US Cable Companies are famous for fiercely protecting their customers (bills) so why would they partner with fast growing upstart Netflicks?
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Just like Abba, for the High Tech Shark, The Winner Takes It All
The Winner Takes It All was a number one hit in 5 countries and Top 10 in 13 others. Abba had nine UK number one singles and five RIAA gold albums, three platinum status, and one 6x platinum. Translate that to today’s start-up or exponential terminology that’s 3 unicorns and 1 decacorn.
In a mere 2.5 years the High Tech Sharks have devoured the competition. In late 2015 there was a clear separation around clusters of Disruptors, Challengers, Followers and Laggards. That positioning has deteriorated as Sharks have pulled away.
As we mentioned previously, our class of 2015 FANGS; Facebook, Amazon and Netflix, Salesforce has been joined by Microsoft, Alibaba, Baidu, and wait for it Best Buy.
What is their recipe for success? As we mentioned in the Introduction to the Innovation Index 2018, a company with a technology platform (wide moat = high ROIC), a subscription based business model with Monthly Recurring Revenues and a huge Annuity of un-booked revenue if Churn is managed well, is now the preeminent model across both Consumer and Business verticals.
A Tale of Two Apples
We could make a case that Apple should be considered a Shark. It added more EV than the rest of the Challenger Group combined and is still the world’s most valuable company. In 2015 we compared the fortunes of Apple vs Verizon in How to Analyze Ecosystem for an Industry?
Using our Strategy Science Toolkit, we start by looking at Enterprise Value and Competitive Advantage Period to see who has greater momentum for driving the Consumer TMT Ecosystem moving forward.
|Enterprise Value $ Blns||954||692||324||319||190.44||120|
|NPOAT $ Blns||46.0||39.5||25.9||43||9.6||2.54|
|Investment $ Blns||13.1||15||1.1||25||10||15|
Competitive Advantage Period or CAP is a measure of how long returns above the cost of capital will be earned. CAP is also known as “value growth duration” or “T” in the economic literature and is also similar in concept to Credit Suisse “fade rate” or CFROI. Clearly Apple’s CAP is shortening from 21.6 to 15.4 and EV creation is slowing.
One Product Apple faces a Saturated Market and Substitution from Samsung and Xaomi
Saturating smartphone markets meant the only manufacturers to enjoy growth during the first quarter of 2018 was the Chinese pair of Huawei and Xiaomi. According to figures from IHS Markit, The market as a whole increased by 2 per cent to 345.5 million, with Samsung and Apple retaining the top two positions.
Samsung shifted 78 million handsets and has 22 per cent of the market, while Apple sold 52.2 million and has 15 per cent and profits reaching £11 billion during its first quarter. Xiaomi recorded an astonishing 129 per cent rise, selling 29.3 million units and securing eight per cent of the market. Chinese phone firms have done well in their domestic market, where low cost and the absence of brand loyalty has allowed multiple new entrants to flourish, but there are signs that even here there is saturation. Fifth and sixth position are held by two other Chinese firms Oppo and Vivo.
Apple knows it needs to become a leader in the subscriber business soon or buy into another growth category like Electric Cars (Hint Tesla @tim_cook, our top performing Disrupter from 2016).
Disney vs Netflix
Only Comcast can challenge Disney in breadth and depth in media and distribution. But as the move from the physical world to digital platforms gathers pace, Netflix, driven by subscriber growth has crossed the chasm and is leading our combined Enterprise Value Multiples Ranking.
|Company||EV||X EV / EBITDA||X EV / SALES||Rank EV / EBITDA||Rank EV / Sales|
While Disney or Comcast could bulk up on Fox (plus Sky), the value driver for Disney going forward is how well their streaming platform performs vs incumbents?
Where are the Societal Benefits of Big Tech?
Finally as I mentioned the business forum from Hannover Messe, one of the key areas of discussion in the negotiation of NAFTA was the inclusion of digital products and services. In a country heavily weighted in Manufacturing, how much corporation tax has Facebook, Netflix, and Salesforce paid in Mexico? As in the World Cup, The Winner Takes It All. Always!
You hear a lot about how Innovation is linked to superior financial performance. The BIQ Innovation Index 2018 (c) tracks exactly that. Here is the 2018 update to the index first published in 2015 with some surprising results and trends.
Shark Tank – Big Tech Leads Innovation
We first warned you about the powerful bite of the FANGs in our 2015 Index. FANG stood for Facebook, Amazon, Netflix and Google. For 2018 we are adding Microsoft to make FANMG which is not such a cool acronym, but a fair representation of Top Innovators. They have strong combination of Enterprise Value creation, year on year sales growth momentum and a high ROIC respective to their industry peers.
