard to keep forefront in the market. That’s the classic “innovator’s dilemma” – someone comes along with a less-good solution but it’s cheaper and people say “that’s good enough” thus switching to the cheaper platform. This leaves the innovator stuck trying to defend their expensive platform and aftermarket sales as the market switches to ever better, cheaper solutions.

It’s great that Apple is milking its installed base. That’s smart. But it is not a viable long-term strategy. That base will, someday, be overtaken by a competitor or a new technology. Like, maybe, smart speakers. They are becoming ubiquitous. Yes, today Siri is the #1 voice assistant. But as Echo and Google speaker sales proliferate, can they do to smartphones what smartphones did to PCs? What if one of these companies cooperates with Microsoft to incorporate Cortana, and link everything on the network into the Windows infrastructure? If these scenarios prevail, Apple could/will be in big trouble.

I pointed out in October, 2016 that Apple hit a Growth Stall. When that happens, maintaining 2% growth long-term happens only 7% of the time. I warned investors to be wary of Apple. Why? Because a Growth Stall is an early indicator of an innovation gap developing between the company’s products and emerging products. In this case, it could be a gap between ever enhanced (beyond user needs) mobile devices and really cheap voice activated assistant devices in homes, cars, offices, everywhere. Apple can milk that installed base for a goodly while, but eventually it needs “the next big thing” if it is going to continue being a long-term winner.

Why You Want To Own Facebook – And Big Investors Have To

Why You Want To Own Facebook – And Big Investors Have To

(Image: Troy Strange.)

Facebook’s CEO recently took a drubbing by America’s Congresspeople. And some thought it bode poorly for the internet giant. There were rumors of customer defections, and fears that privacy issues would sink the company. The stock dropped from a February high of $193 to a March low of $152 – down more than 20%.

But by mid-May Facebook had recovered to $186, and the concerns seemed largely ignored. As they should have been.

Facebook is much more than Facebook. As of January, 2018 Facebook had 2.1M monthly active users (MAUs,) Facebook leads social mediathe most of all social media sites. But Facebook also owns the second most popular site WhatsApp with 1.3M MAUs, and the third most popular site Facebook Messenger with 1.2M MAUs, and the fifth most popular site Instagram with 800K MAUs. Instagram is 5 times larger than Snapchat. And Facebook Stories, which just started in 2017 is now almost as big as Snapchat and surely in the top 10. So, 5 of the top 10 social media sites are owned by Facebook, and they totally dominate the marketplace.

Facebook paid $1B for Instagram in 2012 though it had no revenues. Today, 1/3 of ALL USA mobile users use Instagram. 15 million businesses are registered on Instagram. In 2017 Instagram had $3.6B revenues, and projections for 2018 are $6.8B.

Facebook expands globally

Facebook paid $19B for WhatsApp in 2014, when it had just $15M in revenues. In 2015, WhatsApp had 1 billion users. It is the most used app on the planet – even though not a top app in the USA where mobile texting is generally free. Where texting is expensive, like India, over 90% of mobile users utilize WhatsApp, and users typically send over 1,000 messages/month. In 2017, WhatsApp revenue rose to $1B, and in 2018 it will cross over $2B.

Facebook clones of Snapchat outpace originalFacebook is smart at realizing new ways people can use the platform. It adds functionality constantly, exponentially growing the user base and time spent on its sites. It is untouchable in its social media market domination. And it has proven, more than any other platform (compare Snapchat and Twitter) that it can monetize users into revenues and profits. Facebook’s leadership is constantly in touch with trends and keeps making social media more relevant in the lives of every person.

Unless you somehow think time will go backward, you have to recognize that social media – like all other personal technology – is constantly becoming more useful. It is gaining greater adoption, and more usage. And businesses are using social media to reach customers, thus paying for access, like they once did for newspapers, radio, television and then web sites.

Just the beginning…

Facebook is just getting started, sort of like Amazon did 20 years ago. That’s the Amazon that dominates on-line e-commerce sales. If you bought Amazon on the IPO 21 years ago (May, 2017) your investment would have risen from $18/share to $1,700 – a nearly 1,000-fold increase. Facebook’s IPO was 6 years ago (May, 2012) at $38 – 6 years later it is worth $185, almost a 5-fold increase. Not bad. But if Facebook performs like Amazon in the next 14 years it could rise to $3,600 – an almost 20x gain.

