Microsoft and Amazon – Chalk and Cheese

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Microsoft has the bit between its teeth while Amazon flounders.

  • Microsoft and Amazon reported results on 23rd October leaving me in no doubt that a strong preference for Microsoft over Amazon is the right way to go.

Microsoft Q1 15A

  • Microsoft reported excellent results with Q1 15A revenues and EPS of $23.2bn / $0.54 compared to consensus at $22.0bn / $0.48.
  • The combination of the stability in the PC market and hardware shipments being ahead of expectations, underpinned the outperformance.
  • Cloud, Office 365, Surface and Lumia all had an excellent quarter and this is expected to continue into fiscal Q2 15E.
  • Phone hardware is expected to decline this quarter but this is more due to the rationalisation of the non-smartphone business which I am expecting to be wound down over the next few quarters.
  • This performance is also gratifying as it comes in the midst of the biggest shakeup Microsoft has been through in the last 20 years.
  • Focus has not been lost and I am comfortable that the businesses should continue to perform despite the internal upheaval.
  • The key now is to bring all of the disparate pieces of the Microsoft ecosystem together.
  • When they are all integrated and they all know about each other, then Microsoft can offer a full and complete offering for both Digital Life and Digital Work.
  • This is the panacea that will return Microsoft to steady growth but there still remains a mountain to climb.
  • In the meantime the fundamentals are steady and the stock looks likely to continue its steady performance.

Amazon Q3 14A

  • Amazon reported bad Q3 14A results as growth continues to come at the expense of profitability.
  • Q3 14A revenues and EPS were $20.6bn and LOSS$0.95 compared to consensus at $20.9bn and LOSS$0.75.
  • Included in the figures was a $170m write-down of unsold Fire phone inventory.
  • This looks like a $200 write off per device implying that Amazon had made commitments for somewhere around 1m units.
  • It looks like Amazon has shipped something in the region of 35,000 devices to date.
  • This comes as no surprise (see here) and I continue to believe that Amazon is conducting an expensive series of random experiments rather than having a real strategy to build an ecosystem.
  • Guidance for Q4 14E was also very disappointing with revenues of $27.3bn-$30.3bn expected and net loss of $570m to a net profit of $470m is expected.
  • This compares unfavourably to forecasts of $30.9bn and a net profit of $461m.
  • Erratic ecosystem strategy aside, the fundamental problem with Amazon is that it makes no money.
  • Investors have been waiting a long time for scale to start working in its favour and for the company to start earning some money but it never seems to happen.
  • Worst of all, at 126x 2014E PER and 69.4x 2015E PER the shares are already pricing in improvements that never seem to materialise.
  • The correct valuation for a company that will never make a net profit for shareholders is 1x book value.
  • In Amazon’s case this is $10.3bn which is far below the current market capitalisation of $146bn.
  • It is an extreme statement to say that Amazon will never make any money for shareholders but it is clear that until it does, one should steer clear.
  • Google, Microsoft and Apple are far better places to be.


Microsoft – Trojan Horse

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Apps for Android signal a real change in strategy.

