Tag Archives: e-readers

the tablet war: dispatches from the front lines

September 14, 2010 By in Current Market Thoughts, Entertainment, Industry Analysis, internet, Recent Market Action, Stock ideas, Technology, Wireless Tags: , , , , , , , , , , Leave a comment

In the past week or so, there have been two significant developments in the story of the development of the PC tablet:

–one is the outpouring of reports, both from the blogosphere and in newspapers, that the iPad is cannibalizing the notebook.

–the other is that AAPL has made up with ADBE, sort of.

details

the iPad

The many blogger stories about cannibalization seem to have been generated as the result of a well-marketed brokerage research reports by analysts covering AAPL at UBS and Barclays Capital.  The Financial Times recently had a more comprehensive comment in its Lex column.

Clearly, something is happening.  But I’m not sure the cannibalization numbers add up or that the overall story makes any sense.

We know from INTC that the back to school season has been weaker than had been expected as late as early July.  Last minute processor order cancellations/deferrals were big enough for INTC to make a downward revision to revenues on August 27th, pointing to “weaker than expected demand for consumer PCs in mature markets.”  This quantified the weakness that Taiwanese IT firms and US laptop makers like DELL had been talking about in the prior weeks.

In its press release, INTC revises its September quarter sales down by about $600 million, or 5%.  If we assume 5% is a good proxy for the unit demand shortfall (since the sectors showing weakness are less expensive computers, the 5% probably understates the unit decline), then the reduction in units to be sold in the Us and Europe (mature markets) is about 5 million.  That figure probably exceeds AAPL’s production, and worldwide sales, of the iPad during July-September.

Also, the laptop sales shortfall is reported to be predominantly in the netbook end of the market.  I suspect this is because low-end “regular” laptops have come down in price and now mimicked the features of netbooks.  As a result, for several quarters the latter’s unit sales have been flattish in a rising market.  Besides, I can’t imagine anyone who has used a netbook or an iPad would think they were close substitutes for one another.  You might just as easily argue that smartphones are cannibalizing PCs.

F or what it’s worth, my guess is that the slowdown in consumer PC sales in the US and Europe is a slowdown-in-the-economy phenomenon, not a cannibalization one.

Nevertheless, there is extremely high interest in tablets, even though most of those intending to buy one don’t really know what they are or where they fit in among their digital devices.  According to a Forrester blog post from last Friday 2.5 million US online consumers already own an iPad and 7.4 million more intend to buy one.  An additional 20 million say they’re going to buy a tablet of some sort–not necessarily an iPad–over the next 12 months.  (This 27 million total surpasses the number of Americans intending to buy an e-reader, the next most desired device, by about a third).

The one characteristic of tablets that should jump out for investors is that none will have INTC microprocessors and most will likely have linux-based software, not MSFT’s.

This explosion of interest, and the resulting scramble by AAPL to increase production capacity and by other manufacturers to get their tablet devices into the market, may explain the apparent urgency behind INTC’s moves to acquire McAfee and Infineon’s cellphone chip business.

AAPL and ADBE

Last Thursday, AAPL posted a release on its website about “App Store Review Guidelines.”   It seems innocuous…but it isn’t.  Back when the iPad was being introduced, AAPL said the device wouldn’t support Adobe Flash.  Why?  Steve Jobs eventually wrote his thoughts in an open letter.  Although AAPL and ADBE have a long relationship, he wrote, but Flash is unreliable, poor performing, and not secure.  The world has passed ADBE by, as well.  Ouch!

Two other problems.  Flash is designed for PCs and uses a lot of processing power and battery life.  Also, if you could download Flash onto your iPad you could use services like Hulu and bypass the AAPL apps store.

AAPL went a step further, too.  ADBE had developed a cross-platform compiler, that is, a software program that’s something like a translation device.  It converts a Flash-created app into one in a programming language that AAPL found acceptable.  But AAPL said developers couldn’t use the ADBE compiler, either.  The result was that many app developers had to hire two staffs, one to develop specifically for AAPL, another to develop for the rest of the world.

Last week’s press release is AAPL’s capitulation on app development.  AAPL still won’t allow any Flash code to be downloaded into the iPad, but it will accept programs that have been cross compiled from Flash in to an Apple-approved language.

