OECD Tax Reforms: The Double Irish with a Dutch Sandwich is off the menu

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The Organisation for Economic Cooperation and Development, the leading research body for economic coordination funded by 34 countries, recently unveiled its Base Erosion and Profit Shifting (‘BEPS’) plan aimed at reducing international tax avoidance.

Background

It is estimated that between $100-240bn in tax revenue is lost due to multinational companies with complex corporate structures utilising aggressive tax planning strategies such as the ‘Double Irish with a Dutch Sandwich’ (the ‘Sandwich’) – this particular technique involves a combination of Irish and Dutch subsidiaries with prorits shifting from one Irish company to a Dutch company before moving profits to a second Irish company headquartered in a tax haven. As well as Starbucks, users of this method include major tech companies such as Adobe Systems, Amazon, Apple, Facebook, Google, IBM, Microsoft, Oracle and Yahoo!.

Particularly focusing on multinational tech giants, what has reduced tax revenues is the fact that tax legislation has not kept up to date with the globalisation of business. As stated by Pascal Saint-Amands, the director of the OECD’s Centre for Tax Policy and Administration, in an interview with the BBC:

“We have moved from a world where we were so good at eliminating double taxation with tax treaties and transfer pricing rules that we have facilitated double non-taxation. You have rules – they are bilateral, but businesses are global. And of course they can play on the differences between the sovereignties…” [1]

This is echoed by BEPS which claims that international tax avoidance is due to ‘domestic laws and rules which are not co-ordinated across borders, international standards which have not always kept pace with the changing global business environment and an endemic and worrying lack of date and information.’

As a result of international taxation not keeping up with globalisation, large multinational companies were able to take advantage. For example, in 2012, Starbucks was discovered to have only paid £8.6m in corporation tax in the UK over 14 years despite generating £3bn in UK sales[2]. It was also reported that, in 2011, Amazon incurred a ‘tax expense’ of £1.8m after sales totalling £3.35bn and that Google paid £6m in corporation tax on a turnover of £395m[3].

Although aggressive tax planning is legal, Saint-Amans says that these companies were ‘pushing the boundaries of what was legal’. Hence, with the recession still fresh in public minds, international resentment resulted in the G20 (the 20 major economies) requesting the OECD to develop a plan to curtail tax avoidance in 2013.

The Future

BEPS will need to be approved by G20 finance ministers on 8th October before a vote on adoption in November. Although the level of change that the plan will institute is unclear, the Dutch Sandwich will be abolished and will go some way to unlocking the $2.1tn that the Fortune 500 currently has stored in tax havens. This was confirmed by Saint-Amands: “The problem we had is that you could easily shift risk or capital without any risk… You could have a cash box in a tax haven where there is nobody. This is over.” Moreover, perhaps in anticipation of BEPS, Ireland’s 2015 budget announced that the Double Irish will be fully eradicated by 2020. The Sandwich is therefore off the menu.

Due to the two stages of approval before adoption of BEPS, lobbyists will make their voice heard. This will be especially acute in the US where Congressional Republicans have criticised the OECD for providing other countries the potential to increase taxes on American companies. Moreover, lobby groups that represent Amazon, Apple, eBay, Google Facebook, IBM, Intel, Microsoft, Netflix, Uber and Yahoo! have already argued that the OECD’s plans are flawed. With the world’s largest tech companies criticising them, the OECD will be sure to feel the pressure in October and November.

Because of the risks of multiple taxation and reduction in cross-border investment, it is important to ensure that international taxation will be balanced. It is currently unclear who will have the right to tax these multinationals, but it is near certain that, due to the amount of money involved, there will be increased international tax disputes between regulators and businesses. There are also concerns regarding how new rules can be reconciled with national legislation. For example, although the UK’s recently introduced diverted profit tax (also known as the ‘Google tax’) does seem to be somewhat in line with BEPS, Saint-Amans said that the UK’s measures would have to be ‘coordinated’ with the OECD’s proposals – what this really means is uncertain.

Conclusion

There is some expectation that BEPS will be a significant departure from the loopholes afforded by out of touch policy. H. David Rosenbloom expects that it will be ‘the most important development in international tax in quite a few decades.’[4] However, due to the importance of foreign investment, will governments be genuinely committed to reducing international tax avoidance? Tax Research UK’s Richard Murphy is pessimistic and claims that ‘[a]nyone who thinks that this will solve the problem with international tax is living in cloud cuckoo land.’[5]

With so much opposition to the plan, it is fair to say that international businesses are worried. Calls for increased tax transparency have certainly increased within the past few years, but BEPS’s effectiveness will not be revealed until multinationals’ tax expenses can be reviewed.

 

[1] http://www.bbc.co.uk/news/business-32730305

[2] http://www.thetimes.co.uk/tto/money/tax/article3570128.ece

[3] http://www.bbc.co.uk/news/magazine-20560359

[4] http://www.bloomberg.com/news/articles/2015-10-05/google-to-apple-could-see-tax-loopholes-curbed-in-oecd-proposal

[5] http://www.bbc.co.uk/news/business-34445078

 

Starting Up a Start Up – “Show Me the Money”

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Starting up a Start Up – “Show Me the Money”

Start ups are a big deal. Their ability to disrupt traditional modes of business have attracted sky-high valuations and the recent news is that Airbnb is in the process of a $900m-1bn funding round which values the private company at $24bn, and Uber is currently in a $1.5-2bn round which values the ride-sharing service at an eye-watering $50bn. To put these figures into context, Airbnb now has a higher valuation than international hotel chain Mariott International ($20.46bn) and Uber’s new valuation takes the company higher than 406 public companies on the S&P 500.