  • Microsoft Garage is a skunkworks inside Microsoft known for being a geeky haven, and it has just released three free apps for Android.
  • These apps are free and feature no internal purchases meaning that there is no direct means by which these apps can be monetised.
  • I suspect that I am seeing the beginning of a strategy to push the Microsoft ecosystem across every platform, extending its reach way beyond the devices that it makes in house.
  • Three apps have been launched:
    • 1) Torque. This is an Android Wear application that removes the need to say “OK Google” to activate the voice recognition.
    • Instead users twist their wrists towards them in order to activate the voice function.
    • This raises the possibility of the voice recognition being activated by accident, but I would hope that this has been extensively tested prior to release.
    • Critically, the app returns search results from Bing rather than Google.  
    • 2) Next Lock Screen. This is an app that is aimed at professionals with Android devices.
    • The idea here is to place the most relevant and important information on the lock screen with direct links to the relevant functions.
    • For example if is there is a call to be made on the calendar, this information with the number will be displayed on the lock screen and the user can directly from there.
    • This app will clearly work best with productivity applications, which again shows signs of pushing the Microsoft Digital Work ecosystem onto Android devices.
    • 3) Journeys & Notes. This is location based blogging app that allows the user to log a journey and share it with other users.
    • This is essentially a specialised social networking application whose success will very much depend on how good it is and how many users can be enticed to log their journeys on it.
  • The question is why would Microsoft waste its time and money on developing for Android?
  • The idea here is to draw users into the Windows ecosystem.
  • If users begin to realise that Bing is not as bad as everyone thinks and they begin putting that together with Skype, Here, Minecraft and XBox, they will be spending more of their Digital Lives with Microsoft.
  • At some point there is a chance that they might decide to switch to a Windows product if it can deliver these services in an easier, more fun and useful way.
  • At the moment this is a big ask as these assets remain disparate services randomly scattered throughout the Microsoft empire and they don’t really know anything about each other.
  • They need to be integrated to be more aware of each other such that a better quality service that is more coherent and useful to the user is offered.
  • Furthermore, if Microsoft ever decides to go down the monetisation by advertising route, this will be essential to achieve decent monetisation.
  • I think that more and more of Microsoft’s ecosystem will be made available for both Android and iOS over time making the Microsoft ecosystem available to everyone who wants it even if they don’t have a Microsoft device.
  • This is yet another sign of how much Microsoft is changing.
  • The old “Windows, Windows, Windows” mantra is gone to be replaced with a strategy of making the services so good that users turn up of their own accord.
  • This is the right strategy but now it all comes down to execution which is somewhere where Microsoft has struggled to date.
  • I am hopeful that Nadella will now turn his attention to making it al happen.
  • Microsoft remains, along with Google and Apple, one of my top choices for investing in the mobile ecosystem at the moment.

Yahoo! Q3 14A – Game of numbers

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Yahoo! must focus on registered users to have any chance of growth.

  • Yahoo! reported reasonable Q3 14A results but still the commentary and promises are failing to show through in the numbers.
  • Q3 14A Revenues-ex TAC / EPS were $1.09bn / $0.52 compared to estimates of $1.05bn / $0.30.
  • Display based advertising continues to be the biggest problem which fell heavily by 6% YoY during the quarter.
  • According to Yahoo!, it is PC based advertising that is causing all of the problems which is dragging revenues down by $60m a quarter.
  • This is offsetting growth in search (up 6% YoY in Q3 14A) and mobile which grew 100% YoY to $200m in revenues during the quarter.
  • It is here that I can’t get the numbers to add up.
  • Yahoo! claims that it will generate $1.2bn in mobile revenues for the full year 2014E but it has only generated $200m during Q3 14A.
  • If mobile is growing as fast as it claims, then Q1 14A and Q2 14A mobile revenues would have been much lower than $200m, meaning that Yahoo! will need to generate something like $800m in mobile in Q4 14E alone in order to make the target.
  • This represents QoQ growth of 4x and would massively offset further declines in PC based display advertising.
  • I can only assume that Yahoo! actually means that the run rate of mobile revenues will be $1.2bn by the end of the year implying Q4 mobile revenues of $300m.
  • Even this looks to be a stretch but it is much more credible than what the company has actually stated.
  • Even if this is correct, this represents $100m in incremental revenues compared to Q3 14A, which alone would more than offset the $60m drag from PC advertising and allow the company to see growth.
  • However, this is absent from the Q4 14E guidance with $1.14bn-$1.18bn in revenues representing a YoY decline of 4.2%.
  • The midpoint of this guidance is $1.15bn, below consensus at $1.17bn.
  • Furthermore, Yahoo!’s user figures continue to be misleading in my opinion.
  • Including Tumblr, Yahoo! now reports active monthly users at 550m up 17% YoY.
  • However, this figure includes a substantial number of users just turning up to one of its properties to browse the content.
  • I suspect that less than half of these users are registered users about whom Yahoo! can build a profile and start offering targeted advertising.
  • The rest will only receive the generic display based advertising that Yahoo! is trying so hard to get away from.
  • Consequently, I suspect that registered users are less than 300m of which the vast majority only really use Tumblr.
  • Here lies the challenge for Yahoo!
  • It must take its excellent collection of assets and integrate them such that users want to register and become part of the ecosystem rather than just turn up for a quick look.
  • To do this it must move past just content and offer users services within which they want to live their Digital Lives.
  • That is how the user profiles will be built and how Yahoo! can get access to the revenue streams where advertisers are really spending.
  • This is how Google manages to outperform Yahoo! on growth despite being nearly 15x its size.
  • Until this becomes a reality, the numbers are going to underperform the big promises, harming the potential for a stock that has a lot of fundamental upside.
  • Google, Microsoft and Apple look like better prospects and I would continue to take Alibaba related profits on Yahoo!