Why did AAPL give in?  Some people say it was ADBE’s appeal to the government anti-trust authorities.  Maybe.  But I think the real issue is the stunningly fast development of the tablet market.  After all, the iPad is a limited device.  It’s been crafted to avoid any cannibalization of the iPhone (remember–if we look at profits, AAPL is a cellphone maker with a couple of lucrative sidelines, like MP3 players and computers).  Users are funneled to its app store to get  content to use.  If AAPL could get developers to write code that would be very expensive to adapt for most other tablet devices, its first-to-market advantage would be that much more overwhelming.

It’s this last thing that the bland note linked above is raising the white flag to.  To me, it’s a signal that AAPL sees competition coming for the iPad faster than it had thought.  This isn’t 100% bad for the company.  Its dominance of the tablet market will likely be less complete, but the market will likely be very much larger than it had dreamed.  It wasn’t that long ago (March or April) that analysts laughed at AAPL for arranging for production capacity of 1 million units a month.  It’s now churning out twice that and still scrambling to expand fast enough to keep up with demand.

Barnes and Noble (BKS) is putting itself up for sale. Why?

August 6, 2010 By in Books, e-readers, Industry Analysis, internet, Publishing, Retail, Stock ideas Tags: , , , , , , , , Leave a comment

BKS’s announcment

Earlier this week, the board of directors of BKS announced it was considering putting the book retailer up for sale. The stock, which has been a severe laggard recently, jumped by about 20% in the following day’s trading. The straightforward interpretation of this market movement is that Wall Street feels the company would be better off economically in someone else’s hands. Zin this case, however, it may equally well reflect strong confidence that there is a wealthy buyer foolish enough to make the purchase at a substantial premium. There are, of course, already two significant holders of stock, Leonard Riggio with a 20% holding and Ron Buckle with 19%.  Mr. Riggio has already expressed interest.

What’s going on?

Securities analysts are often forced to make mountainous theories out of molehills worth of information. It goes with the territory. But like any scientist would, we outline our assumptions and conclusions based on the data we have, and then look for information that could prove our resulting theories false. BKS is a case in point.

Here’s my theory:

Three or six months ago, the board of BKS may have been debating selling the company. But it didn’t do anything before now. So it seems reasonable to me that some recent development has either focused their minds or tipped them over the edge toward sale. What could that be?

I don’t think it’s just the recent weak bookselling environment, since this unfavorable development can’t have come as a complete surprise. Nor is it likely the bad blood between the two significant holders of the company’s stock, since this too has been around for a while. Instead, I think the factor involved is an unintended consequence of the move by publishing houses, in concert with AAPL, to force AMZN to raise the price it charges for e-books.

As I’ve written in another post, I think the publishers saw AMZN’s aggressive e-book pricing—it was paying the publishers around $12.50 for a hardcover bestseller and retailing it for $10, thus losing $2.50 a copy—as a threat to mom-and-pop bookstores. The publishing houses’ fear was that the low price would spur rapid adoption of e-books by consumers, shifting business away from mom and pop and destroying a valuable distribution network. That, in turn, would leave AMZN in the very powerful position of controlling a major part of the book distribution network.

For its part, AMZN could afford to use e-books as a loss leader because, although it began as an online bookseller, it has long ago established a thriving online business selling all sorts of other stuff, both for itself and as an agent for others. The contrast between it and BKS is stark. BKS, a purely bookseller, will have cash flow around $250 million this year. AMZN, books + other stuff, will have cash flow of around $1.7 billion, or 7x BKS’s.

What the publishers did was compel AMZN to charge $12.50 a copy for e-books and keep 30% of the revenue and return 70% to the publisher. This is the same deal they offered to AAPL, and is modeled on the standard arrangement with independent bookstores. Note, also, that in using the new system, the publishers were receiving less than AMN was willing to pay them for e-books. So boosting the near-term bottom line was clearly not the reason the publishers were doing this.

Raising the AMZN e-book price by 25%, they apparently reasoned, would slow e-book adoption, preserve small booksellers’ profits and give the publishers some breathing room to figure out what to do next. Things haven’t worked out that way, however.

Maybe higher prices did slow the rate of adoption, but if so the consensus wildly underestimated what that the adoption rate would prove to be.

But I think they also stopped AMZN from making a strategic blunder with e-books and redirected it onto a much more effective long-term path.

To me it’s not surprising that AMZN would be willing to lose money while it established its e-book market position. After all, it spilled red ink for years in its online original book business, propped up only by the billions it cleverly raised from internet-crazed investors in the late Nineties, before the bubble burst. And that turned out ok.