And that’s why you should ignore short–term blips like the Congressional investigation and realize that you, and everyone else, is a Facebook customer. And you want to share in that growth by being a Facebook shareholder.

(Featured image adapted from Troy Strange.)

Amazon Alexa Is Becoming Ubiquitous – And That’s an Apple Threat

Amazon Alexa Is Becoming Ubiquitous – And That’s an Apple Threat

One in five American homes with wifi now has an Amazon Alexa. And the acceptance rate is growing. To me that seems remarkable. I remember when we feared Google keeping all those searches we did. Then the fears people seemed to have about Facebook knowing our friends, families and what we talked about. Now it appears that people have no fear of “big brother” as they rapidly adopt a technology into their homes which can hear pretty near everything that is said, or that happens.

It goes to show that for most people, convenience is still incredibly important. Give us mobile phones and we let land-lines go, because mobile is so convenient – even if more expensive and lower quality. Give us laptops we let go of the traditional office, taking our work everywhere, even at a loss of work-life balance. Give us e-commerce and we start letting retailers keep our credit card information, even if it threatens our credit security. Give us digital documents via Kindle, or a smart device on the web grabbing short articles and pdf files, and we get rid of paper books and magazines. Give us streaming and we let go of physical entertainment platforms, choosing to download movies for one-time use, even though we once thought “owning” our entertainment was important.

With each new technology we make the trade-off between convenience and something we formerly thought was important. Such as quality, price, face-to-face communications, shopping in a store, owning a book or our entertainment – and even security and privacy. For all the hubbub that regulators, politicians and the “old guard” throws up about how important these things were, it did not take long for these factors to not matter as convenience outweighed what we used to think we wanted.

Now, voice activation is becoming radically important. With Google Assistant and Alexa we no longer have to bother with a keyboard interface (who wants to type?) or even a small keypad – we can just talk to our smart device. There is no doubt that is convenient. Especially when that device learns from what we say (using augmented intelligence) so it increasingly is able to accurately respond to our needs with minimal commands. Yes, this device is invading our homes, our workplaces and our lives – but it is increasingly clear that for the convenience offered we will make that trade-off. And thus what Alexa can do (measured in number of skills) has grown from zero to over 45,000 in just under 3 years.

And now, Amazon is going to explode the things Alexa can do for us. Historically Amazon controlled Alexa’s Skills market, allowing very few companies to make money off Alexa transactions. But going forward Amazon is monetizing Alexa, and developers can keep 70% of the in-skill purchase revenues customers make. Buy a product or service via Alexa and developers can now make a lot of money. And, simultaneously, Amazon is offering a “code-free” skills developer, expanding the group of people who can write skills in just minutes. In other words, Amazon is setting off a gold rush for Alexa skills development, while simultaneously making the products remarkably cheap to own.

This is horrible news for Apple. Apple’s revenue stagnated in 2016, declining year over year for 3 consecutive quarters. I warned folks then that this was a Growth Stall, which often implies a gap is developing between the company and the market. While Apple revenues have recovered, we can now see that gap. Apple still relies on iPhone and iPad sales, coupled with the stuff people buy from iTunes, for most of its revenue and growth. But many analysts think smartphone sales may have peaked. And while focusing on that core, Apple has NOT invested heavily in Siri, its voice platform. Today, Siri lags all other voice platforms in quality of recognition, quality of understanding, and number of services. And Apple’s smart speaker sales are a drop in the ocean of Amazon Echo and Echo Dot sales.

By all indications the market for a lot of what we use our mobile devices for is shifting to voice interactivity. And Apple is far behind the leader Amazon, and the strong #2 Google. Even Microsoft’s Cortana quality is considered significantly better than Siri. If this market moves as fast as the smartphone market grew it will rob sales of smartphones and iTunes, and Apple could be in a lot of trouble faster than most people think. Relevancy is a currency quickly lost in the competitive personal technology business.