But before a start up can become a unicorn (a company with a valuation of at least $1bn) and reach such dizzying valuations through ‘Private IPOs’, a start up needs to first start up. There are two main financing options for a fledgling company: debt finance by way of a bank loan and equity finance via venture capital (‘VC’) investment. There is also a hybrid method of financing known as convertible debt. Which of these is more suitable?

Option 1: Bank Loan/Debt Finance

A bank loan is the provision of money from a bank in exchange for regular repayments plus interest. There is no dilution of equity so existing shareholders’ control of the company will not be affected, but the youthfulness of the company will prove problematic.

The lack of a financial history means that the bank will impose onerous obligations on the company to ensure repayment. The company is likely to be a high credit risk so the loan will be secured on the start up’s assets, such as any physical property, intellectual property rights, contracts etc. This security will grant the bank priority in the event of the borrower’s insolvency by allowing it to enforce its security over these assets so as to settle the outstanding debt. This security causes administrative problems because any dealing/disposal of these assets would require the bank’s consent. A start up requires agility and freedom, but a bank’s security would introduce a layer of bureaucracy within the company that would previously have had a fluid operational system.

Note also that, since the company is so young and is not seen as having a stable foundation, banks often require the start up’s founders (often also the directors) to guarantee the debt. They will therefore become personally liable if the company defaults. This is obviously very risky for the individuals guaranteeing the loan due to the substantial personal liabilities that can be incurred, so personal guarantees must be taken into account when considering debt finance.

As another result of the company’s credit risk, the bank will require repayments to be made on a regular basis plus interest. This is vital to the bank because it wants to ensure the safety of its investment and maintain a regular income stream. Consequently, regardless of its profits, the start up will have to stick to its repayment schedule otherwise it risks the bank calling an event of default and accelerating its loan (requiring immediate repayment) and enforcement of the security. Bearing in mind that failure to repay already indicates the start up’s financial ill health, any steps taken by the bank in such a situation would likely break the company. It is also important to note that the threat of defaulting is likely to change the culture of the start up since early development companies are generally more concerned with their products and traction, rather than pure financial figures.

Because of these onerous impositions, a standard loan is unlikely to be suitable for a start up.

Venture Debt

This is a specialised loan aimed specifically at start up companies that have assets, an existing customer base and/or financial history. Especially popular with niche banks in Silicon Valley and growing in use, this method of finance combines the advantages of a loan and VC in that there is no dilution to shareholdings and the company will obtain expertise and connections. However, venture debt would still require the debt to be fixed to the company’s assets, possibly require personal guarantees and will require the company to make regular repayments plus interest.

Option 2: Venture Capital/Equity Finance

First utilised in what was not yet known as Silicon Valley in the late 1950s/early 1960s, VC is characterised by the provision of money in exchange for a percentage of the company’s shares on a preferred basis, rather than common stock, so as to protect the investor during insolvency.

The very first issue to overcome in relation to VC is the fact that shares will be issued. This will require the company to follow company procedure, as set out in the start up’s articles of association/constitution, and is a more complex process than obtaining a bank loan. Once shares are issued, existing shareholdings will be diluted and the Investment Agreement (the ‘Agreement’) would import controls necessary to protect the VC investment. For example, the investor would gain consent rights so that the company must seek approval for any significant decisions, and the Agreement would also grant rights to board representation and impose restrictive covenants on the company so as to reduce the risk. In addition to a restriction on the dilution of the VC firm’s shares, the Agreement would also typically include ratchet provisions that scale up the investor’s acquired equity in the event that targets are not achieved. Entrepreneurs must therefore carefully compare the terms of the Agreement against the capital being receive and make a decision on whether or not the terms are proportionate to the level of funding.

Despite these drawbacks, VC investment would present the company with a much better prospect of growth than a bank loan. The main benefit is that the start up will obtain the expertise and industry connections required to expand the company. This is why Don Valentine in the documentary ‘Something Ventured’ states that his approach to investments was “[i]s our Rolodex strong enough to help these people?” The support that a start up will receive is not offered by a bank and is a key factor that will drive the growth of the company.

Also in contrast to a bank loan is the fact that there are no repayment obligations. Although VC investors will join as shareholders and receive dividends, a regular income stream is not the priority. Instead, the aim of VC is to create a capital gain upon an exit from the company. This therefore minimizes the short term pressure that the start up will face and gives the business time to maximise success.

The Double Edged Sword of Venture Capital

Since VC is provided in exchange for shares, the risk is shared which alleviates some pressure from the pre-existing shareholders’ shoulders. The investor will therefore also have an interest in the company’s success and strive to make it as profitable as possible. However,  at Internet Week 2015, Gary Vaynerchuk perfectly summarised the double edged sword of VC:

“A VC’s playing a game of just one “unicorn” and it pays the whole game… VCs are pushing all these young entrepreneurs in the right direction because if one breaks who gives a **** if you failed on the other hundred, your [return on investment] is so intense on that one Uber, on that one Facebook, that it makes the math work… They’re managing a portfolio and so they’re giving the advice that’s best in their interest…”

The problem is therefore that, although the overall aim for both the start up and the investor is to build growth, the way in which the mission is completed can create tension between the parties. It is because of this that entrepreneurs must ‘separate advice that’s in someone else’s best interest and take the advice that’s in their best interest’, and carefully vet potential VC investors.

