Update: Amazon Reported Earnings after I wrote this and they were really bad, so I wanted to clarify something. I still think they are a buy. The real problems come from the ecommerce outfit, and AWS margins actually improved sequentially. The ad business bucked the trend with google and facebook’s disappointing results and the future seems brighter than ever. Although slowing growth in revenue, specifically at AWS, is concerning, given the macro environment, I view it as a temporary slowdown and not indicative of the long-term potential and fair value of the business.
When you consider the most dominant companies of our age, Amazon is definitely one of them. Their participation in the most innovative and lucrative sectors have historically given them a bit of a rich valuation, but as that has come down, we’ve been given the opportunity to own a very quality business for a fair price. We all know their main business of sending packages around the world at ridiculous speed… But besides ecommerce, they operate in advertising on their platform, operate retail stores (including Whole Foods), have a strong foothold in the video streaming space, and are the dominant player in the cloud market with AWS.
The company’s success in the ecommerce space is unparalleled, and their position is virtually unassailable, with the logistics network being impossible to compete with and growing daily. We see their success in this and Prime Video in the amount of pricing power they have demonstrated over Amazon Prime (Prices raised with little to no churn). However, the most exciting parts of the business are the high margin advertising and AWS businesses. The ad business allows companies using Amazon to promote their products, an has grown incredibly rapidly, up 25-ish% yoy, and 8-9% sequentially. It is this growth that will help propel part of the next stage for the company. At the same time, Revenue at the cloud segment jumped 33% in the most recent quarter and posted 26% operating margins. The value of cloud operations is unmistakable and so the increases in that business are likely to continue.
No one can argue that Amazon is not involved in the most exciting field in the world, so the question is simply what price we should pay for it. I want to do the sum of parts approach by valuing the cloud business first. Annualizing its quarterly revenue, and assuming that it can slightly grow operating margins, with substantially lower growth assumptions of 18% and 14% over the next 5 and 10 years respectively, it is worth almost 1 trillion dollars on its own (Update: Amazon as a whole trades for less than this after October Earnings). We can thus see why it is a good time to jump in. I’m a big fan of the long-term growth opportunities in the Saas space, and AWS is an incredibly profitable proven Saas model that I would love to invest in. The fact I get an incredibly profitable ad business doing 40 billion a year, and the biggest ecommerce player on top is literally just extra past the software valuation.
Besides this, I would also consider that Amazon has cash - debt of 50 billion, and almost 300 billion in property, plant and equipment. If you assume a third of it is liquidatable (to also account for depreciation), you are really paying about 750 billion for the company - making it an absolute bargain. Coming back to the software valuation, that would drop estimates to 16% and 12% growth with much lower p/e values as a result. The company as a whole, considering likely 20% margins in the ad business, and the potential in ecommerce and prime continuing to be high, is likely closer to 1.3Trillion without incorporation cash or properties, giving amazon a fair value closer to 1.4 trillion. Given I’m paying basically half that I’m thrilled to be a buyer.
By: Mateo Gjinali
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