AMZN’s mistake, I think, was to focus on using the book price and not on the readers as a way of gaining market share. Given that the publishers forced AMZN to make a profit on bookselling, they eliminated that option. More than that, they gave AMZN all that “found” cash flow that it could direct into its other strategic e-book weapon–developing better and cheaper e-readers. The first in what I expect will be a series of innovations have just come out. You can now buy an e-reader with better screen resolution (wi-fi only) for $139—or at least be put on the waiting list for one—which is about half the price of the older models a couple of months ago.

BKS is a bookseller. AMZN is a technology behemoth, running mammoth server networks for itself and renting space to other “cloud computing” users. BKS might be able to compete in a battle about who can sell the most books. I think it has decided it can’t compete in a war over who has the best e-reader technology. So it’s sending up a white flag.

It’s maybe too early to tell for sure, but a good guess that the book publishers have accidentally precipitated the demise of BKS. Given the weak condition of Borders and the likely fading away of mom and pop bookstores, this action may also have given AMZN a decisive edge in the battle for book-reading customers.

developments on the e-book front

July 26, 2010 By in Books, e-readers, Industry Analysis, Publishing Tags: , , , , Leave a comment

There are two interrelated struggles going on over the potential revenues from e-book publishing.  One is among the sellers of dedicated e-readers, like the Kindle, the Nook or the Sony e-reader–each with one another, and all with AAPL, the creator of the iPad.  The last is a general internet content consumption device that hopes e-books will be one of many profitable sales opportunities for it.

The second is between authors and their publishers over who possesses the e-book rights to older “backlist” titles, whose contracts don’t spell out explicitly who owns them.  This “software” situation is at least as muddled as the “hardware” one.  Some literary agents and publishers have made their negotiations public; most have not.

The ones I know about on the publishing side seem to separate into two camps:  Random House and everyone else.  The issue is the royalty rate at which authors will be paid for backlist titles sold as e-books.  Authors’ agents point out that the incremental cost of selling an e-book is negligible, and that the e-book question is not addressed in the book contracts.  They conclude that their clients should get a higher percentage of such sales revenue than their contracts specify, since those implicitly factor in a physical publishing cost element.

Smaller publishers have been quietly striking deals with agents.  Random House has not.  It has taken the stance that it already owns the e-book rights to older titles because the contracts don’t explicitly exclude them.  It has also been conducting a gentle op-ed campaign to suggest that a book is really a collaboration between author and editor–and that the final product may be far different from the original manuscript acquired by the publisher.  I take it the suggestion here is that the book may not be the sole intellectual property of the author, to do with as he pleases, even if Random House were to be eventually found in court to have misinterpreted its older book contracts.

Last week, both battles reached a higher public profile when powerful literary agent Andrew Wylie, who represents a stable of hundreds of prominent authors, agreed to sell the exclusive e-book rights to twenty classic novels, including Norman Mailer’s “The Naked and the Dead,” Philip Roth’s “Portnoy’s Complaint,” and Salmon Rushdie’s “Midnight’s Children” to Amazon for the Kindle.  These are all titles under contract to Random House.

Random House has responded by stopping all new English-language book negotiations with Wylie.

This will be an interesting situation to watch.  The Wylie action only includes twenty books.  The Amazon deal is for a limited, two-year, time.  Presumably Wylie has chosen the titles with care–meaning authors/estates with the weakest ties to Random House.  So it is more a shot across the bow than a declaration of all-out war.  Random House’s action seems to me to be an overreaction.

Both moves may have unintended consequences.  I don’t see what Wylie has to lose, however, or what Random House has to gain, from their current positions.

Suppose sales of the twenty titles through Kindle are much better than anyone expects?  Then more authors will want to jump on the Kindle bandwagon and Random House will either have to backtrack or make a more draconian response.  If the latter, will it risk angering Wylie clients and losing them permanently to other booksellers .

Suppose sales are awful?  This is the “good” outcome for Random House–discovering that the e-book rights it is so ardently defending have no value.  I suspect this won’t be what happens, though.

End game for growth stocks: nasty, brutish but not very short. How does AAPL fit the mold?

July 25, 2010 By in Basic Concepts, e-readers, growth vs value, Industry Analysis, Stock ideas, Technology, Wireless Tags: , , , , , , Leave a comment

the growth stock life cycle, in brief

The Wall Street cliché is that the key to successful growth investing is how skillfully you sell the stock (as opposed to value investing, where the key is how you buy it).

The idea is that most growth stocks have a very short life in the stock market sun–five or so years.  The best growth companies continue to reinvent themselves and create new lines of business–as WMT or MSFT did.  But most aren’t able to.

