Category Archives: Q4 2015

Earnings, Payments, Q4 2015, Square

Solid Progress at Square

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Square (finally) reported its Q4 2015 results today, and they demonstrate solid progress on the key things that matter. For a very quick primer on the keys to Square’s long-term success, see the video embedded below. For more detailed earlier analysis, see this piece and this piece.


Here’s an update on some key areas where Square is making progress. As a reminder, the core transaction processing business has pretty much fixed margins – Square takes a roughly 3% cut of transaction value, and keeps around a third of that (or 1%) as gross profit:
Square fixed marginsSo, no matter how much Square grows this side of its business, its margins are capped according to standard payment industry rates. However, Square isn’t just sticking to this business, but instead seeks to build an ecosystem around it through software and data products, so far mostly Square Capital (loans to Square payments customers) and Caviar (restaurant services). That business is very highly profitable because it has few incremental costs, and has been growing rapidly:Square margins by segmentSquare software and data growthAnother positive indicator this quarter was the fact that Square’s renegotiated contract with Starbucks, which was previously a heavy loss maker, broke even in Q4. This deal, which was originally done to drive scale for Square, has always been a drag on the business, but now promises to be much less of one:Starbucks gross marginThat also now means that Square’s three smaller reporting segments are collectively profitable on a gross margin level too:Square three smaller segmentsTo be sure, Square is still loss making overall by every measure but gross margin, but projects to be Adjusted EBITDA positive in 2016 and to start generating margins sometime beyond that. This quarter’s results suggest it’s very much on track for that goal, although it’s still a long way off.

China, Earnings, Emerging markets, India, Lenovo, Motorola, Q4 2015, Smartphones

Lenovo’s Increasingly International Smartphone Business

Note: For two previous posts on Lenovo on this blog, see here and here. See also this post I wrote for Techpinions a while back. The charts in this post are based on the slide deck on Lenovo’s results available as part of the Jackdaw Research Quarterly Decks Service, which also provides decks for other major consumer technology companies each quarter. Note also that in this and other posts on this blog, I use calendar quarters rather than companies’ fiscal quarters in my discussion and in charts, for ease of comparisons and ease of comprehension for readers not familiar with the quirks of companies’ fiscal calendars.

Lenovo reported its results for the December quarter (its fiscal third quarter) this week, and these results came a year after Lenovo’s strongest quarter by far, in 2014. By comparison to those, this quarter’s results were poor, but they’re actually quite encouraging in the context of the first three quarters of 2015, which showed worsening trends in several areas. Today, though, I wanted to focus specifically on Lenovo’s smartphone business, and its increasingly international character.

The impact of Motorola

First up, it’s important to note the significant impact of Motorola here, something I wrote about a year ago today. The acquisition closed in October 2014, and so the addition of Motorola’s results had a noticeable effect on the company’s overall performance, especially in smartphones. Prior to the Motorola acquisition, Lenovo was selling 2-3 million smartphones outside of China, but afterwards, it was suddenly selling 10-15 million, which obviously had a huge impact.

The rapid decline of Lenovo’s Chinese smartphone business

The subject of another post I wrote a few months ago was the rapid decline of Lenovo’s smartphone business in China, and the way in which the Motorola acquisition was helping to prop up overall sales. Two reported quarters later, and the trend is all the more dramatic. Here’s Lenovo’s smartphone sales in China over the past couple of years:Lenovo China smartphone shipmentsAs you can see, smartphone shipments in China peaked right before the Motorola acquisition closed, and have declined steadily since. I discussed the reasons why in that earlier post, so I won’t rehash them here.

Growth elsewhere, especially in emerging markets

At the same time, however, both the Motorola and Lenovo brands have begun selling much better in certain other regions. Lenovo doesn’t provide a consistent or full breakout of smartphone sales by country or region, but it has provided some breakouts for the last three quarters in its earnings slides, and that gives us enough data to interpolate other numbers. On that basis, then, here are some numbers for smartphone shipments in other countries and regions (note that these are not necessarily mutually exclusive, as Brazil is included in Latin America and Russia is included in Eastern Europe):Lenovo country and regional smartphone shipmentsThere are a couple of things worth noting here:

  • Smartphone sales in Brazil (light gray) were very healthy early in the period, thanks largely to the success of Motorola’s lower-cost smartphones in that market. However, that seems to have faded significantly over the past year or so, with sales in Brazil falling over that time. Latin America is still a significant region, but its numbers dropped along with Brazil’s over the past year.
  • Russia has become increasingly important to Lenovo, and it’s the Lenovo brand that’s used there. It sold over a million smartphones in the December quarter in Russia alone. The Lenovo brand has also done well in Indonesia over recent months, though we don’t have the same amount of historical data for that country, so it’s not included in the chart. But it sold 764,000 smartphones there in Q4 2015, compared with just 183,000 in Q4 2014.
  • India has arguably been the star of the past year or so, rising from under a million sales in Q4 2014 to almost three million in Q4 2015. Lenovo now claims 9.6% market share in India, and interestingly this growth has come through both the Motorola and Lenovo brands.