Another issue that needs to be considered when evaluating VC investment is the current culture of companies celebrating giving away equity in order to achieve a ‘milestone’. The start up needs to carefully evaluate whether external investment is truly needed or whether it can make a go of the venture on its own. For example, Vaynerchuk is attracted to ‘building from zero’ instead of unnecessary VC investment because it teaches you core principles of business. He states that the ‘lack of patience… will be the death to 95% of the businesses that are in play right now. Lack of patience is the vulnerability in the marketplace right now.’ These ideas, along with the notions of ‘learning to fail’ and ‘learning through failure’, perhaps sound romantic, but they do need to be taken into account when deciding whether or not to issue equity.

Option 3: Convertible Debt/Hybrid Financing 

This form of financing is a hybrid of options 1 and 2 because it starts out as a loan but converts into equity capital after a certain period of time or upon the occurrence/non-occurrence of a particular event. Obtaining convertible debt is a much cheaper and quicker process than issuing shares, but companies need to be aware that an investor will often set the term of the loan so that it expires after the next round of financing. In such a case, if the loan expires prior to further funding, the investor will require the money to be repaid or the loan will convert into equity – the former has the potential to require the business to be sold at a distressed price so as to settle the debt, and the latter will dilute shareholdings.

Conclusion

Whichever method of financing is chosen, the company needs to evaluate the impact of external investment on the business. External financing must be in the business’ best interests and it must not be obtained purely for the purposes of any internal gratification of reaching a milestone. Additionally, while VC is the most popular route, entrepreneurs need to be wary that it is a double edged sword and not get caught in the excitement of VC investment.

Twitter – AdTech or Fad-Tech?

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Twitter – AdTech or Fad-Tech?

With the recent news of Twitter’s disappointing Q1 2015 results and CEO Dick Costolo announcing his resignation, is Twitter an effective platform within adtech (the use of technology in relation to advertising) or is it just fad-tech that is nearing the end of its run?

Resignation

Costolo will be resigning from the position on 1 July 2015 and will be replaced on an interim basis by Twitter co-founder Jack Dorsey. Costolo has been on the board since 2010 and led the company through its Initial Public Offering (IPO) in November 2013 when it had a market cap of $24.5bn. Since then, Twitter’s valuation has decreased by 41% from a high of $40bn in December 2013 to its current market cap of $23.48bn. It is this stagnation that has led to Costolo’s resignation.

The Financial Numbers

From 2013 to 2014, Twitter has increased its annual revenue by 111% which has corresponded to a 10.46% increase in its net profit. However, this positive change still resulted in a net loss of $577m. Note that the results for the year ending December 31 2013 should not be overstated as 2013 was the year in which Twitter went public.

All values in $000,000’s
Dec 31 2014 Dec 31 2013 (Year of IPO) Dec 31 2012
Total Revenue 1,403.00 664.89 316.93
Annual Revenue Growth (%) 111.01 109.79
Net profit -577.82 -645.32 -79.40
Annual Net Profit Comparison (%) 10.46 increase 712.75 decrease

In relation to the previous 5 quarters, Twitter has experienced:

  • A decrease in revenue of 9.00% from Q4 2014 to Q1 2015;
  • An increase in revenue of 74.03% from Q1 2014 to Q1 2015;
  • A net profit decrease of 29.59% from Q4 2014 to Q1 2015; and
  • A net profit decrease of 22.73% from Q1 2014 to Q1 2015. 
All values in $000,000’s
  Q1 2015 Q4 2014 Q3 2014 Q2 2014 Q1 2014
Total Revenue 435.94 479.08 361.27 312.17 250.49
Net Profit -162.44 -125.35 -175.46 -144.64 -132.36

 Total Monthly Active Users

In addition to increasing competition from Snapchat, Twitter has been eclipsed by the number of monthly active users on Instagram (300m as of December 2014) and WhatsApp (800m as of April 2015) which are both owned by Facebook (1.4bn as of Q1 2015).

The following demonstrates Twitter’s decelerating growth in its number of total monthly active users:

Growth Rates
Period Total Monthly Active Users (000,000’s) Q4 Year on Year Comparison (%) Average Annual Growth (%)
2010 – 2011 54 – 117 116.67 17.65
2011 – 2012 117 – 185 58.12 10.56
2012 – 2013 185 – 241 30.27 6.88
2013 – 2014 241 – 288 19.50 4.58

Note that Twitter has 302m monthly active users as of Q1 2015, which is a 4.86% increase from Q4 2014.

Why is Twitter Decelerating?

Yes Twitter has reduced its net loss from 2013 to 2014 and yes it is still growing, but the quarterly results and the decline in growth are concerning since they affect Twitter’s validity as an advertising platform. Comparing the year-on-year figures, although Q1 2015 revenue was up by 74.03%, the revenue of $435.94m fell short of the average analyst estimate of $456.8m – also, net profit fell by 22.73% in the same period.

Twitter does not resonate with advertisers and its current 302m members is not as appealing as Facebook’s and its subsidiaries’ membership numbers. Additionally, use of ‘newer direct response products’, i.e. hard-sell methods which create immediate sales or traffic rather than ads designed with a softer approach in mind, is attributed as being the cause of Twitter’s failure to hit targets.

In an attempt to allay concerns with the platform, Costolo has stated that ‘we have a strong pipeline that we believe will drive increased value for direct response advertisers in the future’. However, the penetration of any upcoming innovation will be constrained by the problems that lie at the heart of the platform.

