March 16, 2014

The annual Mobile World Congress – a massively-scaled, annual conference aimed at all those involved in mobile communications (which is now essentially most of the technology, media and telecom complex) – recently wrapped up in Barcelona.

Three presentations by CEOs – by Mr Mark Zuckerberg of Facebook, Ms Virginia Rometty of IBM and Mr Hans Vesterberg of Ericsson – underscored some certain strategic themes of relevance to both corporations as well as investors in private equity and public securities in (to deploy and overused term) the TMT ecosystem. Of the three speeches, that if IBM’s CEO merited particular attention.

Facebook – Multiple Voting Shares, “It’s Worth $19 billion?” and M&A Strategy

Facebook’s founder and CEO Mr Zuckerberg gave a sort of informal fireside chat (if two armcahirs on a stage in front of a packed auditorium constitutes the digial equivalent of an informal fireside). He arrived shortly after Facebook announced its $19 billion acquisition of instant messaging leader Whatsapp (purchased, if numbers in Forbes magazine are to be believed, at an eye-popping valuation of an estimated 47.5x 2014 sales.)

He was asked rather pointedly how his board had come to approve this eye-watering valuation. His answer was divided into two parts: intrinsic worth and strategy. He noted that the principal driving force was a drive to see everyone on the planet connected to the internet (and presumably to Facebook shortly thereafter): a goal only 1/3 complete. Cost, he announced, was the barrier, noting that in the US one can buy ann iPhone for $500 and then spend $1500 operating it for two years. (Perhaps it was fortunate he did not provide Canadian wireless pricing points…) Therefore a priority is to orient Facebook’s M&A and its partnering strategy towards driving the cost of basic services – such as the messaging services provided by WhatsApp – down in price to the point where they can be ubiquitous. He pointed out that WhatsApp had 500 million users (70% of whom deploy it daily) and that this was en route to 1 billion.

As for intrinsic worth Mr Zuckerberg suggested that some rival messaging applications are generating $2 or more of revenue per user, implying WhatsApp could be aiming towards $2+ billion of revenue and the generation of significant free cash flow. This is impressive for a company with 55 employees but, as Blackberry and its BBM service have shown, usage does not in and of itself create a competitive moat.

Mr Zuckerberge implied his board’s acceptance of the latter analysis, and explicitly stated that they shared this goal of connecting the world to the internet, hence their support for the transaction.

Left unsaid was the fact that Mr Zuckerberg controls Facebook through multiple voting shares and that, in accepting this at the time of the IPO, his equity providers endowed him with the equivalent of his own personal electronic currency.

When armed with multiple voting shares and compliant boards, some of the CEOs of these firms can undertake “leap of faith” type M&A. Whilst $19 billion is a little over a tenth of Facebook’s market capitalisation, $19 billion dollars is still, by any definition, real money. Facebook may seek to continue to build defenses around its core business, and to expand the breadth and depth of customer relationships, but this does not always mean that any acquisition (especially $19 billion ones) are based on viable financial assumptions. Investors, in particular, ought to be aware of the nexus of multiple voting shares and what can be termed “damn the torpedoes” M&A strategy.

IBM – A Strategic View Applicable To Almost Every Industry

IBM’s CEO Virginia (Ginny) Rometty eschewed the studied informality of armchairs and gave a crisply articulate speech summarising the how corporate strategy – in any industry – was intersecting with the use of data and the cloud.

Ms Rometty represents several firsts. An electrical engineer by training, she is not the typical IBM CEO armed with a background largely in sales. She rose through the ranks before leading various products and services business. It would appear that she was tapped to run global sales only when she became a CEO contender. Since grasping the reins two years ago she has reinforced the company’s services focus, unsentimentally selling off traditional hardware units that had formed part of the core of the old IBM (an example of such a unit is the server business recently sold to Lenovo).

She began broadly, identifying three themes that are reshaping the business landscape.

The first was “Data as a natural resource”. Ms Rometty pointed out that 2.5 billion gigabytes of data were created every day, and that 80% of the world’s data had been created over the past twenty years. (She failed to question how much of this data is actually rubbish…) Given this, she felt it inescapable that data (“big data”) is becoming the basis for successfully separating corporate winners from losers. IBM has invested $24 billion in 30 acquisitions aimed squarely at this space. (Interestingly, IBM has roughly the same market capitalisation as Facebook.)

Her first POINT in the world of data was that “predictive analytics”, especially on unstructured data (the world that Hadoop and semantic RDF databases are beginning to change so profoundly) will soon move to “prescriptive analytics”: the ability to change prediction and data-driven directionality based on new information (much akin to GPS changing a route on a satellite navigation based on a change in traffic conditions). Her second theme was that analytics would need to be married to an ability to exploit the time value of data. IBM’s work suggests that companies deploying analytics and responding to data in real time are vastly more successful in their industries and 2.5x more likely to be able to successfully introduce new products. Data is driving an underlying shift in the basis for competitive advantage.