Kudos to Microsoft, the only successful large cap company that has achieved a digital transformation at scale. This could have not happened under Gates or Balmer and is testament to the leadership of @satyanadella. Azure, Cloud migration of Office 365, and strategic M&A Linkedin and GitHub. Please don’t ask me about the Skype experience.
Add to this group the Chinese internet giants Baidu and Alibaba. Both have implemented innovate business models to attack new markets like mobile commerce that is beyond what western companies having today.
Salesforce also makes the list moving up from Disrupter as the preeminent business software application provider running on the cloud using a rental model SaaS.
A surprise mention for Shark status is Best Buy proving that Americans love their gadgets to play in consumer ecosystems.
Highest EV/EBITDA and EV/Sales Ratios
In 2015 Tesla and Salesforce reported the highest EBITDA/EV ratio as they continue to disrupt the chosen industries of Electronic Vehicles and Business Software Applications. En 2018 we are seeing an entirely different phenomenon. In 2018 the top 5 includes platforms from Netflix, Salesforce, Alibaba, Facebook, and Microsoft.
Most Sharks have a technology platform (wide moat = high ROIC) with a subscription based business model with Monthly Recurring Revenues and a huge Annuity of un-booked revenue if Churn is managed well, is now the preeminent model across both Consumer and Business verticals.
Gulp, get some air and read again.
A company with a technology platform (large moat = high ROIC) with a subscription based business model with Monthly Recurring Revenues and a huge Annuity of un-booked revenue if Churn is managed well, is now the preeminent model across both Consumer and Business verticals.
The Future for Big Tech
As recently as 10 years ago you could still make a case for regulation of Big Oil and 2 of the top 5 Fortune 500 Exxon and Shell. A potential problem for the FANMGs and Big Tech in general is their monopoly power. We are going to have to decide fairly soon whether Facebook, Google, and Amazon are the kinds of natural monopolies that need to be regulated, or whether we allow the status quo to continue, pretending that unfettered monoliths don’t inflict damage on our privacy and democracy. At biggest risk is Facebook with a one trick pony business model and a leader with lax controls and morals.
In the next post we will analyze the Disruptors, Challengers, Followers and Laggards. Discuss briefly the fortunes of Apple vs. Verizon and Netflix vs. Disney. In the final post we will analyze each vertical covered.
You hear a lot about how Innovation is linked to superior financial performance. The BIQ Innovation Index 2015 (c) tracks exactly that. Here is the index and scores for 2015 with some surprising results.
THE SHARKS HAVE BIG FANGS. BE CAREFUL OF THEIR BITE.
While CNBC’s Jim Cramer from TheStreet coined the FANG moniker, 2 companies the “F” for Facebook and “N” for Netflix in streaming entertainment, together with Apple are our top innovators for 2015. They have strong combination of Enterprise Value creation, year on year sales growth momentum and a high ROIC respective to their industry peers.
Due to a lack of historical public data, the no-show is Google. It’s Chinese competitor Baidu does make it into our top 4 with 36% sales growth YOY. Baidu is in the list of Chinese companies like Alibaba and Xiaomi that implemented innovate business models to attack new markets like mobile commerce that is beyond what western companies have today.
Of the 4th Horseman of Apocalypse we reported in June, “A” for Amazon, is continuing to create unicorns and decacorns such as Prime, Logistics and Web Services but has yet to turn a profit. It does it highest EV/Book value highlighting investors are happy with this strategy and management.
Hennes and Mauritz, the challenger to leader Zara/Inditex in fast fashion, continue their worldwide expansion that is continuing to disrupt head on traditional assumptions about fashion and retailing. As such, gone is the idea of 2 seasons such as SS16 and AW17 per year.
In the more prosaic industries Southwest has benefited from doubling it’s potential market with International Routes and the AirTran acquisition. They also reported record sales and ROIC for the December. Microsoft looks leaner and meaner focusing on core businesses such as 365 Office, Cloud and Xbox franchises although Windows is still a basket case of innovation.
Three companies that should have done better this year with the US rebound this year are Wells Fargo, CVS Pharmacy and Toyota. They ALL seem lacking the next big innovation to drive sales, new markets and value growth.
The 5 year EV darling of Bricks and Mortar Commerce, Macy’s, had a spectacular meltdown dropping from Challenger to Follower in the last 6 months on negative sales growth, markdowns, and competition due to the unseasonably warmer weather this fall.
Ebay, and JP Morgan. Ebay sales in core markets were slightly negative for 2015. While JP Morgan grew EV, their 1.12 Book Value to EV is the lowest of the whole model which shows their difficulty of balancing Regulation vs. Innovation across many geographies.
The rest of the companies were included as previous innovators or as part of a peer group. These include American Airlines, General Motors, Oracle, Best Buy and Walmart. Their financial performance, innovation capacity and outlook are neutral to negative.