Warren Buffett Is Loading Up On Apple – Why You Should be Wary

Warren Buffett Is Loading Up On Apple – Why You Should be Wary

In February, Berkshire Hathaway revealed it had dumped its IBM position. Good riddance to a stock that has gone down for 5 years while the S&P went up! What did Buffett do with the money? He loaded up on Apple – making that high-flyer Berkshire’s #1 holding. So, isn’t the smart thing now to buy Apple?

First, don’t confuse your investing goals with Berkshire Hathaway’s. It may seem that everyone has the same objective, to buy stocks that go up. But Berkshire is a very special case. As I pointed out in 2014, we mere mortals can’t invest like Buffett, and shouldn’t try. Berkshire Hathaway has the opportunity to make investments in special situations with tremendous return potential that we don’t have. Berkshire’s investment strategy is to invest where it can create cash to prepare for special situations, or to park money where it can make a decent return, and hopefully generate cash while it waits.

Apple is the #1 most cash-rich company on the planet, and with the new tax laws it can repatriate that cash. This is an opportunity for a “special dividend” to investors, and that is the kind of thing that Buffett loves. He isn’t a venture capitalist looking for a 10x price appreciation. He wants a decent 5% rate of return, and hopefully dividends, so he can grow cash for his special situation opportunities. Apple, the most valuable company on any exchange, is exactly the kind of company where he can place a few billion dollars without driving up the price and let it sit making a solid 5-6%, collect dividends and maybe get a few kickers from things like the cash repatriation.

Second, let’s not forget that Buffett’s IBM buying spree lost money. If he was a great tech investor, he never would have bought IBM. He bought it for the same reason he’s buying Apple, only he was wrong about what was going to happen to IBM as it continued to lose relevancy.

I pointed out in May, 2016 that Apple was showing us all a lot of sustaining innovations, with new rev levels of existing products, but almost no new disruptive innovations. The company that once gave us iPods, iTunes, iPhones and iPads was increasingly relying on the next version of everything to drive sales. Lots of incremental improvement. But little discussion about any breakthrough products, like iBeacon, ApplePay or even the Apple Watch. In a real way, Apple was looking a lot more like the old Microsoft with its Windows and Office fascination than the old Apple.

By October, 2016 Apple hit a Growth Stall. While this may have seemed like “no big deal,” recall that only 7% of the time do companies maintain a 2% growth rate after stalling. Is Apple going to be in that 7%? With the launch of the less-than-overwhelming iPhone X, and the actual drop in iPhone sales in Q4, 2017 it looks increasingly like Apple is on the same road as all other stalled companies.

In the short term Apple has said it is milking its installed base. By constantly bringing out new apps it has raised iTunes sales to over $30B/quarter. And it has a dedicated cadre of developers making over $25B/year creating new apps. So Apple is doing its best to get as much revenue out of that installed base of iPhones as it can, even if device sales slow (or decline.) For Buffett, this is no big deal. After all, he’s parking cash and hoping to get dividends. Milking the base is a cash generation strategy he would love – like a railroad, or Coca-Cola.

But if you’re interested in maintaining high returns in your portfolio, be aware of what’s happening. Apple is changing. It’s not going to falter and fail any time soon. But don’t be lulled by Berkshire’s big purchases into thinking Apple in 2018 is anything like it was in 2012 – or through 2014. Instead, keep your eyes on game changers like Netflix, Tesla and Amazon.

Warren Buffett’s Painful IBM Lesson – Have You Learned It?

Warren Buffett’s Painful IBM Lesson – Have You Learned It?

This February, Warren Buffett admitted he had no faith in IBM. After accumulating a huge position, by 4th quarter of 2017 he sold out almost the entire Berkshire Hathaway position. He lost faith in the IBM CEO Virginia (Ginni) Rometty, who talked big about a turnaround, but it never happened.

Mr. Buffett would have been wise to stopped having “faith” long ago. All the way back in May, 2014 I wrote that IBM was not going to be a turnaround. CEO Rommetty was spending ALL its money on share buybacks, rather than growing its business. The Washington Post made IBM the “poster child” for stupid share buybacks, pointing out that spending over $8B on repurchases had maintained earnings-per-share, and propped up the stock price, but giving IBM the largest debt-to-equity ratio of comparable companies.

