GOOG, MSFT & INTC – Cloud party.

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Cloud and mobile drive 3 for 3.

 Alphabet Q4 16.

  • Alphabet reported excellent results driven once again by mobile advertising but was somewhat marred by a one-off tax payment.
  • Q4 16A revenue-ex TAC / Adj-EPS was $21.2bn / $9.36 compared to consensus at $20.6bn / $9.63.
  • If the one off tax payment is removed, Q4 16 Adj-EPS was $10.13, comfortably ahead of expectations.
  • Alphabet stressed on the call that it was focusing on cloud and the enterprise but I think that this strategy will not work.
  • This is because both Amazon and Microsoft are already far ahead and with a simple version of Office 365 now being free on phones and tablets, there is very little incentive to use Google’s office apps.
  • Furthermore, Alibaba is aggressively expanding its AliCloud offering and has a very strong base in China upon which to base its international investments.
  • Hence, I see Alphabet being driven by its consumer offerings which I do expect to slow somewhat in 2017.
  • I continue to see all the growth as being already priced into Alphabet’s share price.

Microsoft FQ2 17.

  • Microsoft reported good results as the legacy PC-based businesses held steady allowing very rapid cloud growth to show through in the numbers.
  • FQ2 17 revenues / Adj-EPS were $25.8bn / $0.84 compared to consensus at $25.3bn and $0.79.
  • Azure was once again the star of the show with revenues more than doubling YoY together with the prospect of much better gross margins as Azure begins to hit real scale.
  • While Microsoft is going from strength to strength with regard to offering services for enterprise customers and prosumers, its consumer ecosystem continues to whither on the vine.
  • As these businesses continue to be neglected, I can see a growing case for divesting Xbox, Mojang and even Internet Explorer as they could be worth more to someone prepared to really make something of them rather than just let them chug along.
  • I still like Microsoft as these results show that there is still upside to be had from the perspective of offering services to enterprises and prosumers.

Intel Q4 16

  • Intel reported reasonable results as the PC market declined by less than expected allowing chip sales in the data centre to boost revenues.
  • Q4 16 revenues / EPS were $16.4bn / $0.73 compared to consensus at $15.8bn / $0.75.
  • Lower profitability was largely driven by gross margins which have declines to 63.1% from 64.8% a year ago.
  • Intel is under assault on all fronts as chip makers who are willing to accept much lower gross margins are working on creating data centre processors as well having another go at running Windows.
  • Furthermore, almost everybody that is working on Artificial Intelligence is using NVIDIA processors to train their algorithms rather than Intel.
  • In the data centre I still think that Intel is safe as using other processors requires all legacy software to be rewritten but I see risk in both AI and PCs.
  • I think Intel has some time to address those threats but the time to step up is now.

YunOS – Cloudy days.

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YunOS has volume but engagement is less certain.

