- Amazon finally removed the curtain of confidentiality from its cloud computing division, AWS.
- With an impressive sales growth and amazing operating margin, AWS is a major factor in Amazon’s profitability.
- AWS received much attention lately and had a significant impact on the company’s stock price and analysts’ price targets.
For years, Amazon (NASDAQ:AMZN) kept the financial figures of its cloud computing division, AWS, confidential and refused to disclose any financial information on the business. Most analysts estimated that Amazon Web Service’s revenues are reported mainly under the “North America – Other” segment in Amazon’s PnL and used some adjusted version of these figures for any business analysis related to AWS. Most analysts provided pretty accurate estimates of AWS revenues based on the assumptions. However, they were only estimates, and their validity was vague. Even though most analysts presented similar figures for revenues, on the profit side, it was a complete chaos. Some analysts assumed a 5% operating loss, some assumed a 10% loss, and some assumed operating profit. These differences caused AWS profitability analyses to be spread around, and each of them had a different impact on Amazon’s stock price.
Putting the hardware business and its inherent flaws aside, Amazon has two powerful assets: its e-commerce platform and its cloud computing business. Keeping AWS financials confidential had more downsides than upsides for the company that used to mention and discuss AWS' business situation frequently but never provided any financial numbers to support it. It was clear that Amazon could not have continued this for long, as AWS came to constitute a more significant portion of the company’s financials, and speculations about its profitability damaged the stock price.
AWS financial analysis: Revenues
In Q1’15, for the first time, Amazon revealed its AWS financials as another segment alongside the North America and International segments. This segment will continue to include, mainly, revenues from retail sales on the Amazon.com platform while AWS consolidates all cloud computing business financials. In an earlier article about Amazon’s cloud computing offering, I assumed AWS generates around $1B a quarter and grows at a quarterly rate of 10%. These estimations were not that far from AWS’s actual figures of $1.5B in Q1 ’15 and 11% quarterly growth.
The $1.5B revenues AWS generated in Q1 ’15 accounted for 7% of the company’s total revenues in the quarter. The first quarter of each year usually has the lowest revenues in any given year in the cloud computing/big data industry, so investors can assume that AWS revenue will increase in 2015 to more than a mere four times that of Q1. In 2014, AWS generated an annual revenue of $4.6B, which is 49% higher than 2013 and twice as high as the annual growth in the North American and International segments.
Unlike the North American and international segments that experience large fluctuation typical to e-commerce business, AWS presents constant increases as shown in Chart 1 below.
AWS financial analysis: Operating Profit
The AWS figure that attracts most of the attention is the 17% segment operating margin in Q1’15. This incredible number is well beyond any estimate provided and highlights the importance of AWS to Amazon. While North American and international segments present operating margins of 4% and -1% respectively, AWS is the most profitable segment by far.
In Q1’15, 83% of AWS revenue was offset by operating expenses that left only $265M of operating profit for AWS, which represents the 17% margin mentioned above. Most of the AWS expenses are infrastructure costs allocated from Amazon’s Technology and Content expense line while the rest of the non-infrastructure costs are allocated to North America and international segments.
Even though AWS had $1.3B in operating expenses in Q1’15, it did not include any stock-based compensation expenses that were not allocated to the segments and remained at the corporate level within the operating expenses' lines. Allocating 30% of the SBC under marketing, technology and content, and general and administrative expenses to AWS will lower the operating profit to $95M and drop the operating margin to 11%.
Nonetheless, AWS's operating margin (SBC excluded) is impressive and has a huge impact on Amazon’s operating profit: AWS contributes 37% of it even though it accounts for only 7% of the company’s revenue. The rest of the 63% is generated by the North America segment, while International provides no added value to the operating profit of Amazon.
AWS financial analysis: Valuation
AWS plays a central role not only in Amazon’s operating profit but also in its stock price fluctuations. Due to the impressive operating margin of the AWS segment, Amazon’s stock surged by 15%, and at least seven investment firms upgraded Amazon’s rating and price target. So, what is AWS's worth to Amazon? Based on AWS's historical sales trend, seasonal and quarterly fluctuations in the cloud computing industry, and conservative assumptions about future sales, I estimate that AWS will generate between $6.4B and $6.9B in 2015. Assuming AWS has a P/S ratio in the range of 7 to 10, the segment will have a market cap of $48B to $69B, which represents a third of Amazon’s market cap valuation.
AWS, Amazon’s web services division, was, until lately, shrouded in mystery because of Amazon's refusal to reveal any financial information about the business. AWS revenues and operating profit highlighted the central role this business occupies in Amazon’s financials; the segment accounted for only 7% of revenues, but it generated 37% of the company's operating profit. With a 17% operating margin (excluding SBC), and representing a third of the market cap of Amazon, AWS appears to be more vital to Amazon than it was previously assumed.
Disclosure: The information provided in this article is for informational purposes only and should not be regarded as investment advice or a recommendation regarding any particular security or course of action. This information is the writer's opinion about the companies mentioned in the article. Investors should conduct their due diligence and consult with a registered financial adviser before making any investment decision. Lior Ronen and Finro are not registered financial advisers and shall not have any liability for any damages of any kind whatsoever relating to this material. By accepting this material, you acknowledge, understand and accept the foregoing.