Amazon (AMZN) is a fascinating company for many reasons and their latest investor relations move has gotten the markets excited about their stock once again (it’s up 57 points today alone as I write this). Bulls and bears on the shares have long had a disagreement about the company. Shareholders argued that Jeff Bezos and Co. were purposely “losing money” in order to invest heavily in growth and attain massive scale. Bears insisted that the spending was required to keep their customers coming back, and that if the company started to show profits the business would suffer dramatically. Regardless of which camp you are in, one thing is clear; Amazon chooses growth over profitability in the short term if it thinks they can be successful.
So when the company announced that it would break out the financial results of its Amazon Web Services (AWS) business segment for the first time in its nine-year history starting in 2015, the consensus view was that the division would show losses. After all, if Amazon embraces short term losses in exchange for growth, and AWS is its fastest growing business, why would you think otherwise? So imagine the surprise last evening when Amazon announced that AWS is profitable, and not just a little bit. Operating margins for AWS during the first quarter of 2015 were 17%. Add back an estimate of depreciation expense and EBITDA margins are likely approaching 50%. And the stock price is rocketing higher on the news.
All of the sudden it is possible that Amazon does not hate reporting profits (some have speculated that income tax avoidance is a motivating factor). Instead, maybe they are being sincere and simply invest capital when they think they have a good reason, regardless of whether it results in short-term GAAP profits. And maybe the thesis that Amazon’s business model does not allow for profits is incorrect. That is surely what investors today are thinking. Given their corporate philosophy, there is no reason Amazon should be running AWS at a large profit, but they are. Why? Perhaps they have built a very good business. Simple enough.
The implications for the stock are important. We now have evidence that AWS is probably worth the $60 billion or so that the bulls have long thought. At the lows of the last year (below $300 per share), Amazon’s total equity value was only a little more than double that figure ($130 billion). The bears on the stock will probably stick to their guns that the current share price (approaching $450) is irrational, but if you actually run the numbers, it is not that hard to value Amazon in a range of $200-$250 billion based solely on what we know today, given that non-AWS annual revenue will approach $100 billion this year and AWS alone can account for 25-30% of that valuation. The stock is getting close to my personal fair value target, but is not quite there yet. And given that Amazon could very well surprise investors more going forward (they don’t exactly set the bar very high), I am not in a big rush to sell.
Full Disclosure: Long shares of AMZN at the time of writing, but positions may change at any time