Apple Q4 14A – Beat and raise

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Apple on course for a superb quarter to the detriment of Samsung.

  • Apple reported Q4 14A results that comfortably beat estimates and guided above consensus as demand for the iPhone 6 continues to outstrip even the most bullish forecasts.
  • Q4 14A revenues and EPS were $42.1bn / $1.42 compared to consensus at $39.8bn / $1.29.
  • 39.3m iPhones shipped during the quarter compared to forecasts of 38m and I suspect that there is another positive surprise to come in January.
  • 12.3m iPads were shipped compared to consensus at 13m which is a little disappointing but not a huge surprise given:
    • Most users knew there was a new iPad coming and probably held off purchases.
    • The tablet market is slowing to almost no growth at all this year compared to 44% in 2014.
    • I suspect that the iPhone 6+ is likely to cannibalise shipments of the iPad Mini.
  • For the next quarter, weakness in iPad is not an enormous concern as all the attention is being focused on the surging demand for the iPhone 6.
  • Apple sold 5.5m Macs taking its market share to its highest level in almost 20 years as back to school demand had a significant effect this year.
  • Market share is still less than 10% globally but it is inching inexorably up with time.
  • Guidance for the coming quarter (fiscal Q1 15E) was positive with revenues of $63.5bn – $66.5bn expected which compares favourably to consensus at $63.4bn.
  • Q1 15E EBIT is implied to be $19.3bn in line with consensus at $19.4bn.
  • However, I suspect that Apple is continuing to be pretty conservative and consequently, I think that number should be comfortably beaten come January.
  • The popularity of the iPhone 6 is likely to mean market share gains both in unit terms and for the iOS ecosystem overall.
  • The main loser here is Samsung which has owned the large screen phone market for the last 3 years and is now showing every sign of rapid decline.
  • Google is likely to be unaffected in the short term as RFM estimates that 50% of its mobile advertising revenues are generated on iOS devices.
  • Hence a shift in ecosystem share to iOS away from Google’s Android is unlikely to affect revenues in the short-term.
  • However, this is not a great state of affairs for the long run as I am pretty sure that Apple would dearly love to remove Google from its devices and its App Store if it could afford to do so.
  • Reliance on its biggest competitor for its revenue growth is a state of affairs that Google will be very keen to avoid.
  • Google, Microsoft and Apple (for the next quarter) remain the top companies to look at for investing in the mobile ecosystem.


Samsung and Facebook – One chance

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Samsung has one chance to avoid the fate of its predecessors.

  • Samsung looks to be teetering on the edge of suffering the same fate as all market leaders before it as its products have become commodities.
  • In order to prevent disaster, it must add something back to its products to make them again desirable to users.
  • The iPhone now has large screens and the Chinese are voraciously attacking at the low end, leaving Samsung very little to fight with other than price.
  • This is why its relationship with developers and providers of Internet services is now so important.
  • RFM’s analysis has indicated that its best chance is to work with content developers to create Samsung specific versions of their apps. (See Samsung and Google – Gorilla war, 27th May 2014).
  • This is why Samsung’s recent meeting with Facebook is so important.
  • Smartphone users spend 24% of their time on their devices using social networking and Facebook accounts for 75% of that time.
  • If Samsung and Facebook work together to make the Facebook experience meaningfully better on Samsung devices than anyone else’s, then users will have a reason to choose a Samsung product other than price.
  • This is the key to retaining margins at attractive levels as preference is what drives pricing and how Apple makes such fantastic margins.
  • Currently, over half of the Android devices in the hands of users are made by Samsung.
  • This combined with the fact that Android remains very fragmented means that every developer wants to develop for Samsung devices before any other.
  • This creates the potential for a mutually beneficial relationship that can extend far beyond Facebook to all of the other major app developers.
  • Games can be extended with Samsung specific versions with extra levels or downloadable content as can media or productivity apps and services.
  • This is where Samsung must focus and it must do it immediately.
  • The more share that is lost, the less attractive the relationship becomes for app developers and the less willing they will be to write Samsung specific versions.
  • With Google firmly in control of the ecosystem, this is Samsung’s only option to support its handset margins and avoid the death spiral that has consumed all market leaders before it.
  • There is a chance for Samsung to avoid repeating history but it must act immediately and wholeheartedly.
  • In the short-term I still see downside in Samsung to KRW1m where there is significant psychological resistance.
  • Google, Microsoft or Apple in the short-term make far better options in the ecosystem.