  • To make a real splash, YunOS needs to carry Alibaba’s Digital Life services, set them as default and place them right under the user’s nose.
  • YunOS (which means cloud OS) is a branch of Android that is owned and Alibaba and is developed by its AliCloud subsidiary.
  • Of all the Chinese forks of Android, YunOS looks to be the clear leader as it is claiming 30m daily active devices and has just announced a smart car being launched using the software.
  • Yun OS has shipped 70m units cumulatively OS as of May 2016, of which the vast majority where shipped in H1 2016 and is targeting 100m for the full year giving 700% YoY growth.
  • Based on this growth rate in 2016, this means that 12.5m were shipped in 2015, meaning that the H1 2016 must have seen something like 50m units shipped.
  • This is where the numbers get a little hazy as, based on these figures, the daily active user count looks to be much too low.
  • I am certain that the vast majority of the 70m devices shipped will have been handsets which, when in use, are checked over a hundred times per day.
  • This would imply that over half of all YunOS devices are sitting in a drawer somewhere or have been replaced with another ecosystem such as Xiaomi’s MIUI.
  • This strongly implies that user experience offered by YunOS and the appeal of Alibaba’s services that come with it, are far from being good enough
  • RFM research (see here) indicates that increasing control of the devices and preinstalling one’s Digital Life services on the devices is where the Chinese ecosystems need to go in order to compete in the long term.
  • Of all the BATmen (Baidu, Alibaba and Tencent), Alibaba looks to be way ahead when it comes to this strategy as very little has been seen from Tencent and Baidu gave up on developing its own system last year.
  • This is ironic because RFM research indicates that Alibaba has the weakest position when it comes to Digital Life and does not score particularly well when it comes to the 7 Laws of Robotics.
  • Despite this, Alibaba has understood the importance of carrying the ecosystem with all types of devices which is where its partnership with SAIC comes into play.
  • The $22,300 SAIC RX5 will be running YunOS in the head unit supported by AliCloud which will host all of SAIC’s services and the data that the car generates.
  • Alibaba’s payment services will also be available in the car making paying for petrol and so on much easier.
  • This is exactly what most of the other car makers are looking at doing where VW is exploring a system with LG, Volvo is working with Ericsson and BMW appears to be going it alone.
  • I see an opportunity for a neutral party such as HERE to play a big role in helping these plans come to fruition.
  • I think that these moves put pressure on Tencent and Baidu to accelerate their moves in this direction as simply sitting on better Digital Life services is unlikely to be enough.
  • The example of Apple Maps shows that a vastly inferior service can gain meaningful traction solely on the back of being preinstalled on a device and set as default.
  • Consequently, if Baidu and Tencent do nothing and YunOS continues to gain traction, their dominant services could begin to be eroded in terms of engagement.
  • They have time to act, but the time is now as these sorts of developments take a very long time to come to fruition.
  • Despite being ahead in this area, I remain concerned that the market is over optimistic in terms of what it thinks e-commerce will deliver in China this year which is the main reason why I am cautious on Alibaba’s shares.
  • I continue to think that both Alibaba and Google look overvalued.
  • Baidu alongside Microsoft and Samsung remain my top picks for the immediate term but I am keeping a close eye on both Apple and Tencent.

 

Palantir – Success victim.

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Palantir’s silence will only make matters worse.

  • Palantir is a very secretive company but the recent negative press raises valid points that need to be addressed if the gadflies are to be swatted into silence.
  • A recent article on Buzzfeed took a look at Palantir coming to the conclusion that all is not well with the company which was valued at $20bn when it last raised money late in 2015.
  • Buzzfeed’s research found the following:
    • Palantir has lost 3 of its top clients (Coca Cola, American Express and Nasdaq) in the last 13 months
    • Staff turnover has doubled to be in line with the Silicon Valley average at 20% in the last 12 months.
    • Palantir’s attempt to create a cybersecurity product and a data sharing consortium among its clients have failed and the teams have been disbanded.
    • Much greater attention is being paid to cost with reorganisations enacted to ensure maximum efficiency.
    • Serious issues around cash conversion with collections being just $420m in 2015 despite $1.7bn in bookings.
  • The article prompted a vigorous defence of the company from one the founders who no longer works at the company (see here) but this has does nothing to address the problem.
  • I suspect that there is nothing wrong with the company other than that things have not gone as well as the company expected and promised.
  • Furthermore, the little that the company has said raises more questions than answers.
  • The problem is simply that Palantir’s performance has not met the expectations that the company set with its investors and hinted at with the media when it raised money.
  • Cost cutting and an increase in staff turnover are key indications that something has not gone to plan.
  • This does not mean that Palantir is a bad company or that it is badly managed in any way, just that it has not been able to meet the lofty targets it set.
  • The biggest issue for me is cash conversion as this is the life blood of any company and critical to valuation once pie in the sky moves onto execution of strategy.
  • I think the increase in staff turnover is irrelevant and completely normal as Palantir transitions from being a start-up into a big company.
  • Also irrelevant are the failures of two projects as much of building a business involves throwing mud at the walls and seeing what sticks.
  • In fact, it’s a sign of good management that losing strategies have been cut fairly quickly.
  • Many founders become emotionally attached to their strategies and let losers run for far longer than they should.
  • However, I think Palantir needs to defuse the bad press which in a vacuum will only swirl and grow in strength.
  • It needs to do two things:
    • First. It needs to explain how cash conversion works.
    • This is to make up for the mistake of allowing the market to wrongly assume that bookings would translate into revenues and cash within 12 months.
    • Second. It needs to explain how its technology is better than anyone else’s making it impossible to take this kind of analysis in house as News Corp appears to have done.
  • In many ways, Palantir is a victim of its own success because with a $20bn valuation and no profits, one has to perform to an excruciatingly high standard especially in this environment.
  • This means that expectations have to be met at every level and on every occasion.
  • At this price there is no margin whatsoever for error.
  • On the surface, Palantir is very like Autonomy in that they both mine huge troves of corporate data to arrive at meaningful conclusions that can then be used to allow the business to perform better.
  • Furthermore, many of the issues raised by Buzzfeed were also issues at Autonomy when it was independent which a big reason why Palantir needs to nip this in the bud.
  • Failure to address that could result in Palantir being labelled alongside Autonomy which would be truly awful outcome for the company.

