Amazon's Strategic Dominance: Analyzing Recent Market Moves and Long-Term Potential

Why I Can't Stop Buying Amazon (NASDAQ:AMZN)

Yesterday I published an article lamenting the rapid bounce back that we've seen in recent weeks because I was hoping for more time to buy beaten down blue chips into macro weakness. Well, one thing I can't complain about is Amazon's (NASDAQ:AMZN) post-earnings sell-off and the incredible opportunity that investors had recently to buy this big-tech stock at bargain barrel prices. When the market gets shaky, I find solace in secular growth trends. It can be difficult for me to allocate capital to the market when there isn't a dividend involved because of my love of passive income and the organic compounding process that plays out over time with dividend growth and dividend reinvestment. But, as I've said many time before, Amazon's growth runway is special. It's incredibly long. I think there's a lot of opportunity for margin expansion here. And most importantly, I think the market is mispricing AMZN shares in a major way. I highlighted Amazon as a Top Pick For 2024 at the end of last year (alongside Nvidia and Alphabet), saying that shares had upside potential in the 50% range. In February I wrote an article saying that the playbook for 2024 was no different than 2023's...big-tech would be the big winners. At the time there were plenty of naysayers who called those picks unoriginal, but that article has aged pretty well. Both AMZN and GOOGL are up ~18% on a year-to-date basis and NVDA is up by nearly 160%. All 3 stocks are beating the market and the overall basket is crushing it. I'm heavily invested in all 3 stocks so 2024 has treated my portfolio well. Yet, even after these strong gains, I'm still bullish on these companies. But to me, AMZN is the best value of the bunch, which is why I've been accumulating it so aggressively in recent weeks. Recently, I highlighted Amazon as one of my Top 20 Highest Quality Companies In The World. In that article I noted that not many of those blue chips were attractively valued. Many of them were highly overpriced. But Amazon is an exception. And I still think AMZN is cheap today, having regained its post-earnings losses. This company continues to be one of my highest conviction long-term stock picks because of the unique combination of high growth and discounted value. So today, I'll analyze AMZN's most recent quarter and why I liked it so much (despite the market's negative reaction). I'll also discuss my fair value estimate for shares, showing why I believe that Amazon offers strong upside potential from here. Amazon posted second quarter results on 8/1/2024, missing consensus estimates on the top-line but beating them on the bottom. AMZN's Q2 revenues came in at $148b, which missed Wall Street's estimate by $760m. This shortcoming factored into the stock's post-earnings sell-off; however, I think it's important to note that this $148b revenue figure still represented 10.2% y/y growth. How amazing is that? A company posting nearly $150b in quarterly revenue growing at a 10%+ rate...these are statistics that would have seemed impossible a couple of decades ago. AMZN did beat on earnings, posting EPS of $1.26 which was $0.23/share above consensus estimates. Amazon's retail segments performed well during the quarter with North American sales coming in at $90b (up 9% on a y/y basis) and International sales coming in at $31.7b (up 7% on a y/y basis; or 10% excluding negative forex impacts). I think both of these results were fine. The market disagreed, looking for double digit growth there as well. Yet the retail side of Amazon's business isn't what excites me. It's essentially an afterthought when looking over AMZN results. If anything, I think AMZN's online results can speak towards macro trends regarding consumer strength/weakness/sentiment; however, at the end of the day, these are fairly low margin businesses (though, I'll note that the North American income margin has risen nicely over the past year from the 1% range to the 6% range during the past 4 quarters) and therefore, something that I'd avoid if it wasn't for the other segments of AMZN's business. Yes, there are secular tailwinds behind eCommerce but I'm not interested in mid-single digit margins, no matter the revenue base. What I am interested in on the consumer side is the advertising business (which certainly benefits from Amazon's size/scale on the retail side of things). Oh, and of course, I love the AWS cloud segment. Honestly, I think there's an argument to be made that this business alone justifies Amazon's entire market cap. With that in mind, who wouldn't want to receive AMZN's retail + digital ad business for free? I'll start with AWS because cloud computing is still one of - if not the most - important market in the tech space, powering all of the major trends that we're seeing in the space (including AI/automation). Amazon Web Services is the largest/best cloud provider in the world, in my opinion, and its growth just accelerated from 17% to 19%. That 19% growth rate is in-line with MSFT's intelligent cloud growth, but more impressive, in my opinion, due to AWS's larger size. Yes, Alphabet's cloud segment grew faster during the most recent quarter at nearly 29%; however, we're talking about a $40b annual run-rate there compared to AWS's $105b annual run-rate. So while GOOGL may be taking a bit of share, it's still a distant third place and has a lot of catching up to do. AWS's operating income was $9.3b during the quarter, representing an operating margin of approximately 35%. Therefore, AWS is a business with $100b+ of recurring sales (growing at nearly 20%) that generates ~$40b of annual income (growing at ~70% right now). If this was a stand alone company where would the market cap be? It might not be AMZN's current $1.88 trillion, but I think it would be close. Remember...Nvidia's market cap is larger than AMZN's right now; yet, AWS is a larger business in terms of sales and cash flows that probably has better long-term growth potential as well. And on top of the AWS behemoth, Amazon also has a leading digital advertising business (another absolute cash cow because of the connection