Over recent years, Amazon shares have been a Wall Street darling. The online retail franchise is what Amazon is most widely recognized for, but the most profitable business segment—Amazon Web Services (AWS)—has nothing to do with online retail. Amazon Web Services is a cloud services platform offering compute power, database storage, content delivery, and other functionality to businesses.
AWS is Amazon’s fastest growing business segment and its crown jewel. While the retail operation barely turns a profit with margins of less than 1%, AWS boasts margins of more than 25% and growth in excess of 100%. If it were not for AWS, Wall Street may have already given up on Amazon’s ever expanding and seemingly not-for-profit retail operation.
Amazon surely deserves credit for its success in cloud services, but its continued dominance in the space is far from certain, and investors may be paying far too high a premium for profit growth that may prove elusive. Amazon’s strong performance in cloud services has thus far been due to a lack of competition (at least in part). That, however, is beginning to change. Microsoft is stepping up its game and so is Google. IBM is also in the cloud services space and is tying its Watson Artificial Intelligence program in with its offering. All three companies are formidable competitors that have the financial wherewithal to drive down margins and steal market share from Amazon.
Bloomberg BusinessWeek is also reporting that some of Amazon’s current clients who are also competitors to the firm’s retail operation, are looking to either move away from the cloud or move to another cloud provider that doesn’t have a competing retail business.
Here is more from Bloomberg Businessweek.
At a February conference for online retailers, the founder of skin-care startup Beauty by Design, David Weissman, tried to kick off an insurrection. His rallying cry: Ditch Amazon Web Services, because the division’s profits help support Amazon.com’s e-commerce business, a direct competitor to almost every company present at the gathering.
The call to arms at the eTail West conference drew laughter, but it does underscore the quandary many retailers face as they weigh whether to keep buying servers and other computing services, or instead sign up with a cloud provider. Amazon’s “retail business is low-margin, and they make up for it with AWS,” Weissman says. “It’s very profitable revenue that’s being used to subsidize other businesses.” More companies want to move at least some parts of their business to the cloud, so they can handle extra-heavy sales volume around Christmas, Valentine’s Day, or other holidays, and to take advantage of the sophisticated data analytics many cloud vendors offer. While AWS is far and away the market leader, chief information officers at some retailers say they chose to go with Microsoft’s Azure, Alphabet’s Google Cloud, or IBM’s BlueMix rather than entrust important parts of their business to a rival.
None of this offers a particularly sanguine outlook for a stock that trades at 179X last year’s earnings.
Jeremy Jones, CFA
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