IBM was already in a Growth Stall, something about which I’ve written often. Once a company stalls, its odds Virginia Rometty, CEO IBM. Growth?of growing at 2%/year fall to a mere 7%. But it was clear then that the CEO was more interested in financial machinations, borrowing money to repurchase shares and prop up the stock, rather than actually investing in growing the company. The once great IBM was out of step with the tech market, and had no programs in place to make it an industry leader in the future.

By April, 2017 it was clear IBM was a disaster. By then we had 20 consecutive quarters of declining revenue. Amazing. How Rometty kept her job was completely unclear. Five years of shrinkage, while all investments were in buying the stock of its shrinking enterprise – intended to hide the shrink! CEO Rometty continued promising a turnaround, with vague references to the “wonderful” Watson program. But it was clear, Buffett (and everyone else) needed to get out in 2014. So Berkshire ate its losses, took the money and ran.

Have you learned your lesson? As an investor are you holding onto stocks long after leadership has shown they have no idea how to grow revenues? If so, why? Hope is not a strategy.

As a leader, are you still forecasting hockey stick turnarounds, while continuing to invest in outdated products and businesses? Are you hoping your past will somehow create your future, even though competitors and markets have moved on? Are you leading like Rometty, hoping you can hide your failures with financial machinations and Powerpoint presentations about how things will turn your way in the future – even though those assumptions are made out of hole cloth?

It’s time to get real about your investments, and your business. When revenues are challenged, something bad is happening. It’s time to do something. Fast. Before a bad quarter becomes 20, and everyone is giving up.

Are You Adaptable Like Facebook?

Are You Adaptable Like Facebook?

InvestorPlace.com declared Snap stock will be a big disappointment in 2018. Bad news for investors, because SNAP was an enormous disappointment in 2017. After going public at $27/share in early March, the stock dropped to $20 by mid-March, then just kept dropping until it bottomed at just under $12 in August. Since then the stock has largely gone sideways at $15.

This was not unexpected. As I wrote in April, Snapchat was not without competition and was unlikely to be a long-term winner. Even though Snapchat and its Stories feature grew popular with teenagers 14 to 19, in August, 2016 Facebook launched Instagram Stories as a direct competitor. In just 7 months – just as SNAP went public – Instagram Stories had more users than Snapchat. It was clear then if you wanted to make money on the photo and video sharing trends, investors were better off to own Facebook stock and avoid the newly available SNAP shares (stock, not pix!)

Now the situation is far worse. Facebook launched WhatsApp Status as another competitive product in February, 2017 and it took less than 3 months for its user base to exceed Snapchat. As the chart below shows, by October, 2017 Stories and Status each had 300 million users, while Snapchat was mired at 180 million users. With only 30% the users of Facebook, Snapchat has little chance to succeed against the social media powerhouse.

Statista Facebook vs Snapchat

Statista

Facebook is now a very large company. But, it has shown it is adaptable. Rather than sticking to its original market, Facebook went mobile and has launched new products as fast as competitors tried to carve out niches. The question is, are you constantly scanning the horizon for new products and adapting – fast – to keep your customers and grow? Or are you stuck trying to defending your old business while upstarts carve up your market?”

How Traditional Planning Systems Failed Microsoft, and Its Board

Last week Bloomberg broke a story about how Microsoft’s Chairman, John Thompson, was pushing company management for a faster transition to cloud products and services.  He even recommended changes in spending might be in order.

Really?  This is news?

Let’s see, how long has the move to mobile been around?  It’s over a decade since Blackberry’s started the conversion to mobile.  It was 10 years ago Amazon launched AWS.  Heck, end of this month it will be 9 years since the iPhone was released – and CEO Steve Ballmer infamously laughed it would be a failure (due to lacking a keyboard.)  It’s now been 2 years since Microsoft closed the Nokia acquisition, and just about a year since admitting failure on that one and writing off $7.5B  And having failed to achieve even 3% market share with Windows phones, not a single analyst expects Microsoft to be a market player going forward.

So just now, after all this time, the Board is waking up to the need to change the resource allocation?  That does seem a bit like looking into barn lock acquisition long after the horses are gone, doesn’t it?