Perhaps the most significant thing to note is that both Latin America and EMEA passed China in terms of smartphone sales in Q4 2015 for the first time. And India, at just shy of 3 million sales, was only about 10% behind China, meaning that if current trends continue (rapid decline in China, rapid growth in India), India could well become Lenovo’s single largest country for smartphone sales in 2016. Lenovo’s smartphone business has been radically transformed over the last year or so, from one dominated by China to one where China accounts for less than 20% of sales.

The big question now is whether these other new markets will experience sustained growth for Lenovo, or whether they’ll be flashes in the pan as Brazil appears to have been. In Brazil, local economic conditions have likely had an impact, but economic instability is a feature of many of the markets where Lenovo is doing well now, so it will have to demonstrate consistent improvements over time if it’s to continue to grow as it has in these markets.

Better margins

In that earlier post on the impact of Motorola, I pointed out that for all that Motorola was benefiting Lenovo’s smartphone growth, it was also dragging down margins. Lenovo has long promised to turn that trend around, and this quarter it came very close to breakeven in its mobile group for the first time in two years.Lenovo margins by businessThat’s an impressive turnaround, and a sign that – for all Lenovo’s challenges in China – it’s able to exercise enough financial discipline and generate enough scale to build a successful and eventually profitable smartphone business. Given the state of Android smartphone vendors at the moment, that’s quite an achievement.

Alphabet, Earnings, Google, Other Bets, Q4 2015

Breaking down Alphabet’s Other Bets

Alphabet (formerly Google) just reported its first results under its new operating structure, which means that it separated out its “Other Bets” from core Google results, at least for the last five quarters and the last three full years (I wish the company had provided more quarterly results – year on year growth and similar trends are hard to divine with so little data). I’ve just finished putting together my quarterly deck on Alphabet for subscribers (sign up here), and I thought I’d break out some of the charts on the Other Bets specifically for blog readers. Most of these charts (and many others on the rest of Alphabet’s business) are in the deck.

Revenues

The first thing to talk about is revenues – Other Bets revenue is tiny in the context of Alphabet’s overall results. I had to adjust the scale of the chart below to start at 90% just so it would be visible (and it’s still just a tiny stripe at the top of each bar):Alphabet revenue breakdownOther Bets revenue is under 1% each quarter and each year so far, and it was well under 0.1% of revenues for the year 2013. It’s growing, albeit unpredictably – as CFO Ruth Porat mentioned on the earnings call, these Other Bets are inherently volatile, and so revenues are best looked at on a twelve-month basis. Revenue for 2015 as a whole was just $448 million.

To put that in context, the three biggest revenue generating businesses in the Other Bets segment are Nest, Google Fiber, and Verily (the life sciences business). That likely puts Nest revenues at under $300 million for the year, Google Fiber at $100-150 million, and Verily at some smaller amount still. Given that these are only three of the businesses under Other Bets, that means everything else generates minimal or no revenue. Interestingly, these likely aren’t the three businesses with the biggest expenses, but we’ll come to that in a minute.

Profitability

Next, let’s look at profitability. Whereas Other Bets revenue basically doesn’t show up on a to-scale chart of Alphabet revenues, its operating losses certainly do:Alphabet segment incomeAs you can see, operating losses were very significant in the Other Bets segment. The segment lost $1.2 billion in Q4 2015 alone, and three times that much in 2015 as a whole. For context, sometime in 2005 or 2006, that was about as much operating income as the whole of Google was throwing off over a comparable period. It’s about 15% the scale of the core Google segment’s operating profit today, but negative. And it appears to be growing fairly rapidly, since this loss almost doubled year on year while revenues only grew by 37%.

To compare Google’s segment margin with the margin for Other Bets, I had to use a two-axis chart, because the contrast is pretty stark (Google’s operating margin is shown in blue against the left axis, while Other Bets is dark gray and on the right axis).
Alphabet segment margin

Expenses

What, then, is driving these huge losses? Sadly, Google doesn’t break out R&D spending by segment, but I would assume a great deal of the costs in this part of the business would be accounted for under that line in the income statement. The chart below shows Other Bets segment losses and total expenses (i.e. losses plus revenues) as a percentage of Alphabet’s total R&D, as an interesting exercise:Other Bets as percent of RandDDepending on which measure you use, Other Bets expenses were equivalent to between a quarter and 40% of Alphabet’s total R&D spend in 2015. That’s not to say that they actually accounted for that much of R&D spend – given that Nest and Fiber likely have substantial costs in non-R&D buckets, it’s likely less than that. But given how much of Other Bets’ total expense is likely in non-revenue-generating efforts like self-driving cars, I’d bet a lot of that expense is R&D.