Two of the S&P Top 10 by Market Capitalization, Google and AliBaba, together with Lending Club and were excluded from the Index for not having enough historical public data for the analysis. From the rest of the S&P Top 10, we do not cover Berkshire, Exxon, GE, Petro China or ICBC.
Click here to see the full analysis.
How to Analyze Ecosystem for an Industry?
A good starting point is Profit Pool Analysis and Michael Porter’s 5 Forces Framework. Profit Pool Analysis is a technique for analyzing the total profits earned at all points along the value chain or network of an industry providing a meaningful product or service for a customer. This is useful for analyzing the overall industry but also the categories and individual firms within an industry.
Growth and Decline of the PC Era
In this PC era example (below), the Wintel monopoly of CPUs and OS had the highest margen and were scalable businesses. Most other players such Memory Chips, Mother Boards, Software and Services experienced fast growth but were eventually commoditized and could easily be substituted. As PC adoptions have plateaued, both Intel and Microsoft were joined by the successful PC builder Dell, and branched into Business Servers. All in turn, have been disrupted by the cloud. Currently “niche” player Apple owns 50% of the PC hardware profits.
How to Build a Profit Pool Analysis?
The concept of Profit Pool is repeated across many industries. For example, if we look at US Telco market we need to include Wireless, Cable+Broadband, Device, Content + Aggregators, E-commerce, Streaming & Infrastructure. To build the profit pool analysis for US Telco we usually take the top 5 companies and sum the rest (the long tail for each category) into a 6th player. We simplified this model to include all company revenue. Then we look for momentum changes, YOY Growth in Revenue, EBIT and Enterprise Value (the size of the circle).
Delving further into US Telco allows us evaluate the ultimate category killer the mobile phone. Recently, Clay Christensen concluded “Android devices are killing Apple now [with] about 80 percent of the market.” But Fortune says the iPhone “took home 93 percent plus of mobile-phone profits” in 2014 and Forbes says Apple earned “about 60 percent of all smartphone profits” globally in 2013. Since an Ecosystem can have only one Alpha male known as “the Gorilla”, it is all important to understand which brand owns the customer; in this case Verizon or Apple, and which has greater “stickiness” for generating EBIT going forward.
As part of our Strategy Science Toolkit, we start by looking at Enterprise Value and Competitive Advantage Period to see who has greater momentum for driving the Ecosystem moving forward.
Competitive Advantage Period is a measure of how long returns above the cost of capital will be earned. CAP is also known as “value growth duration” or “T” in the economic literature and is also similar in concept to Credit Suisse “fade rate” or CFROI. http://biq.com.mx/credit-swiss-holt-fade/ Apple has higher ROIC, increasing investment levels and improving NOPAT. In a highly leveraged deal, Verizon bought out Vodaphone’s share of the US business, lowering WACC, but tripling profits. However Apple’s CAP has increased to 21.55 years while Verizon’s has been reduced to 3.77 years, mainly due to competitive pricing pressure.
Tying It All Together
What ties Ecosystem, Profit Pool and CAP together, are the network effects of technology for increasing market potential; Moore’s concept of crossing the chasm and attacking adjacent markets, or Christensen’s Innovation Dilemma reducing an incumbent competitive advantage and disrupting an existing ecosystem with a lower cost structure. Both change the underlying CAP premise. Finally if we go back to our mobile example, after a brief sharing of power, cerca Jan 2013, the street says there is more upside to growing Apple’s Device base vs. Verizon’s mobile customers.
So what is this important for you?
- Generally speaking, higher ROIC businesses within an industry are the best positioned competitively (reflecting scale economies, entry barriers and management execution). As a result, it is often costlier and/or more time consuming for competitors to wrest competitive advantage away from high-return companies. In Telco, Apple bests all and clearly drives the ecosystem ahead of Verizon.
- Second is the rate of industry change; Innovation + Deregulation + Regulation. High returns in a rapidly changing sector (e.g., Software) are unlikely to be valued as generously as high returns in a more prosaic industry (e.g., Beverages). Regulation such as Net Neutrality (USA) , breaking up encumbant Telco Monopolies (Mex) and directed taxation such as IEPS (Mex), all effect NOPAT and CAP.
- The final driver is barriers to entry. High barriers to entry— or in some businesses, “lock-in” and increasing return— are central to increasing the CAP and the sustainability of high returns on invested capital. Think Intel in PC CPUs.
Since I covered the future of Financial Services in our Christmas Edition http://biq.com.mx/cuento-de-navidad/, so lets take the example of the Automotive Industry, recently baptised by a GM Exec I met at the San Fran, Digital Innovation Summit, as “Personal Transportation”. Watch this space.