Twitter’s Limitations

Twitter does not possess as much data on its users as Facebook so it is harder for Twitter to sell itself as an effective advertising platform. Twitter marketers cannot target users as specifically as they can on Facebook which offers the use of highly nuanced ‘Dark Posts’. As anecdotal evidence, the disparity in the use of data between the two platforms became evident to me when I saw an irrelevant advert for summer bikinis from Missguided on my Twitter timeline, whereas on Facebook I was hit with an advert for mobile phone mounts after I had been searching for tripod mounts a few days earlier. It is this lack of targeting which has contributed to revenues falling short of targets.

Twitter is noisy and cluttered. As of Q1 2015, there are 302m monthly active users and timelines are now filled with so much noise that the platform does not hold the user’s attention (this is why the largest media networks are publishing content on Snapchat, because the disappearing nature of the content forces users to pay attention). The lack of engagement is why people tweet using images and why there are so many click-bait articles and ‘listicles’. Despite these attempts to attract attention, with so much noise, marketers cannot truly connect with their audience and, combined with its limited application of data, the value proposition of marketers’ already-limited ‘targeted’ ads are diluted whenever the timeline is refreshed and x amount of tweets pushes the ad down.

Bullying and trolling run rampant on the platform, and both are key reasons for stagnating growth. In February 2015, Costolo stated that ‘[w]e suck at dealing with abuse and trolls on the platform and we’ve sucked at it for years… We lose core user after core user by not addressing simple trolling issues that they face every day.’ With the risk of being trolled limiting growth numbers, marketers’ opportunities to fully exploit the platform are capped at a non-maximised growth rate which reduces the value that marketers gain in exchange for utilising Twitter.

People do not like advertising but they do like content marketing. You might have seen the Kenco #CoffeeVsGangs ads in your timeline and, as cynical as it sounds, this is content marketing at its finest. This is because Kenco is indirectly advertising its brand via the publication of its corporate social responsibility. Once it gains traction and the virality of the hashtag grows, Kenco’s goodwill will increase exponentially. However, more often than not, marketers are constrained by their budgets and need to see results immediately. This is what Costolo attributes as being the reason for the recent disappointing increase in revenue.

The Future

Twitter needs to bulk up its capabilities as an effective advertising platform. However, despite purchasing 6 companies a year since 2011, which include marketing, analytics and advertising software firms, Twitter still only accounts for less than 1% of the total $145bn spent on digital advertising worldwide in 2014 – it lags behind Facebook which currently holds 7.93% of the market. Unless it drastically improves its trove of personal data available to marketers, regains users’ attention and addresses bullying on the platform, marketers will not fully invest their efforts into Twitter.

There have been attempts to regain traction, e.g. the acquisition of TellApart, an ex-Facebook ad partner that produces targeted ads, for $533m worth of shares in Twitter in April 2015. The company hopes that this will build upon the previous acquisitions to improve Twitter’s viability as an adtech platform. The company also purchased Periscope for $100m this past March to further improve engagement. Until the quarterly results and growth rates are published, it is hard to fully evaluate the effect of such acquisitions. However, as demonstrated by the company lowering its full-year expectations after the release of its Q1 results, it is near certain that Twitter will continue to plateau.

Marketers need to better engage with the platform and Twitter is attempting to facilitate this with the upcoming introduction of Project Lightning, a curated news service. Whenever a large-scale event happens, people flock to Twitter for information and this is exactly what Twitter needs to monopolise: it needs to consolidate its position as being the first service that people turn to for information, and the introduction of this new curated feed should do just that. As an extension of previous investor Chris Sacca saying that Twitter needs to be the owner of the space for trending events, such ownership will lead to marketers increasing their Twitter-expenditure as they will be able to capitalise on live advertising whilst cutting through the usual noise and clutter.

Conclusion

Without increasing engagement, the growth rates of monthly active users will continue to deteriorate which will result in further disappointing revenues. A continued decrease in growth might represent the fact that Twitter is reaching its maximum scalability and such deceleration would impose a limit on the revenue that can be generated from its position as an adtech platform with a finite number of users.

Therefore, with the company’s current dwindling figures and growing shareholder discontent, Twitter needs to innovate as soon as possible otherwise it risks coming to the end of its run and being remembered as an example of fad-tech.

For more information, please do not hesitate to contact me.

Social Marketing – Floyd ‘Marketing’ Mayweather

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Social Marketing – Floyd ‘Money’ ‘Marketing’ Mayweather

After defeating Manny Pacquiao where he was paid $1 million each by Burger King, Fan Duel and Hublot, Floyd Mayweather posted the following photo on his Instagram account with the caption “I just touched down in Atlanta, GA on Air Mayweather. No luggage is required… just my Diamond Hermès HAC 50 Crocodile money bag…”.

On the face of it, this just looks like a photo of Floyd being Floyd, i.e. flaunting his wealth with his private jet. However, stating the model of the Hermès bag makes it seem as if this is more of an advertisement for the luxury fashion house, rather than just a simple photo.

With this in mind, I wanted to take a closer look at the need for transparency in social media advertising using the ‘UK Code of Non-broadcast Advertising, Sales Promotion and Direct Marketing’ (the ‘Code’) as created by the Committee of Advertising Practice and administered by the Advertising Standards Authority.

Toeing the line 

The purpose of the Code is to benefit consumers, society and businesses. It ensures that the public is not mistreated and fills in any gaps left open by legislation. To this end, the Code sets out guidelines for businesses to follow and to regulate themselves without the fear of costly litigation.