As the company demonstrates surprisingly strong earnings growth, the stock market attitude gradually changes from one of disbelief to fandom–extrapolating the period of superior profit expansion much farther into the future than will likely pan out.  This tendency shows itself in a huge price earnings multiple–both absolute and relative to the rest of the market.

Normally, the seeds of future earnings disappointment–and consequent price earning multiple contraction–are already being sown in a qualitative sense at least.  But many investors ignore, or explain away, these early warning signs even when they begin to be evident in reported earnings.  At some point, disillusionment, and subsequent underperformance, begins.

MSFT as an example

MSFT is a good example of this phenomenon.  In the four years from 1995 to 2000, MSFT’s reported profits per share grew at a 40% annual rate,  meaning they quadrupled over that span.  The price earnings multiple expanded from 29 to 53, and advance of 83%, over the same period.  Therefore, more than two fifths of the total 10x stock gain came from p/e expansion.

Over the subsequent decade, MSFT’s eps grew at a little more than a 10% clip–and the stock’s p/e contracted steadily from 53 to 13 (or 3.5x the market average multiple to .9x currently).  Despite the doubling in earnings the  stock price has been cut in half, more than all of which is due to p/e contraction.

If we look at MSFT in general conceptual terms, the stock was first driven by the acceptance of the MS-DOS operating system, then by the Office suite, and finally by successive iterations of the Windows graphical user interface–all in an expanding PC market.  Then the market for its products matured, MSFT came late to the Internet, its diversifications earned little money and…  Nevertheless, it’s important to note that MSFT lasted as a growth stock for such an unusually long period because of its successive waves of innovation from MS-DOS on, not just because the PC market was growing quickly.

How does AAPL fit this model?

Looking in the most general terms, AAPL was a moribund personal computer firm with a cult-like following among individuals using PCs that had a change of management.  New leadership introduced a portable music player, the iPod, that was so successful it quickly doubled the size of the company.  AAPL subsequently introduced a revolutionary smartphone, the iPhone, which again doubled the size of the company.  Now it’s introducing a third product, the iPad in a hope of doing the same trick again.

What AAPL has done over the past decade is truly remarkable.  Earnings per share have grown at a 60%+ annual rate, and are now 10x what they were in 2005. The company is now one part PCs, one part iPod, and two parts iPhone, three of which weren’t there five years ago.

Two potential questions about AAPL’s future performance have emerged:

–One is the “concept” observation that to have the same positive effect on the overall company as the iPhone has had, the next product, presumably the iPad, has to be twice the size of the iPhone.  This is just a fact of the company’s recent growth.

–Android phones are emerging as a potential competitor to the iPhone; iPod unit sales are slipping; Chrome-based tablets are potentially going to be on the market for this year’s holiday season.  Wall Street is presumably thinking that Chrome products will end up being a case of the Zune redux.

one big difference

In 2005, AAPL’s stock was trading at 26x earnings per share.  Today, after a period of extraordinary earnings growth, AAPL’s stock is trading at under 17x eps, a pe multiple contraction of 30%.  AAPL’s relative pe was 1.4 in 2005.  It’s 1.1 now.

Unlike the typical growth stock, more than 100% of AAPL’s stock performance has been driven by earnings growth.  The pe contraction means investors have been increasingly forcefully betting that the company can’t continue its present rate of expansion.  In fact, one might argue that a pe multiple of 17- means the market thinks AAPL won’t grow earnings by more than 15% from now on.

my thoughts

Personally, I think tablets will create a new revolution in computer usage.  I’m not sure the AAPL will get the market share with the iPad that it has been able to achieve with the iPhone or the iPod.  Still, if my reading of the stock price dynamics is correct, I think Wall Street is being much too pessimistic about AAPL’s prospects.  Hard as this is to say about a stock that has had 15x the market return over the past five years, that’s what the numbers tell me.

Net Neutrality: this week’s appeals court decision

April 9, 2010 By in Current Market Thoughts, e-readers, Entertainment, Industry Analysis, internet, Publishing, Technology, Wireless Tags: , , , , , , , , , , Leave a comment

the Comcast lawsuit

Three years ago, the Associated Press responded to consumer complaints by running tests that showed that Comcast was slowing down access to peer-to-peer file-sharing services like BitTorrent, which allows users to swap large files, like movies.  Comcast first denied doing anything, but later said it acted because a small number of users were hogging bandwidth and slowing down access speeds for everyone else.

