Amazon.com, Inc. (NASDAQ:AMZN) would certainly be a much less valuable company today without its cloud business, which is called Amazon Web Services (or AWS). And this should really be worrisome for investors, as there are ominous signs that AWS is coming under more pressure.
OK, before seeing why, it’s first important to get an understanding of the importance of the business for Amazon stock. The roots of AWS go back to 2002 and the irony is that there was much resistance from the board of directors for the effort. Shouldn’t AMZN be more focused?
Well, of course, CEO Jeff Bezos was spot-on yet again. With AWS, he proved to be much more visionary than many others in the enterprise software market.
As of now, AWS is the dominant player in the cloud industry, with a market share of over 30%. This is actually twice the level of its nearest rival, which is Microsoft Corporation (NASDAQ:MSFT).
During the latest quarter, AWS posted revenues of $4.1 billion, up 42% on a year-over-year basis. The operating income also came to a hefty $916 million, representing a 22% margin. To put this into perspective, the rest of the company’s North America business generated operating income of only $436 million on revenues of $22.4 billion. In other words, AWS is the main source of cash to fund the wide-ranging initiatives of Amazon.
No doubt, the company’s rivals know this — and are trying to starve AWS. To this end, Wal-Mart Stores Inc (NYSE:WMT) and Target Corporation (NYSE:TGT) are starting to move away from the service. Hey, what’s the point in subsidizing a competitor? After all, AMZN’s $13.7 billion acquisition of Whole Foods Market, Inc. has been a big-time warning sign of the company’s intentions.
It’s true that the pushback from WMT and TGT will probably not result in a significant drop in revenues. AWS has thousands of diverse customers in its base. But over time, the erosion is likely to dent the growth ramp. Besides, it would not be surprising if other companies in threatened industries, such as healthcare, also take steps to shift to alternative cloud providers.
But such moves are not the only threats to AMZN stock. Let’s face it, the competitive environment for cloud services is getting more intense. So far, it appears as if MSFT has made the most progress. The firm has leveraged its extensive assets, such as Windows, SharePoint and Office, to make a big play for the cloud. But there have also been smart acquisitions, such as for LinkedIn, which has provided a professional network of over 500 million members.
Yet, at the heart of the cloud strategy is the Azure platform, which allows for hosting of web sites and apps. And, yes, the business has seen torrid growth, with revenues spiking 97% during the latest quarter. Keep in mind that the overall cloud business is on track to generate over $20 billion in annualized revenues.
Although, MSFT is certainly not the only clear threat to AMZN stock. Over the past couple years, other mega tech operators have invested aggressively in the cloud category like International Business Machines Corp. (NYSE:IBM), Alphabet Inc (NASDAQ:GOOGL,NASDAQ:GOOG) and Oracle Corporation (NYSE:ORCL)
Bottom Line on AMZN Stock and the Cloud
Perhaps the biggest issue for AWS is that Amazon is becoming a sprawling, complicated organization. Just some of the competitive markets the company is gunning for include delivery, streaming, movie production, apparel and devices. On the other hand, many of the company’s cloud rivals have more focused businesses and can devote more attention and resources to fight for marketshare.
Granted, Bezos has been masterful in managing the complexities. But there is certainly a major vulnerability for distraction, which could ultimately impair the cash cow of AWS.
Tom Taulli runs the InvestorPlace blog IPO Playbook and is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.