The Code states that ‘[t]he central principle for all marketing communications is that they should be legal, decent, honest and truthful.’ There therefore needs to be transparency to allow the audience to discern what is and is not a piece of marketing. Hence, any marketing communications must be ‘obviously identifiable as such’.

This is where Mayweather’s Instagram photo falls short. The detailed description of the bag suggests that this is more than just an image for social media, but it does not specify whether or not this is part of a marketing campaign for Hermès – is Mayweather simply showing what he owns (as he has previously done with other items from the same brand) or is this a piece of promotional content?

How to have posted the photo in accordance with the UK Code

If this is a piece of marketing, as I think it likely to be, the Code dictates that Mayweather should have indicated that he was being sponsored by Hermès to post the photo. In recent years, guidelines have been set for UK celebrities to inform their Twitter followers with a specific hashtag, such as ‘#ad’, whenever they are advertising a product or service. This would have been a method for Mayweather to illustrate such a commercial relationship.

But with as much brand equity as Mayweather has, would he have been willing to dilute his captions and personality?

For example, Mayweather signed a shoe deal with Reebok in 2009 which was not renewed in 2010. The story goes that, just three weeks after signing, Mayweather spent thousands in a Nike store and posted photos of the goods on his social media accounts in contravention of his shoe deal – Reebok obviously expressed their displeasure and Mayweather opted to repay Reebok instead of limiting his personal content. On the other hand, in his post-fight interview on May 2, Mayweather thanked Hublot for their sponsorship.

Maybe the reason why he acknowledged Hublot and not Reebok is because of the difference in the type of goods he was promoting and the level of difficulty with which either sponsor could be replaced. Based on this rationale, it follows that Mayweather could also be willing to mention Hermès’ sponsorship especially given suggestions that the bag in the photo is worth $150,000. However, he has not done so in past photos with Hermès products, nor has he done so since.

Hermès also would have its own responsibility to the public in regards to transparency of sponsorship. This is exactly what Hublot did on the day of the Mayweather-Pacquiao fight, by publishing a statement that they had signed a ‘knockout’ partnership with the fighter. On the possibility that the Instagram photo is a piece of marketing, a similar statement should have been made to keep in line with the Code, not least for Hermès’ own marketing purposes.

Moving forward

If you have ever been on Mayweather’s Instagram or seen any of his photos, you know that he often poses with high-end goods but it is nearly always unclear what is and is not a piece of third party marketing. He may not have to use a label as pronounced as ‘#ad’ or ‘#spon’ but, in keeping with the UK’s Code, an indication of sponsorship would do much to improve transparency and protect his audience.

For more information, please do not hesitate to contact me.

The Power of Tesla

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“The issue with existing batteries is that they suck” – Elon Musk, CEO of Tesla

In keeping with its name and goal of energy innovation, Tesla recently revealed its new stackable battery system that stores electricity for both domestic and commercial use. Although no specific figures have been released, the new batteries are expected to increase Tesla’s annual revenue by billions.

Domestic units known as the Powerwall are currently available for pre-order for shipping in the summer. Prices start from $3,500 and units will provide enough electricity to run some home appliances for a few days in a blackout. The consensus is that this price point appeals to those whose homes are solar powered, but it is not yet cheap enough for either the average US or the average UK national grid-connected customer.

The larger version, the Powerpack, has been gaining traction and Tesla counts Wal-Mart, Amazon and Target as its customers. An undisclosed utility company has also approached Tesla for an order of 2,500 Powerpack towers. In the short term, this seems to be more promising than the batteries for residential use and commercial success could lead to penetration into the energy industries of emerging markets that rely heavily on diesel such as India – the potential here is therefore extremely high.

Tesla’s Relationship with its Investors

Tesla is not without its sceptics and its own investors wonder when the company will begin to make money. In the past three years, Tesla has made losses of $294m, $74m and $396m from revenues of $3.2bn, $2bn and $413m in 2014, 2013 and 2012 respectively. In the face of increasing shareholder pressure, there are three areas that could perhaps be streamlined: “Cost of Revenue”, “Cost of Research and Development”, and “Cost of Sales, General and Admin.”. These are the exact figures:

All values in $000’s
2013/2014 2012/2013 2011/2012
Total Revenue 3,198,356 2,013,496 413,256
Cost of Revenue 2,316,685 1,557,234 383,189
Cost of Research and Development 464,700 231,976 273,978
Cost of Sales, General and Admin. 603,660 285,569 150,372

Given that Tesla is so high profile and tech-dependent, it is not surprising to see such high costs. However, these figures significantly lower its total revenue and could be reduced to ease investor discontent.

It was expected that Chinese sales of Tesla’s Model S electric car would be roughly on par with US sales, but Tesla has so far found China to be a difficult market With two China managers having already left the company in 2014, a positive international outlook is something that investors will gauge Tesla’s success by. In recognition of this, and under need to better tap into China, Musk has not been shy of informing the company that country managers who are ‘not on a clear path to positive long-term cash flow’ will be removed.

A Long Term Bet

After failing to meet its target for the number of car deliveries in 2014 and inconsistent earnings per share, what does the future hold for Tesla?

Judging from the falling prices of batteries and the increase in the economic viability of solar power, the energy storage industry will soon be breaking open and Tesla’s position within the domestic battery market will pivot on how much economic appeal it can find with consumers. However, its already-strong base in the commercial market, increased projections for car deliveries (50,000 for 2015 growing to 500,000 by 2020) and the expected release of its new SUV (the Model X) suggest a more investor-friendly company with significantly higher revenue. Whether revenue will result in profit remains to be seen, but Tesla is a high profile, research-dependent company so a corresponding increase in the three aforementioned costs is also to be expected.

