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Amazon’s (AMZN) Cloud Segment Remains a Major Growth Driver for the Stock

support@smarteranalyst.com (Ben Mahaney)

Amazon (AMZN) continues its momentum in the cloud segment where it produces the bulk of Amazon’s profits, or roughly half of profits. The growth in the cloud business is outpacing its retail business, and it’s driven by on-going efforts by various IT chiefs to reduce cost and improve efficiency in IT spending. This on-going transition to public cloud is anticipated to continue based on the ease of adopting the AWS suite, and the lack of vendor lock-ins. This is great news for shareholders, as the profit narrative, and profit growth is entirely dependent on AWS.

In FY’18 the domestic and international segment when combined contributed $5.125B in operating income, whereas the AWS business alone produced operating income of $7.296B. AWS contributed 60% of total profits last year, and with its current growth rate, it’s likely to produce more than 65% of profits in the upcoming fiscal year. Given its heightened dependency on the IT business, it’s good to gauge where IT spending is likely to trend.

Amazon’s stock has remained a little more range-bound when compared to various other tech firms, so anticipated growth in its cloud business has become of greater importance.

Amazon has shifted from strictly a revenue growth, market share growth narrative to more of a profit narrative due to the attractiveness of revenue and profits from the AWS business. AWS produces a 28.4% operating margin versus its U.S. retail business that produces a 5% operating margin (just in terms of USA) whereas international retail lost money. Excitement has shifted to AWS though the retail business could improve in profitability assuming they reduce losses internationally (though this seems unlikely as Amazon continues to use pricing as leverage to whittle down competition internationally).

The bigger narrative is the hemorrhaging of revenue from pre-existing IT companies like Oracle, IBM, Dell and so forth.

Source: Morgan Stanley

Amazon and Microsoft are expected to gain market share at the expense of Dell, Hewlett-Packard Enterprise, IBM, Oracle, NetApp and even SAP. The rest is of the pie continues to shift to Amazon and Microsoft. 28% and 26% of CIOs in the Morgan Stanley survey anticipate Amazon and Microsoft spending will increase whereas the legacy IT providers will experience more meaningful cutbacks this year among the base of respondents from the survey. Microsoft is anticipated to gain more spending share than Amazon over the next 3-years, but with Amazon Web Services already producing $25B in sales in FY’18, expectations for further migration, or expected growth should moderate given the already impressive scale of the business.

Source: Morgan Stanley

What this points out, however, is the sheer number of losers in the segment, where it’s quickly turning into a case where Amazon’s gains aren’t coming to at the expense of its number two rival Microsoft, but perhaps everyone else. When you just combine the preferred vendors for hybrid-cloud environments its turned into a two-horse race, Amazon accounts for 37% and Microsoft 34%, therefore the two combined represent around 71% of the entire hybrid-cloud market. The transition to these two vendors means the remaining will likely get left in the dust, as more and more companies opt to rent servers on demand, as opposed to hiring a labor force to manage their datacenters in-house.

This business model is attractive, but the business rationale for why companies are transitioning to just AWS or Azure has a lot to do with the expected efficiency gains. The more Microsoft and Amazon get rewarded and scale their datacenters the less and less scale the other competitors have, and the more likely the two companies can continue to order parts at discounts or introduce other features to keep costs lower than competing cloud providers.

This bodes well if you’re an Amazon shareholder, especially because the profit and growth narrative has shifted mostly to AWS lately. But, if you’re still invested in other IT providers, things are expected to get uglier.

To read more on the nitty gritty of what’s going on in the tech industry, click here.

 

Disclosure: The author doesn’t own a position in either Amazon or Microsoft.

Read more: Amazon Makes Strides in the Grocery Game; Stock Remains a Strong Buy

 

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