The problem is that historically Boards receive almost all their information from management.  Meetings are tightly scheduled affairs, and there isn’t a lot of time set aside for brainstorming new ideas.  Or even for arguing with management assumptions.  The work of governance has a lot of procedures related to compliance reporting, compensation, financial filings, senior executive hiring and firing – there’s a lot of rote stuff.  And in many cases, surprisingly to many non-Directors, the company’s strategy may only be a topic once a year.  And that is usually the result of a year long management controlled planning process, where results are reviewed and few challenges are expected.  Board reviews of resource allocation are at the very, very tail end of management’s process, and commitments have often already been made – making it very, very hard for the Board to change anything.

And these planning processes are backward-oriented tools, designed to defend and extend existing products and services, not predict changes in markets.  These processes originated out of financial planning, which used almost exclusively historical accounting information.  In later years these programs were expanded via ERP (Enterprise Resource Planning) systems (such as SAP and Oracle) to include other information from sales, logistics, manufacturing and procurement.  But, again, these numbers are almost wholly historical data.  Because all the data is historical, the process is fixated on projecting, and thus defending, the old core of historical products sold to historical customers.

Copyright Adam Hartung

Copyright Adam Hartung

Efforts to enhance the process by including extensions to new products or new customers are very, very difficult to implement.  The “owners” of the planning processes are inherent skeptics, inclined to base all forecasts on past performance.  They have little interest in unproven ideas.  Trying to plan for products not yet sold, or for sales to customers not yet in the fold, is considered far dicier – and therefore not worthy of planning.  Those extensions are considered speculation – unable to be forecasted with any precision – and therefore completely ignored or deeply discounted.

And the more they are discounted, the less likely they receive any resource funding.  If you can’t plan on it, you can’t forecast it, and therefore, you can’t really fund it.  And heaven help some employee has a really novel idea for a new product sold to entirely new customers.  This is so “white space” oriented that it is completely outside the system, and impossible to build into any future model for revenue, cost or – therefore – investing.

Take for example Microsoft’s recent deal to sell a bunch of patent rights to Xiaomi in order to have Xiaomi load Office and Skype on all their phones.  It is a classic example of taking known products, and extending them to very nearby customers.  Basically, a deal to sell current software to customers in new markets via a 3rd party.  Rather than develop these markets on their own, Microsoft is retrenching out of phones and limiting its investments in China in order to have Xiaomi build the markets – and keeping Microsoft in its safe zone of existing products to known customers.

The result is companies consistently over-investment in their “core” business of current products to current customers.  There is a wealth of information on those two groups, and the historical info is unassailable.  So it is considered good practice, and prudent business, to invest in defending that core.  A few small bets on extensions might be OK – but not many.  And as a result the company investment portfolio becomes entirely skewed toward defending the old business rather than reaching out for future growth opportunities.

This can be disastrous if the market shifts, collapsing the old core business as customers move to different solutions.  Such as, say, customers buying fewer PCs as they shift to mobile devices, and fewer servers as they shift to cloud services.  These planning systems have no way to integrate trend analysis, and therefore no way to forecast major market changes – especially negative ones.  And they lack any mechanism for planning on big changes to the product or customer portfolio.   All future scenarios are based on business as it has been – a continuation of the status quo primarily – rather than honest scenarios based on trends.

How can you avoid falling into this dilemma, and avoiding the Microsoft trap?  To break this cycle, reverse the inputs.  Rather than basing resource allocation on financial planning and historical performance, resource allocation should be based on trend analysis, scenario planning and forecasts built from the future backward.  If more time were spent on these plans, and engaging external experts like Board Directors in discussions about the future, then companies would be less likely to become so overly-invested in outdated products and tired customers. Less likely to “stay at the party too long” before finding another market to develop.

If your planning is future-oriented, rather than historically driven, you are far more likely to identify risks to your base business, and reduce investments earlier.  Simultaneously you will identify new opportunities worthy of more resources, thus dramatically improving the balance in your investment portfolio.  And you will be far less likely to end up like the Chairman of a huge, formerly market leading company who sounds like he slept through the last decade before recognizing that his company’s resource allocation just might need some change.