Tesla has previously been linked to an acquisition by Google and there are current rumours of an acquisition by Apple. These rumours show that, despite the fact that Tesla is not currently making money, its potential is extremely concerning/attractive to two of the most pioneering technology companies. Regardless of how other companies view the company, this can only provide Tesla with a positive long term outlook. Investors who are still bullish on the company are therefore likely to be betting on the company either to continue to grow and eventually make a profit, or to become a vehicle for a successful exit upon an acquisition, and each of these scenarios is likely to compensate investors for their current dissatisfaction.

For more information, please do not hesitate to contact me.

Tidal – Washed up already?

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Just over two weeks after its star-studded press conference, Tidal has fired 25 employees including CEO Andy Chen. This is a clear red flag; its re-launch was supposed to establish a new direction and the fact that the CEO has already been replaced by someone with a ‘clear vision’ shows that Tidal is in disarray. What exacerbates the situation is that Chen will be replaced by Peter Tonstad, former CEO of Tidal’s parent company Aspiro – if Tonstad has such a ‘better understanding of the industry’, why was he not made CEO prior to the re-launch?

Why would a company that has just embarked on a new direction embark on another new direction with new personnel? The answer is simple: Tidal is not connecting with the market.

The Numbers

Three weeks after re-launch and Tidal has crashed out of the top 700 apps in the US iPhone download chart. It had some initial success climbing into the top 20 downloaded apps, but any traction that it gained has now been lost. That said, there has been some suggestion of corporate espionage with Jay Z tweeting that ‘there are many big companies that are spending millions on a smear campaign’ and unofficial sources have stated that Apple has manipulated Tidal’s download numbers by being slow to approve the app’s iOS updates. It might therefore be fairer to check the numbers on Google Play Store. At the time of writing, Tidal is not within Play Store’s top 540 downloaded apps and it does not appear unless you manually search for it. In comparison, Spotify is Google’s 7th most downloaded app.

In his #TidalFacts Twitter session, Jay Z said that ‘Tidal is doing just fine’, that it has over 770,000 subscribers and that it has only been in business for one month. However, he failed to mention that it already had 550,000 subscribers prior to the re-launch. Disregarding whether these new members are people using the free one month trial or if they are early adopters who have anchored themselves to the platform, it must be noted that each of these artists can generate more sales figures in the first week of their solo albums than what Tidal has achieved in a month. There has therefore not been a conversion of fandom into membership.

Meaning of the Numbers

Yes it is just the first month of business for the revamped Tidal, but it is clear that consumers have not warmed to the platform. In an economy of price-conscious and value-driven millenials, consumers find no appeal in Tidal giving artists more money in exchange for expensive subscriptions, little exclusive content and lossless audio that only those with specialist equipment can truly appreciate.

Tidal is tailspinning into irrelevancy. It needs to change, but it will not offer a free subscription model because that would defeat its purpose. An exclusive Jay Z and Beyonce album could prevent Tidal from becoming washed up, but how will it fare when the pirates get their hands on the booty?

What Next?

Although it markets itself as a niche product, the fact that Jay Z compared Tidal’s valuation to the valuations of Apple, YouTube and Spotify shows that it wants to compete with the key figures in this industry; 16 of the world’s most renowned artists holding equity in Tidal also betrays its image of being a specialist service. Therefore, to compete with Spotify or another similar service, it must become more consumer-friendly. It currently adds no value, or at least not enough to detract a significant number of customers away from services which do offer a free membership.

The vital move would be to change its pricing strategy and offering a free membership would be most beneficial. On the face of it, this seems like it would defeat the purpose of Tidal, which is to give artists more ownership over their work, but do not forget the star power that the company wields. The advertising revenue that could be generated in a move into adtech to subsidise the free memberships would be extremely significant and the idea is that Tidal could scale up advertising fees alongside its growing membership. This is a long term strategy that could work but the artists would need to all buy in to the system for maximum effectiveness.

Another very promising feature would be to expand on the exclusive content, not just the music but on concerts and sporting events, as indicated by Jay Z’s recent tweets. To give consumers an experience truly distinct from its competitors, broadcasting live events for a one off fee in cinemas would be a novel way of moving far beyond what Spotify, Pandora etc currently do. A consistent schedule of live events would generate the excitement that the initial re-launch press conference warranted.

With the streaming market becoming increasingly competitive, Tidal also needs to bear in mind that the European Commission is currently investigating the competition aspects of a joint venture between German, UK and Swedish collecting societies (the bodies that manage copyrights in music on behalf of their members and who also licence the works out to companies like Spotify). If such a joint venture is successful, its dominance could increase the prices that streaming services pay which will ultimately benefit the artists and take away from the purpose of Tidal. Increasing membership and generating revenue so as to reduce the purchasing power of Spotify would protect Tidal’s position and, granted Tidal is still in its infancy, if Jay Z is honest about the company being in it for the long haul, this is certainly something that it needs to consider.

Conclusion

Despite what Jay Z says, it seems that the market is in agreement that Tidal is about the artists and not about the consumers. That is fine. Tidal is a business and it is supposed to benefit its stakeholders, but it must make itself more appealing to the customer and what it absolutely cannot do is continue with this current pricing strategy.

For more information, please do not hesitate to contact me.

