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Amazon’s biggest source of operating profit is its cloud computing business — AWS. That has not escaped rivals — most notably Microsoft which last October won a $10 billion contract with the Pentagon.
I think investors should expect Amazon to take a profit hit due to market share losses at the hands of AWS’s rivals. Also, having suffered a significant slowdown in its stock market momentum over the last 16 months, I see no catalyst for buying its shares.
(I have no financial interest in the securities mentioned in this post).
Cloud is a Large, Fast-Growing Industry
Gartner expects the worldwide public cloud services market to grow 17% in 2020 to $266.4 billion — from $227.8 billion in 2019. Gartner breaks this down into five components — the largest of which is the roughly $100 billion (2019 sales) cloud application services industry.
Amazon Dominates But Rivals are Making a Dent in its Dominance
Amazon’s share of the cloud is some two-and-a-half times greater than that of its nearest competitor but its lead is getting smaller. Between 2016 and 2018, AWS’s share dropped from 53.7% to 47.8% while Microsoft’s share increased from 8.7% to 15.5%, according to Gartner.
This rivalry — most recently epitomized by Microsoft’s win of the so-called Joint Enterprise Defense Infrastructure (JEDI) contract which could be valued at $10 billion — may shift more market share from AWS to Microsoft. Amazon has filed a case in the U.S. Court of Federal Claims against the Pentagon’s decision, claiming bias against the company’s bid, according to the Wall Street Journal.
AWS CEO Andy Jassy threw shade at Microsoft during its annual customer meeting in Las Vegas in December. According to the Journal he accused Microsoft of copying AWS’s innovations and rushing the copies out to customers to “say we have it too,” according to the Journal
Microsoft has counter-attacked. Microsoft has been telling potential clients that if they use its Azure service, they won’t need to worry that they are placing valuable customer data or product information with a rival who can use the data to compete with them. According to the Journal, Julia White, corporate vice president of Microsoft Azure, said in an October interview that unlike with AWS, Azure is “not about using customer data and competing with them.”
Gartner sees the potential for many companies that have not yet adopted cloud computing to do so with Microsoft. According to its research director, Raj Bala, “A fair number of these customers will certainly end up at [Microsoft’s] Azure, because they...run a lot of Windows, they tend to want to play it safe, and the decision makers in that camp tend to favor Azure to a large extent,” noted the Journal.
Amazon Derives Most of its Profits from AWS
AWS’s success is due in part to its early embrace of the cloud. Over 10 year ago, Amazon was investing in computers and servers to run its core business and realized it could rent that capacity to other companies — which would save them the investment of building their own computing systems.
AWS became Amazon’s profit engine (accounting for about $7.3 billion in operating profit or 73% of Amazon’s 2018 total). Companies hired AWS to store their data and by the end of September 2019, it represented 13% of Amazon’s sales and a whopping 62% of its operating income, according to its most recent quarterly report. AWS revenue grew 38% in the first nine months of 2019 as its operating income increased 41%.
While competition is clearly cutting into AWS’s market share, it does enjoy five competitive advantages. As I wrote in July 2018, these include
- Provide industry thought leadership. AWS is something Amazon knows well. Jeff Barr, AWS chief evangelist explained to me that by the time it launched AWS, Amazon believed that it excelled at "operating massive scale technology infrastructure and data centers."
- Hire hundreds of CEOs. Now that AWS is a multi-billion dollar business, Amazon CEO Jeff Bezos can't keep it in the lead without help. So Amazon hires what it calls builders — people with CEO-like skills — for each of its AWS services. "On our development team we hire hundreds of CEOs. They each own their own destiny. We show them an opportunity and they pick it up, study it, and build a business around it," said Barr.
- Listen to customers and build what they need quickly. Rather than dream up new products in the lab, AWS listens to customers and launches solutions to their problems quickly, gets feedback, and makes the services better. As Bezos says, “Our customers are delightfully dissatisfied, they always want something more.”
- Cut prices and let customers know how to save the most money. Amazon customers remain loyal because AWS looks at its customers’ utilization of the service and suggests that they stop spending on components that they don’t use. “Over the last couple years, we've sent out 2.6 million notifications that have led to actual annualized savings of $350 million a year from the Trusted Advisor service. That is in addition to the savings from the price cuts," according to Barr.
- Monitor results weekly. Amazon keeps close tabs on how things are going every week. AWS sets weekly goals for its managers and tracks thousands of metrics. As Barr said, “If they do not meet a goal, the general manager must explain to Jassy why and what they are doing to get back on track."
Is Amazon Stock Overvalued?
Amazon could — as it has done many times in the past — find a new growth vector to make up for a possible AWS growth slowdown. Over the last 25 years, that ability has helped propel its shares. Indeed between its May 1997 IPO and July 2019, Amazon shares soared more than 129,000%.
However in the last 16 months, the growth trajectory of its stock has been less impressive. After peaking at $2,205 in August 2018, Amazon stock has bounced around and as of January 3 traded about 7% below that all-time high.
At the moment Amazon shares appear richly valued. Its price-earnings to long-term growth ratio (PEG) is near a lofty 3.0 — with a price-earnings ratio of 83 and earnings expected to grow at a 28% annual rate for the next five years.
Its stock is not a buying opportunity.
"profit" - Google News
January 06, 2020 at 08:54PM
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How Much Of Amazon’s $7.3 Billion AWS Profit Will Rivals Win? - Forbes
"profit" - Google News
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