Capital spending

Another interesting way to look at all this is capital spending, which Alphabet does break out for the new segments. On the earnings call, Ruth Porat said the majority of Other Bets capex goes to Google Fiber. How much does Other Bets spend on capex?Alphabet segment capital spendingAs you can see, unlike revenue, capital spending by Other Bets is visible in the context of overall company spending – again, Other Bets punches above its weight in this category. For further context, look at capital intensity (capex/revenues) below: Alphabet segment capital intensityGoogle’s capital intensity is shown on the left in this chart, and as you can see it’s been falling steadily over the last year or so, landing at under 10% in Q4. By contrast, Other Bets’ capital spending has been over 100% (i.e. it spends more on capital expenses than it generates in revenue) for all five reported quarters. If we take the bare minimum estimate of capex spent on Google Fiber (i.e. 50% of total capex), that still means that it spent $435 million on capex in 2015 while generating $100-150 million in revenue.

Trajectory

We’ve taken a look at several aspects of Alphabet’s Other Bets segment, but we’ve only touched on perhaps the most important element: trajectory. In other words, which direction are these numbers heading in? In brief, using Ruth Porat’s suggestion to look at annual results:

  • Revenue is growing, at about 37% year on year from 2014 to 2015
  • Operating losses are growing faster, from $1.9 billion in 2014 to $3.6 billion in 2015
  • Margins are worsening too, from (and these numbers are a bit ridiculous) -488% in 2014 to -685% in 2015
  • Capex is growing faster than revenues on an annual basis, and capital intensity rose from 150% in 2014 to almost 200% in 2015.

None of those is moving in a happy direction as far as the future financial performance of Alphabet is concerned. There is some evidence that Porat’s arrival precipitated some tougher decision making regarding the Other Bets and that some of these numbers began to improve in late 2015, but it’s too early to tell how much of the apparent improvement is real and how much is the volatility she talked about. What is clear is that Google is spending massive amounts on these efforts, and generating very little revenue today. The prospects for Nest and Fiber as revenue generators and profitable businesses are not great, especially given that massive capital expenditure, so it will be the other businesses that will need to justify this investment. My bet (no pun intended) is that we’ll see increasing pressure for Google to provide more detail on what’s going on behind these numbers, and to have more to show for this massive investment, over the coming year.

Apple, Earnings, iPhone, Q4 2015

The iPhone Paradox

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For reference, this page lists all prior Apple posts, with a little context. Subscribers to the Jackdaw Research Quarterly Decks Service will be getting a preliminary Apple deck tomorrow, with a final deck to follow once Apple files its 10-Q. 

This is a post I’ve been meaning to write for a while now, but it seems particularly apt given Apple’s results announced today. My key point is this: even as Apple continues to diversify its revenue streams beyond the iPhone, the size of the installed base of iPhones becomes ever more important to its revenue growth.

The context here is that I’ve been talking to lots of reporters over recent weeks in the run-up to Apple’s earnings, and I’ve heard this question (or variations on the theme) a lot: “is Apple’s increasing dependence on the iPhone a problem?” The reason for the question is twofold: on the one hand, Apple’s revenues and margins have been increasingly dominated by the iPhone, and on the other it’s become increasingly clear that iPhone growth would slow following its stellar year off the back of the iPhone 6.

My answer usually goes something like this, and this gets to the heart of the paradox here. On the one hand, yes, Apple has been increasingly dependent on the iPhone for revenue and margin growth, but it’s been working hard to introduce new products and services to the market which can help to contribute meaningfully to growth and profitability. The Apple Watch, Apple TV, Apple Music, and iPad Pro were all introduced in 2015, and could over time provide significant additional revenue and margin. So Apple has the potential to lessen its dependence on the iPhone over time in this way.

However, the other side of the paradox is that almost all of these new products and services are tied to the iPhone in some way, and benefit greatly from the installed base of a half billion iPhone users. The iPad Pro has the weakest tie here, but obviously benefits from its use of iOS and the App Store, and with features like Handoff and iCloud works better with the iPhone than it does independently. The rest have much closer ties to the iPhone: the Apple Watch is (for today at least) strictly an iPhone accessory, the new Apple TV runs apps, most of which were originally developed for the iPhone, Apple Music will be used on iPhones far more than on any other devices, and so on. Even if iPhone growth slows or goes negative (as it will now certainly do in the March quarter), that massive base of iPhone users will keep many other contributors to Apple’s financial success ticking over nicely.

Interestingly, Apple seems to have latched on to this idea as a key talking point for its earnings today, with an emphasis on Services revenue tied to the overall installed base of devices, which it pegs at 1 billion users. (My estimate for the end of December for iOS devices plus Macs was 996 million, so adding in Apple Watch and Apple TV should certainly push it over that billion user threshold). This base of devices, and the rather smaller number of unique users it represents, is Apple’s single greatest asset, and one it will increasingly leverage both as it continues to grow the product and service lines it announced in 2015 and as it adds to them going forward. As such, even as the iPhone itself as a product contributes less to Apple’s overall performance, it’s going to become ever more central to Apple’s future growth.