LinkedIn Purchases Lynda.com for $1.5bn

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As part of its expansion plan, LinkedIn has agreed to purchase Lynda.com, an e-learning company, for $1.5bn. This will be LinkedIn’s largest acquisition and 52% of the purchase will be financed by cash with the remaining 48% in stock.

Why did LinkedIn purchase Lynda.com?

Comparing the Q4 numbers from 2009 to 2014*, LinkedIn’s membership growth rate has been falling:

  • 2009 – 2010: 64%
  • 2010 – 2011: 61%
  • 2011 – 2012: 39%
  • 2012 – 2013: 37%
  • 2013 – 2014: 25%

 *statistics from statista

These declines in growth rates led to the acquisitions of Slideshare for $119m and Pulse for $90m in 2012 and 2013 respectively, in an attempt to expand LinkedIn beyond its roots of being merely a hub in which job seekers and recruiters can network. These previous acquisitions allow users to consume content more easily, but the Lynda.com purchase will now allow LinkedIn to go further and produce its own content.

The acquisition is an example of how social media platforms are moving towards creating content. At a macro level, most of the growth numbers for the different social media services are not what they used to be so many are now beginning to focus more on retention rather than pure growth. They have penetrated the market but, if companies do not innovate, fatigue of their services leads to stagnation and, with how rapidly the sector develops, this can result in their demise. All platforms recognise that, to avoid becoming the next Myspace, they need to add value and the best way to do this is by giving users content.

Lynda.com offers over 5,700 courses and 255,000 video tutorials for professional development, and sells to both individuals and corporate clients. The synergies between the two companies are therefore clear and the purchase will allow LinkedIn to go from merely possessing data about what skills their users have and need, to being able to offer users the support to help them to develop their required skills.

Potential in Emerging Markets

Much like how Facebook is developing Internet.org to establish internet connectivity in emerging markets such as India, the acquisition gives LinkedIn the opportunity to enter into the same high potential markets. In areas where education is prohibitively expensive or where appeal for online learning can be found, LinkedIn could be the first to offer courses that are professionally-geared. Being the pioneer in these countries would allow LinkedIn to gain disproportionate value and, similar to how Internet.org is powered by Facebook, establish an educational ecosystem that is dependent on LinkedIn. The long-term benefits of becoming a major educational figure in these international markets would far outweigh this initial $1.5bn investment.

Conclusion

Because of how compatible LinkedIn and Lynda.com are, this acquisition boosts LinkedIn’s ability to create content and will become a key foundation of LinkedIn’s business strategy. The opportunities for entry into online education in both domestic and international markets will only consolidate LinkedIn’s market-leading position.

As for the social media sector in general, there will be continued developments regarding how companies produce content. Although CEO Jeff Weiner suggests that LinkedIn will now be growing content organically because, “in many regards, [the acquisition] is that last piece of the puzzle and at this point it’s just a question of scale and time”, the industry will continue to see further drives to deliver content either through acquisitions or via in-house development.

For more information, please do not hesitate to contact me.

Tidal – A Sea Change in Music Streaming?

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Aspiro was acquired in January this year for $56m and is now worth $250m thanks to the relaunch of its subsidiary streaming service Tidal. 15 of the world’s biggest artists each own 3% equity in Tidal with Jay Z, another investor and record labels owning the rest. However, despite its star-studded New York conference, Tidal exists with an inherently flawed business model in a market that will only become more competitive.

Why does Tidal exist?

To understand the reasoning behind Tidal, it is important to understand why content streaming exists. As a very brief background, the widespread availability of the internet in the 2000s allowed for the heavy piracy of mp3 files whereby downloaders uploaded and downloaded content without payment. With the development of faster internet speeds, this led to huge losses by the record labels and, out of what seemed to be their ashes, arrived the legal streaming services. The key streaming platforms include Spotify, US-based Pandora, Deezer, YouTube and the upcoming Beats and YouTube Music Key.

Although these streaming services do generate revenue, their profit margins are low and artists have complained that the little royalty fees that they receive dilute the value of their music. As an example, Taylor Swift notably removed her discography from Spotify in protest in 2014. It is within this context of artists’ dissatisfaction that Tidal exists. Under the guise of providing lossless quality music and exclusive content, Tidal addresses artists’ concerns by placing control back in their hands with a paid-subscription model.

What are Tidal’s flaws?

Tidal’s business model is inherently flawed because of its strategies regarding high pricing and exclusive content. The highly competitive streaming industry is also not conducive to Tidal’s success.

The service’s concessions to the artists come at the expense of consumer satisfaction. Unlike YouTube and Spotify which offer free ad-based content, Tidal’s membership options are fixed at $9.99 and $19.99 for standard and lossless quality music respectively. The high costs are unappealing to the average consumer who can use alternative free services and the lossless quality option will only be appreciated by audiophiles with specific equipment. These high price points also go against the very reason why streaming is so popular – streaming was born from piracy which is itself a product of people being innovatively frugal. As a result of how much it costs, not only will consumers not be attracted to Tidal but fears that this will lead to an increase in piracy may eventually come to fruition.

Without free memberships, Tidal promises exclusive content in an attempt to allure consumers away from other services, but it is doubtful how much this will compensate for the service’s pricing strategy. What sort of content will be exclusive – a song, two songs, a whole album? As much as these artists may love creating and sharing music, they are in a business driven by sales. If an artist produces an album exclusive to Tidal that can incur costs in the millions, this limits the amount of investment that can be recovered to just the income from Tidal’s membership fees. This is absolutely unsustainable and it is far more profitable to release an album to the masses. It is therefore more likely that exclusive content will be in the form of a standalone songs and it is very doubtful that a significant number of consumers will care enough about this exclusive content to subscribe to Tidal.