Facebook’s Surge, Apple’s Slide and Chipotle’s Stall – It’s All About Growth

Facebook’s Surge, Apple’s Slide and Chipotle’s Stall – It’s All About Growth

Growth fixes a multitude of sins.  If you grow revenues enough (you don’t even need profits, as Amazon has proven) investors will look past a lot of things.  With revenue growth high enough, companies can offer employees free meals and massages. Executives and senior managers can fly around in private jets.  Companies can build colossal buildings as testaments to their brand, or pay to have thier names on  public buildings.  R&D budgets can soar, and product launches can fail. Acquisitions are made with no concerns for price. Bonuses can be huge.  All is accepted if revenues grow enough.

Just look at Facebook.  Today Facebook announced today that for the quarter ended March, 2016 revenues jumped to $5.4B from $3.5B a year ago.  Net income tripled to $1.5B from $500M.  And the company is basically making all its revenue – 82% – from 1 product, mobile ads.  In the last few years Facebook paid enormous premiums to buy WhatsApp and Instagram – but who cares when revenues grow this fast.

Anticipating good news, Facebook’s stock was up a touch today. But once the news came out, after-hours traders pumped the stock to over $118//share, a new all time high. That’s a price/earnings (p/e) multiple of something like 84.  With growth like that Facebook’s leadership can do anything it wants.

But, when revenues slide it can become a veritable poop puddle. As Apple found out.

Rumors had swirled that Apple was going to say sales were down.  And the stock had struggled to make gains from lows earlier in 2016. When the company’s CEO announced Tuesday that sales were down 13% versus a year ago the stock cratered after-hours, and opened this morning down 10%.  Breaking a streak of 51 straight quarters of revenue growth (since 2003) really sent investors fleeing.  From trading around $105/share the last 4 days, Apple closed today at ~$97.  $40B of equity value was wiped out in 1 day, and the stock trades at a p/e multiple of 10.

The new iPhone 6se outsold projections, iPads beat expectations.  First year Apple Watch sales exceeded first year iPhone sales.  Mac sales remain much stronger than any other PC manufacturer. Apple iBeacons and Apple Pay continue their march as major technologies in the IoT (Internet of Things) market. And Apple TV keeps growing.  There are about 13M users of Apple’s iMusic.  There are 1.5M apps on the iTunes store.  And the installed base keeps the iTunes store growing.  Share buybacks will grow, and the dividend was increased yet again.  But, none of that mattered when people heard sales growth had stopped.  Now many investors don’t think Apple’s leadership can do anything right.

Growth StallYet, that was just one quarter.  Many companies bounce back from a bad quarter.  There is no statistical evidence that one bad quarter is predictive of the next.  But we do know that if sales decline versus a year ago for 2 consecutive quarters that is a Growth Stall.  And companies that hit a Growth Stall rarely (93% of the time) find a consistent growth path ever again.  Regardless of the explanations, Growth Stalls are remarkable predictors of companies that are developing a gap between their offerings, and the marketplace.

Which leads us to Chipotle.  Chipotle announced that same store sales fell almost 30% in Q1, 2016.  That was after a 15% decline in Q4, 2015. And profits turned to losses for the quarter.  That is a growth stall.  Chipotle shares were $750/share back in early October. Now they are $417 – a drop of over 44%.

Customer illnesses have pointed to a company that grew fast, but apparently didn’t have its act together for safe sourcing of local ingredients, and safe food handling by employees.  What seemed like a tactical problem has plagued the company, as more customers became ill in March.

Whether that is all that’s wrong at Chipotle is less clear, however.  There is a lot more competition in the fast casual segment than 2 years ago when Chipotle seemed unable to do anything wrong.  And although the company stresses healthy food, the calorie count on most portions would add pounds to anyone other than an athlete or construction worker – not exactly in line with current trends toward dieting.  What frequently looks like a single problem when a company’s sales dip often turns out to have multiple origins, and regaining growth is nearly always a lot more difficult than leadership expects.

Growth is magical.  It allows companies to invest in new products and services, and buoy’s a stock’s value enhancing acquisition ability.  It allows for experimentation into new markets, and discovering other growth avenues.  But lack of growth is a vital predictor of future performance.  Companies without growth find themselves cost cutting and taking actions which often cause valuations to decline.

Right now Facebook is in a wonderful position.  Apple has investors rightly concerned.  Will next quarter signal a return to growth, or a Growth Stall?  And Chipotle has investors heading for the exits, as there is now ample reason to question whether the company will recover its luster of yore.