Amazon / Baidu Results – Away from home.

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Both companies being driven by new businesses.

Amazon Q1 16A. 

  • Amazon reported mighty results as Amazon Web Services (AWS) grew by 64% YoY and contributed 55% of group EBIT despite only contributing 9% of total sales.
  • Q1 16A revenues / EBIT / EPS were $29.1bn / $1.07bn / $1.07 compared to consensus at $28.0bn / $584 / $0.59.
  • Although North America remained nicely in the black, the star of the show was AWS which generated $604m of EBIT accounting for almost all of the better-than-forecasted performance.
  • This strength also underpinned guidance where Q2 16A revenues / EBIT are forecasted to be $28.0bn – $30.5bn (midpoint $29.25bn) / $375m – $975m (midpoint $675m) compared to consensus at $28.4bn / $878m.
  • Despite being the largest cloud provider, AWS gained share during the quarter and is increasingly looking unassailable.
  • Its huge scale gives it the ability to offer global points of presence which meaningfully improves performance for global companies and it can offer this with lower costs.
  • Furthermore, the underlying AWS software upon which companies build their IT operations is unique to Amazon, making switching an increasingly difficult and painful process.
  • Hence, I think AWS will remain strong which combined with the steady progress in retail keeps the overall growth outlook good.
  • However, the same cannot be said for the valuation.
  • Even including an EPS upgrade to $6.00 for this year and $10.00 for 2017 leaves the company trading on 113x 2016E PER and 68x 2017E which is way too rich for my blood.
  • Amazon’s valuation has been discounting future profits for years and now that they have arrived, it is time for the multiple to begin returning to normal levels.

Baidu Q1 16A. 

  • Baidu reported results that met expectations as profits from its dominant position in search continued to be ploughed into O2O and online video investments.
  • Q1 16A revenues / EPS were RMB15.87bn ($2.4bn) / RMB2.2bn ($340m) almost exactly in line with consensus at RMB15.82 / RMB2.2bn.
  • Mobile now makes up 60% of revenues with Baidu’s ecosystem reaching 663m users meaning that 89.1% of Chinese mobile users are actively using its services.
  • However, this looks like a slight loss of market share as in Q4 15A, RFM estimates that Baidu’s ecosystem reached 89.8% of China’s smartphone users implying that Qihoo and Sohu have gained slightly in Q1 16A.
  • Despite this, search remains hugely profitable but much of this is being ploughed into new businesses
  • This becomes apparent when one separates search from the O2O (online to offline) and online video businesses.
  • Group adjusted operating margins were 15.4% but if losses from O2O and online video are removed, search margins are revealed at 49.8%.
  • Between them, these two businesses have racked up RMB5.7bn in losses in one quarter alone making them a very big bet as far as investors are concerned.
  • Fortunately, the outlook for growth in 2016 is reasonably good meaning that search is likely to keep delivering cash for investment.
  • Whether Baidu can deliver returns on these investments remains to be seen but comments on the call such as “we will worry about the business model later” do not inspire confidence.
  • Baidu has a stranglehold on the Chinese search market very much like Google does in the rest of the world.
  • However, it is there that the similarity ends as Google clearly understands the ecosystem and Baidu does not even though it has reasonably good coverage of the Digital Life Pie.
  • Consequently, everything depends on Baidu being successful with Nuomi, its platform for e-commerce and O2O services.
  • Here its GMV of RMB16bn is just a fraction of Alibaba’s at RMB964bn meaning that it has to do something very special to prevent itself from being squeezed by its much larger and more powerful rival in e-commerce and O2O.
  • Baidu is likely to remain volatile while its develops it services beyond search.