Google Q3 14A – Law of large numbers

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Slowing growth does not make the shares unattractive.

  • Google reported slightly disappointing results as growth from its core advertising business in fixed Internet slowed a bit more quickly than expected.
  • Q3 13A revenues (ex-TAC) and EPS were $13.2bn / $6.35 compared to consensus at $13.2bn / $6.54 and RFM at $13.0bn / $6.28.
  • RFM has tended to be more cautious than consensus due to its view that growth will slow steadily over the next few years.
  • However it should remain comfortably above 10% driven by mobile.
  • Video, multi-screen and mobile continue to be the strongest growth areas with desktop and display lagging behind.
  • Google is investing heavily in R&D as most of 3,000 recruits during the quarter were engineers.
  • This has been partially offset by a fall in the GNA spend as a % sales which is good news as I have long held the opinion that Google grossly overspends on GNA.
  • This has resulted in slightly lower operating margins which was compounded by a higher tax rate to give the EPS disappointment observed.
  • There is bad news for Lenovo in these figures (reports Q2 14E on 7th November) as losses at Motorola Mobility look to have ballooned again.
  • Losses from discontinued operations increased to $185m compared to losses of just $68m in Q2.
  • In the absence of the 10-Q filing, it is not possible to see exactly how much of the loss is coming from Motorola, but it is clear that profitability has nose-dived once again.
  • This will increase pressure on Lenovo which is taking on the loss making division for $2bn and does not have the financial flexibility to endure ongoing losses.
  • For Google, this is a rounding error that no one really notices and consequently it has no impact on my view on the company going forward.
  • In this vein, the combination of mobile and video should keep the company growing nicely and I expect a solid end to 2014E.
  • At 17.4x 2015E and 16.1x 2016E PER (close 16th Oct), Google remains attractively valued and remains one of my top places to look when considering investments in the ecosystem.

Apple vs Google – Spoiler war

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Q4 14E will be the most competitive ever for devices.

  • Apple’s accidental launch of the new iPad Air 2 and iPad Mini 3 combined with Google’s attempt to steal its thunder with its new Nexus devices sets the scene for brutal competition in Q4 14E.
  • First up was Apple’s accidental launch of its new iPads on the iTunes store.
  • Screenshots of the new devices were accidently uploaded for a short period showing new devices that offer very little more than an evolutionary upgrade.
  • The devices have added the fingerprint reader to the home button and are also expected to have faster processors and better battery life.
  • Full details will be revealed at the event today at 6pm UK / 7pm CET / 1pm ET / 10am PT but it is clear that there are going to be no fireworks.
  • Apple’s main driver for the next 2 quarters is going to be the iPhone 6 and demand for the device continues to be very strong.
  • This leaves me comfortable with Apple in the short-term although my long term concerns are still there.
  • At the same time Google has officially released its latest range of Nexus products.
  • The Nexus 6 smartphone made by Motorola is a 5.9” monster with Android L and all of the other high end specifications.
  • The device will sell for $649 compared to $749 for the iPhone 6+ and will be available through all 4 main US operators.
  • The Nexus 9, made by HTC, is a 8.9” tablet that will start at $399 and be available from next month.
  • The aim of these devices is not to sell huge volumes but to serve as a roadmap for other device makers to highlight what is possible using Google Android.
  • Google also launched a set top box called the Nexus Player that interestingly uses an Intel chip rather than one powered by ARM.
  • Given that Intel is virtually giving its chips away and compensating manufacturers for the added cost needed to use Intel rather than ARM, this looks like a cheap way to get good performance at low cost.
  • Android TV is a version of Android that is optimised for the large screen but because it is running Intel rather than ARM, it is very limited in terms of apps. that are available.
  • This device looks a lot like PlayStation TV which is hoping to piggy back on the success of the PS4 and the resurgence of Sony in gaming.
  • The device industry line up for the all-important Q4 14E selling season is now in place and it looks very much like it is Apple’s to lose.
  • At the high-end, Apple has the most fun and easiest to use ecosystem and now that it has large screen devices, it is the ecosystem that everyone wants.
  • At the low end the Chinese and Indian vendors are making inroads by selling reasonably specified devices at very low prices.
  • It seems very unlikely that they are making any money and this combined with the resurgence of desirability of Apple devices is squeezing all other handset makers from both ends.
  • Samsung has had a dreadful Q314A and Q414E looks like it will be even worse.
  • The other handset makers are faring no better and the outlook remains pretty grim when it comes to profitability.
  • In the hardware space there remains only one name to choose: Apple.
  • In the ecosystem, both Google and Microsoft look attractive.


