What An AAPL Loss Means for AWS & Amazon.com, Inc. Stock

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During the final two days of this week, more than $10 billion in market capitalization fell from Amazon.com, Inc. (AMZN). Ironically, markets reached their highs for 2016 on those same days.

What An AAPL Loss Means for AWS & Amazon.com, Inc. StockThe reason for this loss in Amazon stock was a report from tech site CRN that Apple Inc. (AAPL) is taking its cloud infrastructure (laaS) business elsewhere, specifically to Alphabet Inc (GOOG, GOOGL).

Amazon Web Services, or AWS, has been key in supporting Apple’s iCloud and other cloud-based services for years. Reportedly, AAPL spends about $1 billion annually on AWS.

Therefore, if AWS actually loses its ties with Apple, could Amazon stock fall further? Or, is the loss already priced into AMZN?

What Losing AAPL Means for AWS

First, the report suggests that AAPL is spending about $400 million to $600 million on the Google Cloud Platform, which means it is still a customer of AWS. So if this story is true, AMZN is not losing AAPL entirely.

Bernstein Research estimates that AWS will grow 57% in 2016, reaching revenue of $12.4 billion. If AWS were to lose this business, that growth rate would still be an impressive 50% to 52%. When you consider these facts, the $10 billion that Amazon stock lost in value late last week takes into account the loss of Apple — which, might I add, is just a rumor. We can’t forget that CRN’s sources may be wrong.

A Bigger Problem for Amazon Stock

While Amazon stock likely took the bulk of its beating thanks to the potential loss of AAPL as a customer, the reaction of investors highlights a much bigger problem. That is Amazon stock’s reliance on the performance of AWS, and how quickly speculation can push it lower.

Keep in mind, AMZN is expected to create almost $130 billion in revenue during 2016. This means that AWS will account for less than 10% of total sales. However, it might very well be worth half of Amazon’s $250 billion market capitalization, possibly more.

Back in April of last year, I explained that AWS could be worth upwards of $85 billion in the free market, as a standalone entity. This came after Amazon reported earnings for AWS, and its performance unveiled much greater profitability and faster growth than investors and analysts expected.

Since then, AWS’s revenue and margins have grown even faster. Therefore, it is very possible that AWS is worth $125 billion to Amazon stock. If we assume that AWS can maintain an operating margin near 29%, a $125 billion valuation implies a price-to-FY2016-sales ratio of 10 and a price/FY2016 operating income of less than 35.

Nevertheless, with so much of Amazon’s valuation tied to AWS, and so much of AWS’s future being speculative, it creates a perfect storm for downside risk in the event of bad press, or underwhelming performance. Fact is that AWS may have captured more than 70% of new revenue “flow share” during Q4, according to Bernstein, but the likes of Google, Microsoft Corporation (MSFT) and International Business Machines Corp. (IBM) are all coming on strong.

Yes, AWS has far more capacity and is far larger than any of its competitors, but as pricing becomes more aggressive and competitors invest to increase their capacity, it is likely that AWS will lose some customers over time.

And because of its valuation, investors should expect more days where billions of market capitalization get wiped out in response to rumors, true or not, related to AWS.

As far as I’m concerned, that’s a good reason to sit on the sidelines.

As of this writing, Brian Nichols owned shares of AAPL.

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Article printed from InvestorPlace Media, https://investorplace.com/2016/03/what-an-aapl-loss-means-for-aws-amazon-stock/.

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