Qualcomm – Built to serve

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Triple whammy benefit no longer held up by software?

  • Intel finally has a credible challenger in the server market as Qualcomm has made an entrance in conjunction with partners Mellanox and Xilinx.
  • With growth rapidly declining in smartphones, tablets in negative territory and MediaTek aggressively attacking at the high-end, Qualcomm has been looking for new avenues for some time.
  • Wearables, IoT, e-health, automotive and so on all offer long-term potential but servers are big and are here and now.
  • The data centre generates $12bn – $14bn of revenues for Intel where it has over 90% share of the market.
  • Furthermore, the rationale for using an ARM based chip in the server is very strong as the operator of the data centre gets a triple whammy in terms of benefit.
    • First: The ARM processor consumes far less power than the equivalent processor from Intel, meaning less power consumed and less heat generated.
    • Second: Less heat generation obviates the need for fan cooling meaning cheaper build costs and a smaller footprint.
    • Third: Less heat consumption also means less air-conditioning is needed for the data centre, reducing costs even further.
  • The net result is substantially lower running costs because power is far and away the biggest operating expense of a data centre (excluding depreciation).
  • Hence, at first glance it would seem to be a no brainer to run all one’s servers on ARM based chips but there is a huge problem: software.
  • Intel has dominated this market since its inception and because of this, all the software written to run on servers is based on the x86 processor.
  • This means that any company that wishes to switch to an ARM-based server will have to completely re-write the software that runs its operation.
  • To date this has been an unsurmountable challenge as the cost and difficulty of doing this has vastly outweighed any of the benefits gained from using ARM.
  • However things have changed such that an alternative to Intel might just have a chance.
  • In the early days of servers, everyone got them off the shelf from suppliers like IBM of HP but that has now changed.
  • The really big ecosystems like Google, Facebook and Apple increasingly want customised servers which means that they design the hardware and write the code themselves.
  • This gives them the ability to do whatever suits them in the data centre.
  • Furthermore, they are now at such a size that the power bill has become so huge that it is worth considering alternatives.
  • I suspect that this will begin with a new Digital Life service or design of server where the code has not yet been written and where it is just as feasible to write it for ARM as Intel.
  • This is why the Qualcomm offering is targeted directly at the hyper-scale data centres where the servers are custom designed and built.
  • I think that Qualcomm represents the first really credible entrant into this field which to date has been populated by a series of start-ups who have been unable to overcome the software problem.
  • Qualcomm is the king of execution and if it can get a foot in the door, then there could be real trouble on the horizon for Intel.
  • Intel’s financial performance for the last few years has been almost single-handedly driven by the data centre and the outlook for it to get a position in mobile remains extremely bleak.
  • Its early days but Qualcomm is threatening to do to Intel what MediaTek has done to it.

Amazon Q1 15A– Silver lining

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Amazon Web Services outshines a dull earnings report

  • Amazon Web Services (AWS) was the bright spot in a set of results that came pretty much in line with expectations.
  • Revenues / EPS were $22.74bn / LOSS $0.12 compared to forecasts of $22.4bn / LOSS $0.11.
  • Guidance was weak with revenues / EBIT expected at $20.6bn-$22.8bn ($21.7bn) / LOSS $500m – $50m (LOSS $225m) compared to estimates of $22.1bn / LOSS $15m.
  • However, Amazon revealed that its Cloud business, Amazon Web Services (AWS) is much bigger and more profitable than many had expected.
  • In Q1 15A AWS grew revenues 49% YoY to $1.6bn and reported operating margins of 16.9% which is far ahead of what most commentators had assumed.
  • By contrast Microsoft’s Azure business is currently at $1.1bn in sales but is growing at 114% and I estimate that gross margins are around 40%.
  • I think that most commentators had assumed that AWS was roughly the same size as Azure and very unprofitable.
  • This surprise has caused many to meaningfully increase their valuations of this part of Amazon.
  • This report shows that Amazon is comfortably the leader in the public cloud but it also shows that outside of AWS nothing else has changed.
  • Amazon is still investing heavily in growing its empire but there is no sign that these investments are being made with any particular strategy in mind.
  • Instead they continue to feel like a random series of experiments with Amazon throwing mud at the wall to see what sticks.
  • Unfortunately, nothing is sticking and this is because Amazon still seems to have no real understanding of the ecosystem.
  • It has a range of assets such as Amazon Prime, Kindle, Twitch, Maps and so on but all of them are independent from one another.
  • In order to be a coherent, easy to use and fun ecosystem, Amazon needs to integrate these offerings together into something where users are going to want to spend their Digital Lives.
  • Furthermore, Amazon needs to split its free shipping off from its ecosystem as this creates a $99 per year barrier to joining the ecosystem.
  • To me the fact that it has not done this is evidence that still has no understanding of it is trying to achieve and until it does it is likely to continue wasting money on experiments that yield no results.
  • Amazon remains very far from the top of my list of places to be in the digital mobile ecosystem.