Rather than its competitors needing to be worried, Tidal should be extremely concerned about what is happening in the market: i) Spotify will soon be raising $400m from investors including Goldman Sachs and the Abu Dhabi Sovereign Wealth Fund, thus valuing the company at $8.4bn (33 times more than Aspiro); (ii) YouTube, one of the world’s largest social media platforms, is preparing to launch its own paid subscription membership; and (iii) Apple, with over 500m credit card details and also currently negotiating with artists for exclusive content, is also expecting to relaunch the Beats platform this June. Competition is drastically increasing and, though there is money to be made, the increasing competition will decrease the potential for profit which may eventually price Tidal out of the market – yes it may be the more glamorous option, but it lacks the financial infrastructure of a Spotify, YouTube or Apple that is required to withstand consumer pressure.

Had Tidal entered into the market earlier, the streaming landscape would be dramatically different. However, it is currently in an industry that is nearing saturation with consumers’ memberships being fiercely fought for.

Conclusion

Unless it drastically changes its model to include a free membership option, Tidal will not become a key provider of content. If it does vary its pricing strategy then it defeats the very purpose for which it was created (to provide artists’ with more control and a higher return on their music) which may ultimately result in artists’ removals of content. The increasingly fierce competition will also add pressure on Tidal and its future looks bleak. Granted it is still very early on its life, but its inherently flawed model will not institute the sea change in music streaming that its star-studded entrance suggested.

For more information, please do not hesitate to contact me.

Why will the $400m adidas-NBA Partnership not be Renewed?

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In 2006, NBA Commissioner David Stern said that ‘the adidas presence on a global basis is extraordinary’ and the deal to produce NBA apparel was extended until the end of the 2016/17 season for $400m. Despite this, although the NBA has becoming increasingly global, adidas recently announced that it would not renew the contract amidst reports that the NBA would hold talks with Nike and Under Armour.

So what has happened since 2006 to cause the relationship to break down?

The key issue is that, compared to its US-born rivals Nike and Under Armour, adidas has lost the US market. This was recognised by CEO Herbert Hainer who stated, “we lost some of our brand desirability because we didn’t focus enough on the needs of our consumers.” However, this admission may be too little too late because increasing competition from Under Armour has resulted in adidas dropping to third in the market for US athletic apparel sales, with Under Armour in second place and Nike in first; in relation to basketball specifically, adidas only owns 2.6% of the market. This lack of understanding which translates into a lack of sales means that the company has lost its ability to grow the NBA brand as well as it used to.

adidas also lacks appeal with the players themselves itself. It does not have a healthy superstar player on its books that can elevate the brand, whereas Nike and Jordan Brand (Nike’s subsidiary) are worn by 322 out of 440 NBA players, and Under Armour sponsors potential-MVP Stephen Curry. Not only has the consumer lost faith in adidas, but the players themselves also seem to have lost interest. As a result of adidas’ popularity waning both on and off the court, it is not surprising that the NBA will instead negotiate with the company’s fiercest competitors.

The declining market share and rumours that the company is contemplating selling off Reebok after having already sold off its Rockport business demonstrate that adidas no longer has the sales-gravity that it once commanded. Its deteriorating ability to influence the sports market is not a sufficient launchpad from which it can continue the NBA’s growth strategy and the loss of this partnership will make it hard for adidas to attain its own growth forecasts of “high single digits” so as to defy analysts’ more conservative projections of 6-6.5% annual growth.

For more information, please do not hesitate to contact me.

What is the significance of the Apple Watch?

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With only 4.6m wearable bands (technology worn on the wrist) shipped in 2014 and Apple going into production for 5-6 million units of the Apple Watch with sales projections of 10-15m for 2015, 9th March 2015 was the day that Apple threw down the gauntlet for rival tech companies.

For our statistically-minded readers, these sales projections may seem miniscule compared to the smartphone sector with the iPhone moving 74.6m units in just the previous quarter. However, the Apple Watch isn’t about cash revenue, it’s about consumer adoption and whether Apple will be able to sell enough Watches to stimulate competition and reinvigorate the wearable tech market.

Ignoring the debates surrounding the technological merits of Apple’s products, purely as a business, Apple is in a tier of its own breathing life into new markets, and we only need to look at its successes with the iPod and iPhone to find evidence of this. Low sales of wearable bands therefore mean that many companies, including its rivals Samsung and Sony, are looking to Apple to catalyse the market for wearable tech. However, the question of consumer adoption remains to be seen so keep a close watch over the next 6-9 months for an indication of where the wearable tech sector is heading.

So what does a successful Apple Watch mean for law firms?

Obviously this will mean more work in relation to intellectual property rights, purchase agreements, dispute resolution, mergers, acquisitions etc, but that’s a generic answer. The key is to remember that law firms are businesses which invest in new areas to pursue their own commercial interests.

The tech sector has been booming and firms have opened offices in both Silicon Valley and our very own Silicon Roundabout. A successful establishment of the wearables market as part of the wider ‘Internet of Things’ will therefore prevent the tech bubble from bursting and protect these firms’ investments. We’ve seen the effects of the recession on most firms and, though the effects of a collapse of the tech market may be less generalised, law firms will certainly appreciate the fact that the bubble will not burst in the immediate future.

For more information, please do not hesitate to contact me.