Amazon.com Inc: Why The VMware Deal Is Great For AWS And AMZN Stock

  • Amazon has carved a cloud partnership with virtualization company VMware.
  • The partnership will help AWS offer its first true hybrid cloud solution.
  • The new partnership marks a big paradigm shift in Amazon's approach to the public cloud.

Amazon (NSDQ:AMZN) stock has tanked more than 6% over the past 30 days, eating into the gains that had propelled the stock to an all-time high of $847. The downtrend was triggered by the company's Q3 report where it narrowly managed to beat top line expectations but badly missed on the bottom line after posting EPS of $0.52 vs. $0.78 consensus on the Street. The company's recent announcement that it had struck a significant cloud deal with Vmware (NYSE:VMW), widely considered a market leader in private clouds, did little to stem the tide. Here's why that's surprising.

It's perhaps ironic that the same thing that has helped AMZN turn a profit consistently over the past six quarters is also partly responsible for the company's lower than expected profit - AWS. Amazon has been spending tons of cash on AWS capital expenditure and capital leases, with sources releasing estimates that Amazon, Microsoft (NSDQ:MSFT), and Alphabet Inc-C (NSDQ:GOOG) combined spent ~$30 billion on cloud investments over the past 12-month period ending Sep. 30 2016. That's a 12% year-over-year increase compared to the previous year's corresponding period. With Amazon continually building out its AWS infrastructure network around the world, investors should expect that trend to stick around for many quarters to come.

AWS property and equipment capital expenditure

AMZN-3_new

Source: The Next Platform

The other big reason why Amazon's profitability has come under lots of pressure lately can be chalked up to the company's heavy investments in the Indian ecommerce space. In a previous article, I had discussed the reasons why Amazon has failed to make an impact in China ecommerce and now plans to double-down in India instead. The company invested $2 billion in India in 2014-2015, and had announced its intention to invest another $3 billion over the next 12 months.

Also Read : Amazon.com Inc: Why I Would Buy AMZN Stock Post Q3 Earnings

Amazon-VMware cloud partnership

Amazon and VMware have formerly announced a cloud partnership about a week after Amazon held its third quarter earnings call. The new cloud service, dubbed "VMware Cloud on AWS,"  will be built on AWS and will encompass VMware's still-popular vSphere virtualization platform. The cloud will be managed and sold as an on-demand elastically scalable solution.

For a long time now, Amazon and VMware have promoted diametrically-opposing cloud strategies, with AWS having a strong emphasis in the public cloud while VMware is good at building private cloud partnerships. Although AWS customers can use its Direct Connect Service to build a bridge between their private data centers and AWS, but it's not possible to build a true hybrid cloud on AWS.

It's perhaps, this lack of a proper hybrid cloud strategy that has been slowing growth for AWS. AWS posted revenue of $3.23B for the third quarter, good enough for 55% year-over-year. Whereas that kind of growth still looks impressive, it's about 20-percentage points lower than where it stood six quarters ago.

AMZN-2_new

Source: Recode

Microsoft does not usually disclose Azure revenue numbers though it does report year-over-year growth. During the last quarter, the company announced that Azure grew 116%, marking the fourth straight quarter of triple-digit revenue growth by the cloud. In actual revenue numbers, Azure is still much smaller than AWS, with analysts throwing off estimates of ~$800M per quarter. Microsoft's total cloud revenues including Office 365 rival AWS in size though. One big reason why Azure has been growing so fast is because of its popularity in the enterprise, which in turn is partly due to the ability of users to host their workloads on Azure while still allowing them build on-premise private clouds to host their sensitive workloads.

Also Read : The Stock Market Won't Crash And These Charts Confirm It: Amazon.com (AMZN), Apple Inc (AAPL), Microsoft (MSFT)

Amazon has for long been an advocate for an ''all-in'' cloud strategy. But whereas some organizations are more than happy to have AWS host all their workloads,though many more will continue operating in a hybrid mode for a long time. The VMware partnership will go down as Amazon's first real attempt at a hybrid cloud solution. As the undisputed leader of server virtualization, VMware still has lots of customers tied to its legacy solutions including vSphere, VSAN, and NSX. Before the AMZN partnership, VMware customers were forced to make a binary decision between continuing using VMware's network infrastructure and migrating their workloads to AWS since the two are incompatible. The new arrangement now allows them to enjoy the best of both worlds.

VMware formed a similar cloud partnership with International Business Machines (NYSE:IBM) in February. The company recently announced that more than 1,000 of its customers had already migrated their VMware workloads to IBM's cloud. With AWS being a much bigger player, you can expect the momentum to be much greater for the new cloud partnership.

Investor takeaway

AWS has for long lacked a proper hybrid solution. But whereas the momentum for organizations to shift to the public cloud remains strong, many more companies are preferring a hybrid approach. The new partnership with VMware will give a proper entry point for such customers and make AWS an even more viable option for more enterprises.

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