Apple – Fixing ABC.

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Apple is moving to fix the basics of iCloud to ensure its future.

  • Apple appears to be intent on improving the plumbing that makes a number of its Digital Life services far from best in class.
  • Apple looks like it is on the verge of acquiring FoundationDB, a start-up company that uses a new design of database that makes the storage, retrieval and analysis of data much faster and more efficient.
  • I presume that Apple intends to integrate this technology into iCloud and also make it the backbone of HealthKit and HomeKit.
  • iCloud looks good on the surface but its performance, stability and reliability leave a lot to be desired.
  • Users constantly report issues with synchronisation and back-up of devices as well as increasingly slow back-ups of their data to iCloud.
  • Part of the reason for this is that synchronisation and back-up look like very simple tasks but they are fiendishly difficult to get right.
  • iCloud has not been around long enough and has not been used in the enterprise where much higher standards are required to be selected.
  • Furthermore this type of software is not in Apple’s DNA which combined with its relative youth make it inferior to most of its competitors.
  • OneDrive is a much clumsier and less fun user experience, but because it is based on SharePoint it offers great reliability and enterprise class performance.
  • RFM research indicates that Apple is aiming to differentiate its devices in the long-term with HealthKit, Home Kit and Apple Pay.
  • If Apple can make its devices the hub that collects all of a user’s health and home data, it can offer functionality that none of its competitors will be able to do.
  • In that instance it will have achieved differentiation despite remaining weak in its own Digital Life services and consequently it will be able to preserve its hardware margins.
  • However, underneath this needs to be software plumbing and databases that are rock solid with fantastic performance.
  • Failure to fix the problems of iCloud will probably bring these long-term strategies crashing down and this is what I think is sitting behind Apple’s move to acquire FoundationDB.
  • Google and Microsoft have nothing to worry about for the moment but they should be using the opportunity to improve the user friendliness of their offerings before Apple gets its house in order.
  • Microsoft remains my top choice in the ecosystem, followed by Google with Apple staying in third place.

 

Privacy – Same boat.

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Microsoft has taken the most heat from the latest revelations but it looks like everyone is in the same boat.  

  • The latest revelations reveal that Microsoft has actively participated with the NSA to allow the authorities to circumvent its encryption.
  • Outlook.com, SkyDrive and Skype have all been compromised but it is unlikely that the circumvention has been limited to these.
  • Microsoft has been the subject of court orders (from the secret court) that has forced it to make its systems available to the security services.
  • Microsoft has not included any software in its systems that allow the NSA to eavesdrop but simply helped it to hack into the data flow.
  • I very much doubt that Microsoft has been alone in its receipt of court orders and I suspect that all the providers of Digital Life services are in the same boat.
  • Android is one step further along as it seems that Google has actually included NSA code in the Android operating system.
  • Apple appears to be less tarnished by these revelations and this is because its own services (to which the NSA is almost certainly demanding access) are much less used than those of Microsoft, FaceBook and Google.
  • Skype has around 660m users, Facebook has 1.1bn users with Google being in the same ballpark.
  • Apple has far less. Lots of people use Apple devices to get access to third party services but because Apple is not hosting these services itself, it does not have the data.
  • For its own services like Mobile Me, iChat and iCloud, I am certain that it has received the same requests and co-operated in the same way.
  • However, because the user numbers are much smaller, it has not been the main focus as these revelations have come to light.
  • Frankly, I do not believe that any provider of a Digital Life service based in the US has not been forced into co-operation and I suspect the same is true overseas.
  • For example, the Indian government recently announced that it is now ready to intercept all communications carried by the BlackBerry system.
  • Therefore, I do not believe that any one company is in a better position or is more to blame for handing out customer data than any other.
  • This incident is likely to further increase demand for services like VPN encryption and increase user willingness to try alternative services.
  • The problem is that any service will always be vulnerable to state intervention wherever it is located as it is very clear that the US is far from alone in this activity.