Intel Q314A – Waiting for Godot

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Core M is the key to a laptop replacement cycle.

  • Intel reported solid Q314A results as corporate PC demand continues to keep the PC market on an even keel. .
  • Q314A Revenues and EPS were $14.6bn / $0.66 compared to estimates of $14.4bn / $0.65.
  • Intel won market share from AMD during the quarter, but that aside, the market has remained supported by corporate demand from developed markets.
  • This has a lot to do with the upgrade of PCs from XP to Windows 7 as well as a normalisation of inventory compared to this time last year when vendors were extremely cautious.
  • In anticipation of a more normal Q414E, guidance was a little ahead of expectations with revenues of $14.2bn-$15.2bn (midpoint $14.7bn) forecasted.
  • This compares favourably with the consensus which is expecting $14.5bn in revenues in Q414E.
  • The take home message from these figures is that the PC market remains steady thanks to the corporate upgrade cycle.
  • I am reasonably comfortable that Windows 10 will enable that cycle to remain steady and that the PC market is not about to start declining again.
  • Against this backdrop I see opportunity.
  • The most significant event during the quarter was the launch of the Core M family of products which I think are key to changing the PC landscape.
  • The Core M family are 14nm processors that use Intel’s 3D transistor technology and come with a meaningful power efficiency improvement.
  • This means that for the first time, PCs no longer need fans, enabling all the power of a laptop to be put into a form factor like the iPad Air.
  • Using Core M, the Microsoft Surface Pro 3 could be reduced in thickness by 2mm and weight by 200g.
  • This would make it 7mm thick with a weight of 600g. By comparison the iPad Air is 7.5mm thick with a weight of 469g but it only has 9.7inch screen compared to the SP3 at 12 inches. ,
  • 7mm thick and 600g is pretty much what I am expecting for the Surface Pro 4.
  • Having the full power of a laptop in a 12” tablet that weights the same as the iPad renders the laptop form factor obsolete.
  • The only reason to have the keyboard physically attached to the screen is to create space for the components and the battery.
  • This is no longer necessary and users no longer have to make the compromises in terms of ergonomics and ease of use when it comes to using portable computers.
  • Unfortunately, users have been making this compromise for 30 years and the marketing departments of Microsoft and the OEMs are so blinded by legacy that they have yet to realise that the laptop form factor is now obsolete.
  • These new devices are in fact “Portable Desktops” and offer a whole new series of use cases all of which are superior to a laptop.
  • Furthermore, there is no longer a need to buy a tablet meaning that the budget for laptop and tablet can be combined when considering the new devices.
  • The problem is that the users have no idea how much the computing experience improves with these devices and until they get it, the cycle is unlikely to take off.
  • This means that until the companies stop trying to sell these devices as laptops, users are going to remain horrified at the prices being charged and sales will stagnate.
  • I expect this problem to be solved eventually but consequently it is impossible to say when the replacement of the laptop will really begin.
  • Fortunately, the valuations of the two main beneficiaries, Microsoft and Intel, are not too demanding and so investors can afford to wait.

