Alphabet: Challenges Ahead For Android?

| About: Alphabet Inc. (GOOG)

Summary

OEMs pursuit of proprietary mobile OS could be a long-term risk to the Android ecosystem.

Samsung's Tizen has been less successful but continues to scale in various pockets. Huawei could be a long-term risk to Android.

Remain bullish on GOOG in the near-term as I'm positive on the Other Bets. Cautious in the long-term on Android's ecosystem.

Media reported that Huawei is looking to develop its own OS to offset its reliance on Google (NASDAQ:GOOG) (NASDAQ:GOOGL). Given that Huawei is becoming one of the largest smartphone makers in the world with roughly 10% of the global market share, it makes sense for Huawei to develop its own OS to lessen the risk associated with being overly reliant on Android. If Huawei decides to develop its own OS, it would be the second company after Samsung (OTC:SSNLF) to consider developing a proprietary OS. I do not see near-term downside on the Android ecosystem because neither Samsung nor Huawei have successfully created an app ecosystem that support their OS but GOOG investors cannot underestimate the long-term risk to Android when both Samsung and Huawei together which accounts for 30% of the global market share migrate away from Android.

Such a scenario could potentially destabilize the entire Android ecosystem, creating a domino effect where other large-scale OEMs have broad geographic footprints, large product portfolios and negotiation power on app developers to pursue their own mobile OS. This will certainly negatively impact GOOG's ability to sell advertising to current handsets that run on Android and further reinforces my view that GOOG needs to scale its Other Bets divisions such as driverless cars, broadband, wireless services and home automation to offset the risk to its core search business (see - Alphabet: Google Fiber Will Eat AT&T And Verizon's lunch).

Between Samsung and Huawei, I believe that Samung poses the biggest risk to the Android ecosystem and has the strongest negotiation power over the app developers but Huawei remains a risk in the long term because Huawei has been growing at a much faster pace than Samsung with shipments growth of +59% as recently as Q1 vs. Samsung which has been flat. That said, I continue to like GOOG due to its focus on developing its moonshot projects but I would be cautious on the company's long-term prospects.

In a highly commoditized smartphone market, hardware OEMs faces the prospect of lower pricing power, higher competition and lower buyer power over the mobile OS. Although Android is largely free to OEMs, overly reliant on GOOG is the single biggest risk to the handset OEMs so it is natural to move up the value chain by creating a proprietary OS. Samsung's backing of the Tizen OS was an early sign that a hardware company is making that transition. Tizen is a Linux-based open source operating system that was created from the merger of several Linux-based systems including LiMO (Samsung/Linux), MeeGo (Nokia/Intel) and Bada (Samsung's prior mobile OS). Tizen differentiates from Android and iOS because it is highly scalability, developer-friendly and has high cross-platform flexibility in that it can be applied to a wide range of connected devices such as smartphone, tablets, laptops/netbooks, vehicle infotainment systems, smart TVs and home appliances. The cross-platform flexibility is a key selling point as Tizen uses HTML5 so developers can maintain a single codebase and perform minimal modification when applied to a different platform.

Tizen supports web applications such as HTML, Javascript and CSS and provide a wide range of services, including app services, content, location, messaging, multimedia, network social and system services. The platform also can sustain extreme performance thresholds with minimum memory requirement which is ideal for mobile devices such as smartphones and tablets. Currently, Tizen can be developed across a variety of Samsung-branded products such as phones, tablets and smart home appliances but the only bottleneck is the availability of the apps. Unless Samsung can persuade the Android and the iOS app developers create apps for a third OS, the current status quo is unlikely to change. However, I believe that if Samsung were to partner with another large OEM such as Huawei or Lenovo, then the app developers will likely consider the additional ecosystem.

Samsung'a and Huawei's decision to work on their mobile OS also serves a secondary purpose in that they could venture into GOOG's territory of generating recurring revenue streams post device sales. GOOG and Apple (NASDAQ:AAPL) benefit from targeted ads, location-based-services video content and app sales. I note that Samsung, along with other OEMs, have been at a severe disadvantage in the Google partnership in that the OEMs had minimal success in attracting users to its own mobile content and services while Google benefited from its search bars, app store and mobile services on Samsung's Galaxy devices. With a successful mobile OS, both Samsung and Huawei could generate recurring and high margin revenue from app stores and other mobile services.

Although Samsung's Tizen and Huawei's proprietary mobile OS are still in their early stages of development, we could see an escalation of ecosystem battles among the established OEMs going forward, led by Samsung and a handful of Chinese OEMs. As a sign of OEM's commitment to this issue, Huawei hired Abigail Brody from Apple last year in a clear attempt to improve its product design and interface. Besides AAPL, Huawei has made senior hires from BlackBerry (NASDAQ:BBRY) and Nokia (NYSE:NOK) to beef up its mobile OS features so a competing ecosystem is certainly in the making and could potentially disrupt GOOG's current Android dominance in the long run.

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