Her second theme took the over-used term “cloud” and clarified it and made it relevant to every industry. Cloud she defined – or perhaps redefined – as being any process or business service offered “as a service” (or aaS in techno-acronym speak). This differs from standalone software or processes run on in-house machines. Ms Rometty noted that by 2016 fully ¼ of applications will be run in the cloud and, even more strikingly, that 80% of all software developed today is for the cloud.

Her development of the theme was interesting in that she identified the cloud as a business process choice rather than a technology choice. Many corporations will choose to focus on offering a product, allowing for flexible choices regarding infrastructure. The infrastructure most likely to be deployed will depend on hybrid cloud architectures – some private cloud as well as some public cloud for business areas where speed and customer engagement are key (this is one reason why IBM invested $1.2 billion to boost the number of global cloud data centres from 25 to 40). Data management and data security will be key, as will understanding of (and respect for) the varying national regimes around data privacy. The result will be what she termed the “API economy” (an API being an ‘application programming interface’ – a means of taking services or modules and scripting them together to form new services and applications). IBM now generates $4 billion in cloud revenues.

Her final theme related to Engagement: the process by which a corporation understands its customers. Modern culture, she argued, was not defined by age but rather by empowerment through knowledge. With fully 50% of consumer purchasing decisions influenced by online research it becomes imperative to understand how best to interact with people. Customers now reach out to companies via social media, and expect a response within minutes. Customers will also increasingly trade off information for something of value (for example their GPS location in exchange for relevant and helpful information regarding, say, cinema schedules). In this context security and trust will be key issues; $1 trillion of additional online retail transactions hang in the balance around doing this correctly. These issues of trust and security apply equally in the mobile and landline worlds, which are, in fact blurring.

In sum, the new world characterised by widespread access to mobility, analytics, cloud-based “as a service” and trust-based engagement will put a premium on corporate cultures that have an iterative style. In a nod to the audience, she said that the DevOps-style of technology companies would become widespread.

Ericsson – In An Era Of Open Source, Stay Close To Your Customers

CEO Hans Vesterberg gave a lively presentation that very much conformed to the at-times splashy, consumerist tone of WMC (he bounced an internet-connected basketball to prove a point, for example). He spoke about the opportunity – and accelerating pace of change – in moving from 500 million mobile broadband connections in 2010 to 2.1 billion today and 8 billion in 2019.

He was rather more oblique about the significant challenge, indeed threat, facing communications equipment firms as a result of software defined networking based around more open standards.

To date communications network designs have relied on proprietary hardware and software design, generally from one vendor or a handful of suppliers. Habitually, once a client was signed it was – to a considerable degree – locked into that communications equipment provider for expansion and upgrades, generally providing the vendor with something approaching a dependable base of business for several years.

In contrast, software defined networking abstracts much of the value layer from the hardware – which to an extent becomes more of a standard commodity product – and moves it into a ubiquitous software environment controlling virtualised hardware. By removing the rigidities imposed by hardware, services can be delivered faster and at lower cost. In so doing it removes the competitive moat that hardware design accorded to vendors.

AT&T, a rather significant Ericsson customer, threw a bombshell at the conference when it announced a move to software defined networking. AT&T, which has a capital expenditure budget of $21 billion per annum, plans to roll out this initiative over a period of five years: advance warning to suppliers, certainly, but a worrying trend all the same. AT&T named four vendors as being core to the programme: Ericsson as well as three much less well-known firms (Affirmed Networks, Metaswitch Networks and Tail-F Systems).

Versterberg ‘s oblique approach to addressing this was to invite the CTO of AT&T to describe Ericsson as a great firm to work with. He also invited a senior executive from Singapore Telecom to praise Ericsson’s collaboration. Both essentially argued that Ericsson was a good partner and that they looked to equipment vendors to provide more than infrastructure. Instead they ought become part of the “innovation team” (to quote M Allen Lew of SingTel); helping provide not only the infrastructure but also help capture customer insights.

If other carriers adopt the approach of AT&T then equipment vendors will increasingly see a core area of competitive advantage (hardware and being designed into a network) eroded even as they must develop new skills in partnering with carriers on the services and analytics side. Whether the remaining traditional hardware vendors (Alcatel Lucent, Ericsson, Nokia Siemens) will find that this allows them to regain the upper hand over new entrants (such as Huawei) that deployed price cutting and low-cost vendor financing to win share remains to be seen.