Why Phablet Growth is Bad for Microsoft

Why Phablet Growth is Bad for Microsoft

Phablets are a very hot, growing market.  Phablets are those huge phones (greater than 4″ screen size) that some people carry around.  From almost nothing in 2012, over the last 3 years the market has exploded:

Source: Jay Yarrow, Business Insider http://www.businessinsider.com/in-one-chart-heres-why-the-ipad-business-is-cratering-2015-3?utm_content=&utm_medium=email&utm_source=alerts&nr_email_referer=1

Source: Jay Yarrow, Business Insider http://www.businessinsider.com/in-one-chart-heres-why-the-ipad-business-is-cratering-2015-3?utm_content=&utm_medium=email&utm_source=alerts&nr_email_referer=1

The original creator of this market data, Kulbinder Garcha of Credit Suisse, thinks this demonstrates cannibalization of tablet sales by phablets.  And this is supposedly a bad thing for Apple.

But there is another way to look at this.  By introducing and promoting a phablet (iPhone 6+ and Galaxy S6,) Apple and Samsung are growing users of mobile media and mobile apps.  As the chart shows, growth in tablet sales was nothing compared to what happened when phablets came along.  So people who didn’t buy a tablet, and maybe (likely?) wouldn’t, are buying phablets.  The market is growing faster with phablets than had they not been introduced, and even if tablet sales shrink Apple and Samsung see revenues continue growing.

Who wins as phablet sales grow? Those who have phablet products in the market, and newer versions in the works.

Smartphone sales 2014-15

Source: Kantar WorldPanel and Seeking Alpha http://seekingalpha.com/article/3032926-microsoft-the-china-mobile-backed-lenovo-windows-10-smartphone-could-be-a-future-tailwind?ifp=0

 

 

As this chart shows, the companies who dominate smartphone sales are those who make Android-based products (#1 is Samsung) and Apple. Microsoft missed the mobile/smartphone trend, and even though it purchased Nokia it has never obtained anything close to double digit share in any market.

Unfortunately for Microsoft enthusiasts, and investors, Microsoft’s Windows10 product is focused first on laptop (PC) users, second on hybrid (products used as both a laptop and tablet), third tablets (primarily the slow-selling Microsoft Surface) and in a far, far trailing position smartphones.

Source: IDC

Source: IDC

As data from IDC shows, Surface sales are inconsequential.  So the big loser from phablet cannibalization of tablets will be Microsoft. Given its very small user base, and the heavy losses Microsoft has taken on Surface, there is little revenue or cash flow to support an intense competitive effort in a shrinking market.  Apple and Samsung will market hard to grow as many sales as possible, and likely will make the tablet products more affordable. Thus one should anticipate Microsoft’s very small tablet share would decline as tablet sales shrink.

This is the problem created when any business misses a major trend.

Microsoft missed the trend to mobile.  They didn’t prepare for it in any of their major products, and they let new products, like music player Zune and Lumia phones, languish – and mostly die.  By the time Microsoft reacted Apple and Samsung had enormous leads.  Microsoft is still trying to play catch-up with its “core” Windows product.

But worse, because it is so far behind, Microsoft’s leaders are unable to forecast where the market will be in 3 years.  Consequently they develop products for today’s market, like tablets (and their hybrid products,) which we now see will be obsolete as the market shifts to new products (like phablets.)  Because Apple and Samsung already have the new products (phablets) they are prepared to cannibalize the old product sales (tablets) in order to overall grow the marketplace.  But Microsoft has no phablet product, really no smartphone product, and will find itself most likely writing off more future Surface products as its tiny market share erodes to nothing.

So this trend to phablets continues to make a Microsoft comeback as a major personal technology competitor problematic.  Windows 10 may be coming, but its relevance looks increasingly like that of new Blackberry models.  There is little reason to care, because the products are years late and poorly positioned for leading edge customers.  Further, developers will already be onto new competitive platforms long before the outdated Microsoft products make it to market.  Without share you don’t capture developers, without developers you don’t have a robust app market, without apps you don’t capture customers, without customers you can’t build share — and that’s a terrible whirlpool Microsoft is captured within.

Be sure your business keeps its eyes on trends, and does not wait to react.  Waiting can turn out to be deadly.