Are Amazon and Alphabet the New Apple?

barrons.com/articles/are-amazon-and-alphabet-the-new-apple-1477715802

10/29/2016
Photo: Getty Images
Technology trends can gain such momentum that they become unstoppable, offering spoils to the victors for years,
even decades.
Eventually, however, dominant tech trends often reach a period where their prevalence just begs for a revolution, an
overturning of the established order.
Thats the quandary Apple (ticker: AAPL) found itself in this week, as it sold another awesome 45.5 million iPhones,
topping expectations, in its fiscal fourth quarter ended in September. The forecast for this quarter is even better, with
revenue projected to rise more than expected.
But its shares sagged 2% on Wednesday, after Apples earnings report the night before, and ended the week down
2.5%. Despite decent expectations for the newly introduced iPhone 7 in the December quarterand even better
times ahead for what some speculate will be a radically different iPhone 8 a year from nowWall Street is
desperate to know whats next after the iPhone.
Apple, and its chief competitor, Samsung Electronics (005930.Korea), still dominate the market for smartphones,
with a collective 32% of units sold last quarter, according to research firm Strategy Analytics. Apples 12% share is
still measurably ahead of the third, fourth, and fifth players. Both companies continue to crank out profits as the
phone increasingly becomes a work tool as well as a lifestyle choice. It is a gadget whose dominance and relevance
seems unstoppable.
And so, when confronted with OK but not stellar results, Wall Street asked Apple chief Tim Cook last week whats
next.
Morgan Stanley s Katy Huberty pointed out to Cook that research-and-development spending at Apple has more
than doubled in the past three years, but sales growth has not seemed to reflect the investment. After the first annual
revenue decline in 15 years, Huberty wanted to know: Are R&D investments just less efficient than they were in the
companys history?
Cook answered tersely that theres a lot of R&D put into products that are in the development phase. Someone
else raised the matter of television. All of Wall Street remembers when an actual TV set was supposed to be Apples
next act. But the years have come and gone without a gleaming Apple TV set. Cook said last week that TV remains
an area of intense interest for the company.
But two days after the report, Apple unveiled not a TV set per se, but a piece of software to run on its existing Apple
TV set-top box that it calls TV. It is a guide that integrates the various video offerings streamed over the Internet.
Nice, but hardly the piece of living-room furniture some had been hoping would be next.
ANY NUMBER OF OTHER THINGS have been tossed about, such as cars and a product to compete with
Amazon.com s (AMZN) popular Echo home appliance. Analyst Steve Milunovich, perhaps expressing the general
exasperation on the Street, told Cook that some investors are antsy that Apple hasnt acquired new profit pools or
introduced a financially material new product in recent years.
The question is, said Milunovich, does Apple today have a grand strategy for what you want to do? Cooks
response: We have a strong sense of where things go.

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Maybe, but as the years stretch on without the giant new product category, the dominance of mobile seems as much
a prison for Apple, from Wall Streets perspective, as its constant triumph. As long as Apple keeps turning in
amazing numbers based on the dominance of the iPhone$9 billion in net income last quarter, and $16 billion in
cash generated from operations in just three monthsits hard to fault Tim Cook. But the shares, up 8% this year,
seem to need something larger, some grander vision if they are to keep delivering in years to come.
ANOTHER TREND that isnt slowing down is cloud computing, and last weeks earnings rush saw two great
examples of that. Thursday night, Amazon and Google parent Alphabet (GOOGL) both reported earnings, with very
different market responses. Amazon sank 5% on Friday, while Google rose fractionally. Amazon was punished for
having poor margins because it has decided to spend more on things such as buying video for its Prime subscription
service. That, and building warehouses: Its fulfillment centers saw square footage rise by 30%, year over year.
Google, on the other hand, was able to deliver admirable revenue growth of 20%. Moreover, its line item called
Other on the income statementthe one that includes its YouTube servicerose by 39%. Google also announced
a $7 billion stock buyback program, its first ever. Hence, Google was the steadier company, with a newfound
interest in investor friendliness.
An area in which both shone brilliantly was the cloud. Amazon, widely regarded as the top dog in cloud-computing
services by revenue, saw its Amazon Web Services sales rise by 55% from the prior-year period. Although thats a
figure thats slowed a little bit each quarter, its still way above both the 26% growth in Amazons traditional North
American e-commerce business and even the 28% in its overseas operations.
At $3.2 billion for the quarter, growing by more than 50% is quite impressive. Equally impressive, Amazon Web
Services operating profit margin is rising. It was at 31.6% last quarter, compared with 25% a year earlier.
GOOGLES CLOUD services are smaller in size than Amazons, with the company generally ranked third or fourth
in the market behind Microsoft (MSFT) or International Business Machines (IBM), depending on whose statistics
you use. But analysts credited that 39% increase in Googles other revenue in part to cloud, so its paying off.
Both companies, then, whatever their blemishes, are riding a wave of cloud computing that shows no signs of
stopping, just as Microsoft did a week earlier with its strong showing in cloud. As was said in this space back in
June, dominant companies arent disrupted every day, they tend to remain dominant for a long time, just as Intel
(INTC) did in the PC era (see Alphabet, Amazon: Corporate Chameleons, June 4).
Asking what might be next after cloud is probably a bit like someone asking, at the end of the 1990s, what comes
after the Internet: more Internet.
Unlike Apple, at least for now, the staying power of the cloud isnt a prison for Amazon and Google. Its an endless
gift for their shares.

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TIERNAN RAY can be reached at: tiernan.ray@barrons.com, www.blogs.barrons.com/techtraderdaily or

www.twitter.com/barronstechblog
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