The Federal Communications Commission ordered Comcast to stop this, under “net neutrality” principles it had laid down in 2005.  Comcast sued.  Earlier this week, an appeals court ruled that the FCC had no legal authority to issue the order.  So, barring another appeal, Comcast has won.

What is Net Neutrality?

First of all, one should note that the name itself is a very clever, highly political choice, sort of like the Patriot Act or the Employee Free Choice Act.  Just as no one wants to be seen as opposing free choice or patriotism, it seems unreasonable to be against neutrality.  So opponents are already on the defensive, no matter what the actual concepts are that lurk behind the names.

FCC statements on net neutrality say consumers are entitled to:

–access all lawful content

–run any applications or services

–connect to the internet with any legal, non-harmful device

–competition among service, application and content providers

–disclosure of operating principles by ISPs

–no discrimination by ISPs against any legal content or applications.

two observations

1.  This is all jockeying for economic advantage.

On the one side, cable and telephone companies have spent billions building out internet networks, with at least vague imaginings of being able to operate the kind of “walled gardens” that Apple’s iPod and iPhone now run, and AOL did in the Nineties.  They don’t want to be reduced to being “dumb pipe” conduits earning a minimal return for transporting very profitable applications run by others.   But they suffer from the weakness of any capital-intensive industry (think:  container shipping or cement plants) that their capital is already sunk in the ground and can’t easily be retrieved.  So they are almost by definition price takers.

On the other, content and application providers are radically dependent on ISPs to deliver their products to consumers.  They wonder (fear?) what would happen if an ISP owned a service that competed with theirs–like Comcast when it takes control of NBC Universal.  Would, say, competing news services find their offerings delivered at slower speed than NBC’s?  Would content/application providers that didn’t link up with Hulu find themselves shunted onto the local track while more NBC-friendly competitors stayed on the express rails?

You might say that an ISP would be foolish to do this, but outside the most densely populated areas, what recourse do consumers have?  There’s no competing internet service to switch to.

At this point, this is mostly in the realm of “what if?”.  Other than the BitTorrent instance, there’s scant evidence that ISPs are acting on what may well be their secret fantasies.

2.  Almost everything that has been said about Net Neutrality is couched in negative terms–what ISPs are not allowed to do.  The other side of the coin has been pretty much ignored.  ISPs are allowed to sell different classes of service, with minimum quality of service guarantees.  And wealthy service providers (think:  Google) can maintain cutting-edge server networks of their own to support their products.  They can also pay ISPs to colocate their equipment with the ISPs to increase service speed.

So neither side is exactly the powerless “victim” of the other that its proponents would like to portray it as.

investment implications

1.  The Roberts family, which controls Comcast, are very shrewd businessmen.  Their attempt a few years ago to acquire Disney and its current agreement to buy an interest in NBC Universal illustrate what they think of the future of the IPSs (i.e., dumb pipe).  In the BitTorrent case, they had two options:  slow down service or add capacity.  The second would mean capital spending that wouldn’t generate any more revenue.  Whether you think Comcast did the right thing or not, it’s an indicator of the maturity of the business if option #2 makes no economic sense.

2.  The wired broadband networks have by and large been built with private money.  This suggests they shouldn’t be regulated as public utilities.  Even if that were possible, and net neutrality thereby assured, I don’t think anyone wants that.  The next step, I think, would be taxation along the lines of telephone services, raising the cost of internet service for everyone.

In theory, tax increases would get parceled out among consumers, ISPs and content providers according to their economic power.  But no one really wants to find out what that allocation would be.  And everyone except the government is worse off.

3.  Content providers want security but they don’t want regulation.  What do they do?

a.  They attack the “walled garden” that Apple has established by providing/supporting the creation of equivalent devices at lower prices.  The Google phone, the Chrome netbook or the $100 iPad-equivalent that Marvell recently displayed are examples.

b.  They promote the proliferation of alternative ways of internet access–WiMax, municipal free internet services.  The more alternatives a consumer has, the less able any one ISP is to take content-unfriendly action.  Also, an ISP would certainly hesitate to take action if that meant that a whole town or county or some other political entity were affected.  Doing so would invite adverse political consequences.

4.  How to invest?

I suspect a value investor would have a field day rooting through the cable companies and the traditional media companies, since many have already acted on their belief that these firms are the ultimate losers in the internet revolution.

That’s not what I do, however.  I continue to think that the designers of new devices, and of the key components that go into them, are the best bet.