Google – Chasing ghosts

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Amazon is not the problem. Its Apple.

  • Amazon is what keeps Eric Schmidt up at night but in reality what he should be worrying about is Apple.
  • An interview during a recent visit to Berlin revealed that he worries more about Amazon than he does about Yahoo! or Microsoft.
  • Amazon is certainly more dangerous than either of these companies at the moment but the one that can do Google real damage is Apple.
  • This is because a significant portion of Google revenues are being generated by Apple devices which is something Apple would like to put an end to.
  • RFM estimates that in 2014E, $7.9bn or 49% of all Google’s mobile advertising revenues will be generated by Apple iPhones and iPads.
  • This is still greater than the $6.9bn generated by Android despite there being over 1bn Android devices in the market.
  • I also believe that if Apple could, it would remove all of Google’s apps from the app store, which would reduce Google’s ability to generate revenues on iOS to almost zero.
  • The problem is that Apple’s own ecosystem is not yet nearly strong enough and jettisoning Google would probably lead to a large number of users switching to Android.
  • There is no sign of Apple being even close enough to contemplate this move, but in the long run, I am sure that this is on the horizon.
  • This, combined with the poor user experience on Android, is why Google is taking more and more control of the Android user experience.
  • When Google has complete control, the open source (Android Open Source Platform) piece will be a tiny kernel with Google’s software sitting on top.
  • In effect Google will have migrated Android to look just like iOS or Windows Phone.
  • In this way Google will improve the user experience on Android thereby increasing usage and consequently its own ability to monetise its users.
  • Amazon is certainly a problem for Google but users in the fixed Internet still only spend a small portion of their overall online time shopping.
  • This means that Amazon is really only competing with Google in a small portion of the overall area within which people use search.
  • It’s a valuable area but it is a small piece of the pie none the less.
  • Amazon is trying to expand outside this core area but its strategy to date looks like a series of badly thought out, very expensive experiments.
  • Outside of its core market of e-commerce, Amazon currently offers very little threat to Google.
  • I am far more worried about Apple but its current inability to do anything about Google leaves the road clear in the medium term for steady growth in revenues and profits.
  • There remains some distance to go in Google and this remains one of my favourites in the ecosystem.

Tablets – The long goodnight

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The latest releases from Apple are unlikely to reignite growth.

  • The tablet market has been the fastest market to go from birth to rapid growth to commoditisation to maturity.
  • After a few short years of stunning growth, this segment already looks very mature with just 4% growth expected this year after 44% in 2013A.
  • I think that there are three main reasons for this:
    • First. It is the smartphone that is the driver of the digital ecosystem not the tablet. I have long held the view that a tablet enriches Digital Life and skews user behaviour more towards media consumption and gaming but it is not the defining device. Therefore the tablet is a nice accessory to have but it is not a must have. Users would rather have a smartphone.
    • Second: A lot of users who only consume content (browse, email, watch and listen) have purchased a tablet instead of a laptop. For these users this device makes much more sense and this shift has been a trend over the last few years. I see this trend coming to an end and consequently the demand for tablets has slowed.
    • Third: The creation by Samsung of a segment of the market with very large screens has eroded the bottom end of the tablet market.
  • The net result is that the market is likely to stagnate from here on and Apple’s refresh of the iPad on Thursday is very unlikely to change that outlook.
  • Furthermore, I suspect that Apple will not refresh the iPad Mini as the iPhone 6+ could really cannibalise demand for this product.
  • I expect that the new iPad Air to be lighter, thinner, with longer battery life and a faster processor but that’s about it.
  • The iPhone 6 is a big deal for Apple as it addresses what has long been a major gripe with earlier devices. Hence I can see strong replacement demand and switching from large screen Android products.
  • The new iPad Air is likely to be simply a slightly better version and consequently unlikely to trigger meaningful replacements or ecosystem switching.
  • Hence, I am looking for the next two quarters to be almost entirely driven by the iPhone 6 where Apple looks extremely well placed.
  • Although the longer term margin issues persist at Apple, the short term is looking healthy and I am happy to be in this one until at least the end of January.