Amazon.com (AMZN) reported fourth-quarter results last week so I thought it would be an interesting time to take a closer look at the company.
For the year, Amazon reported $136 billion in revenues (up 27% from 2015) – a nearly 3x increase from five years ago. It’s worth noting that the growth rate accelerated by ~700 basis points in 2016. The business falls into three buckets: North American e-commerce (~59% of sales), International e-commerce (~32% of sales), and Amazon Web Services, or AWS (~9% of sales). To try and get our hands around the business, let’s look at e-commerce and AWS separately.
E-commerce
The company’s global e-commerce businesses reported ~$124 billion in sales in 2016 (an increase of 25% from 2015), with nearly two-thirds from North America. For some perspective, that's nearly 10x larger than Walmart’s (WMT) e-commerce business. Even that number is a bit skewed, because roughly half of Amazon’s business (measured by units) is from third-party sales.
On 3P transactions, Amazon only reports the net revenue (commission) it receives as opposed to the purchase price; it’s estimated that its fee is 10% to 15% per dollar of sales (as far as I know, that doesn’t include incremental revenues earned from services offered to third-party sellers like FBA). If we account for this factor, Amazon’s gross merchandise volume, or GMV, is somewhere in the range of $220 billion (assumes first-party and third-party transactions are the same size). Using industry data, this implies Amazon has a low teens share of global B2C e-commerce.
There's reason to believe Amazon’s competitive position is strengthening, particularly at home: according to Slice Intelligence, Amazon captured more than 50% of e-commerce growth in the U.S. in 2016. The company is using its dominant market position to fund continued investments in fulfillment capacity (it has doubled its network in the past three years), a push that will enable quicker deliveries at lower unit costs. Retailers that have struggled to keep up with Amazon over the past decade are likely to face an even tougher competitor in the coming years.
Amazon Web Services
Amazon Web Services (AWS) reported $12.2 billion in revenues, an increase of 55% from 2015. In addition, AWS reported $3.1 billion in operating income with margins increasing 630 basis points from 2015 (both metrics include stock-based compensation expense). As in e-commerce, Amazon has an enviable market position; according to Synergy Research Group, AWS currently has 40% market share of the public infrastructure as a service (IaaS) and platform as a service (PaaS) markets – a significant lead over Microsoft (MSFT), the No. 2 player in the space (measured by market share).
This leadership position, if maintained, will allow AWS to ride the wave of growth in cloud computing. Analysts at Goldman Sachs (GS) have been speaking with chief information officers (CIOs) and chief technology officers (CTOs) about this trend for the past few years with recent survey results suggesting we’re at an inflection point. In the most recent survey, CIOs expected 40% of workloads to move to the cloud over the next three years (from ~18% at the end of 2016); this is a meaningful upward revision from where expectations were six to twelve months ago. By Goldman’s math, the public cloud computing market could potentially increase to $140 billion by 2020 – a CAGR of more than 40%. If Amazon maintains its current lead, AWS will be multiples of its current size within a few years.
Conclusion
Amazon’s growth over the past few years has been astounding. When the market is disappointed by 20%+ revenue growth from a company with annual revenues of more than $100 billion (as was the case last week), you know you’re looking at a rare bird.
The biggest issue I have with Amazon is trying to get my hands around “normalized” margins. When I looked at this company a few years ago, I based my assumptions for the e-commerce business on reported results from leading brick-and-mortar retailers. Over time, I’ve concluded that this was too conservative – particularly after considering the impact of third-party sales (based on the numbers reported by peers, it’s safe to model EBIT margins in this business of roughly 30%; that assumes Amazon's cut is 4% of the gross transaction value).
In a recent appearance on CNBC, Bill Miller made an interesting comment:
“They’ve consistently maintained since the IPO that at maturity the retail operating margins will be well over 10%.”
I’m not sure what he’s referring to, but I think there’s a good chance he’s in the right ballpark. When I blend 1P and 3P margins (and account for the net sales mix), I come to a similar number.
As it relates to AWS, I’m less certain about the long-term margin profile (and top-line growth for that matter). To make our lives easier – and to avoid stepping outside of my comfort zone – I’ll simply use reported full-year 2016 EBIT margins of ~25% (the fourth-quarter came in at 26.2%).
If we assume the e-commerce business grows at a 15% annual clip over the next five years (a significant slowdown from recent levels), sales will be roughly $250 billion in 2021. At 10% EBIT margins, the retail business is capable of “normalized” operating income of $25 billion.
If we accept the AWS metrics presented above (40% CAGR), revenues could reach $65 billion in 2021. At 25% EBIT margins, AWS could report more than $16 billion in operating income.
For Amazon as a whole, that’s $41 billion in "normalized" operating income (I'm not saying Amazon will actually report $41 billion in operating income in 2021). Assuming a tax rate of 30%, after-tax earnings power would be just shy of $30 billion. If the number of outstanding shares continues to climb ~1% per year (impact of stock-based compensation), Amazon will have 505 million shares; based on those assumptions, normalized EPS would be ~$55 per share in 2021.
Here’s the thing I find odd as I work through this exercise: broadly speaking, I don't think those assumptions are too aggressive (maybe you disagree). In fact, the top line estimates could prove conservative (as a reference point, e-commerce penetration in the United States is still in the single digits). I don’t know many – any? – companies with more than $100 billion in sales that I’d model at a growth rate in the double digits - let alone approaching 20%.
This speaks to the unique nature of Amazon. It has put itself in position to dominate two huge markets (where scale matters) with astounding near-term growth rates. It’s impressive.
I’ll close with something investor Pat Dorsey once said that I find thought provoking:
“How many of you have bought something on Amazon without checking the price elsewhere? Okay, that’s 70% to 75% of you. Isn’t that an amazing statistic? How hard is it to click to another website? I’ve talked other places and that’s the same number of hands that go up. Trust matters more online. I give Amazon enormous credit for figuring this out early.”
Disclosure: Long Walmart and Microsoft.