Google Reader– The boring truth

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Google Reader has gone because it is not big enough. That’s all.

  • The retirement of Google Reader has nothing to do with the “free” internet model and everything to do with its size.
  • A common view out there is that Google is retiring Reader because it is free and are using the example to dish the “free” internet / software model.
  • Unfortunately the reality is much more boring.
  • Google Reader is a niche product that has not been invested in for some time and is now obsolete.
  • Other services like Google Currents offer a much richer and nicer way to scan the news and as a result there is no real reason to keep it going.
  • Smaller niche players are already beavering away to come up with replacements so that users (like myself) will have more than one alternative come July 2013.
  • As for the “free” model, this remains alive and very well as the growth figures for Facebook’s and Google’s advertising revenues show quarter in, quarter out.
  • There remain two ways to pay for the Internet: crisp, hard cash or personal data.
  • Given that cash is an ever scarcer commodity these days, I suspect that the majority of the internet will be financed via the free, personal data model.
  • I suspect that when it came down to it, Google looked at Reader and saw that the numbers of people using it were too low to justify the cost of running and hosting the service.
  • If only Google would think like this when it came to buying useless assets, then I would be a much happier investor.
  • A billion dollar London HQ, Motorola Mobility and half of an airport in California all leap to mind as useless assets that have no business being part of Google.
  • These are all signs of a company that is run for the benefit of the employees rather than shareholders and such companies inevitably come a cropper sooner or later.
  • I love the business of Google; I just think management needs to rethink its priorities and how it spends other people’s money.

Amazon Q4 – To hell with reason

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There is no rhyme or reason in the valuation of this company.

  • Amazon reported disappointing results but still managed to rise 10% in after-hours trading as the bulls dug deep to find justification.
  • Q4 Revenues / EPS were $21.3bn / $0.21 compared to estimates of $22.2bn / $0.27.
  • Guidance was also weak with Q1 revenues and EBIT of $15.0bn-$16.6bn / Loss $285m – profit $65m compared to estimates of $16.9bn / profit $261m.
  • 2 good things came from the numbers:
    • First. Margins in North America improved nicely to 5% from 3% 12 months ago.
    • This was taken as a sign that there is more to come and the turnaround in profitability is beginning.
    • Second. The attach rate of content to Kindle devices looks like it is moving in the right direction.
    • Sales of the dedicated e-book readers may be falling hard, but sales of the content that go on them grew by 70% YoY.
    • This goes hand in hand with the weakest quarter ever for regular books and a very strong quarter for tablets in general.
    • This implies that iPads and the generic Android tablets such as the Amazon Kindle Fire are being increasingly used for consuming paid content.
    • Amazon’s strategy to sell hardware at cost and make money on the content looks like it is beginning to work.
  • These are positive developments but in no way make up for the fact that Amazon barely makes any money, had puny cash flow of $395m and has a PER ratio to make your nose bleed.
  • I like Amazon’s strategy. It started as a retailer of online books, became an online seller of everything and now is a contender to be a giant of the internet.
  • There are not many companies around that have the ability to re-invent themselves in such a manner but it is already in the price.
  • To have a PER of 14x (with which I could be comfortable), net margins would need to increase 10 times from where they are expected to be in 2013 (0.2%) to 21%.
  • I would much rather have Google 16.4x or Apple at 10.2x 2013 PER and both of these have huge cash balances to deduct to make the ratio even cheaper.
  • Amazon is investing hard for the future but there are going to be bumps in the road.
  • Wait for a big bump and then revisit once Wall Street has panicked and Jeff and his chaps are fitting the wheels back on.