to its retail segment). During Q2 AMZN's Digital Ad segment produced $12.77b in sales (up 20% on a y/y basis). The company doesn't break out its digital ads profitability metrics, though management is clear that it's a big part of its profit plans overall and I'm sure that ongoing growth in the Digital Ads segment is contributing to the records cash flows that AMZN is generating. Oh, and it's probably worth mentioning that AMZN's subscription services business (Amazon Prime, Prime Video, etc) posted $10.8b in sales last quarter, up 10%. People love companies like Costco (COST) because of the defensive nature of its subscription sales on top of its retail numbers; well, AMZN is following the same path very effectively. All in all, this company is a cash flow machine. Management has shown before that they can pull profit levers anytime they want (instead of heavy capex investments) and they did that during Q2. People love to nitpick AMZN about small misses here or there, or share-based comp issues, or macro environment concerns, but to me, this is all that matters: Give me cash flows like that and I'm going to be a buyer. Especially at AMZN's current valuation. For years, people have complained that AMZN is too expensive. Yet, all the stock does is defy that suggested gravy, floating higher. I think the problems that so many people have with this stock from a valuation standpoint stems from paying attention to the wrong metrics. I track AMZN's earnings-per-share, but it's not the primary metric that I use to evaluate the stock. AMZN's EPS ebbs and flows because of its inverse relationship to the company's massive capex endeavors. At the very least, it can be frustrating to track. Also, these unpredictable figures can make the stock difficult to analyze. Thankfully, there's another metric that's more consistent. I'm talking about operating cash flows. AMZN's OCF growth has been much more consistent over the years and I don't think it's a coincidence that the company's P/OCF multiples have been fairly stable over the years as well. As you can see, AMZN's y/y OCF growth has only been negative once during the past decade (during the COVID-19 disruption). The same thing cannot be said of the company's non-GAAP EPS, which has seen major swings...down 188%, up 340%...up 55%, down 108%, up 1200%...etc, etc, etc. This EPS volatility makes it difficult for anyone to declare where Amazon shares should trade (regarding their P/E multiple). Yet, the relatively consistent OCF data makes it a lot easier to compare the present (and future growth estimates) to the past, which is a major part of deciding where fair value lies. Above, you'll notice that for years, the stock followed the blue line (~25x OCF) and then in a post COVID world, AMZN appears to have been re-rated lower towards the 20x P/OCF level. Until the stock's recent pullback, AMZN had followed that 20x OCF multiple like a charm. Could we be witnessing the beginning of another downward re-rating? Possibly. But, since AMZN's ongoing OCF growth trajectory isn't all that different from its historical one, I think it's more likely that we'll see mean reversion back up to the 20x mark...or even that 25x area, both of which would result in massive upside from. 20x the consensus estimate for AMZN's OCF in 2025 would be $266/share (representing 48% upside potential). 25x that same 2025 consensus OCF estimate would be $333 (representing 85% upside). I'm not calling for a near-term double here, but I do think that very strong double digit upside is likely here. Being that AMZN's OCF is expected to grow by 19% next year and 26% the year after that, even if we don't see any multiple expansion from today's ~18x level over the next couple of years, a stagnant multiple would still result in ~25% annualized returns between now and the end of 2026 based purely upon fundamental growth. Because of this fundamental growth, I think the downside is fairly limited from here. If AMZN posts the OCF growth that Wall Street expects to see over the next 2 years and the share price moves sideways, then we'd be talking about an ~11x multiple on a stock growing its bottom-line at a 20-25% clip. That'd be ridiculous. No stock comes without risks. Obviously AMZN has to continue to execute on its growth initiatives while maintaining leadership in the cloud space for this OCF growth to play out. But, I have strong faith in this company's management team due to their ability to consistently execute over the years. I don't see any meaningful competition outside of MSFT and GOOGL entering into the cloud space (and AMZN has been able to hold them off for years). And lastly, and potentially most importantly, AMZN doesn't appear to be facing the same regulatory headwinds that several of tis big-tech peers do right now as far as potential anti-competitive practices goes. That removes a potentially large overhang above the stock price and if the issues that names like Alphabet, Apple, and to a lesser degree, Microsoft face right now get worse, then I could imagine a world where tech-hungry investors rotate into AMZN. I hate this anti-tech stance in DC. I think US politicians and regulators should celebrate our biggest, most innovative companies. But who knows...maybe these regulatory headaches will be the spark that leads to increased demand for AMZN shares (and therefore, multiple expansion). I think AMZN is worth about $240/share right now and therefore, even though I've been buying this company aggressively in recent weeks, AMZN remains at the top of my personal watch list. Don't be surprised to hear about me buying more Amazon in the near future. Especially as the market's rally causes value to dry up elsewhere. I'll be happy to push my position even further overweight because of the attractive risk/reward that I see when I look at this ticker. ~30% upside with limited downside expectations? I'll make that bet any day of the week.

Why Amazon's Dip Should Be Bought (NASDAQ:AMZN)

Looking for more investing ideas like this one? Get them exclusively at Beyond the Wall Investing. Learn More " Since I first initiated my coverage on Amazon.com, Inc. (NASDAQ:AMZN) stock here on Seeking Alpha, my ratings have fluctuated between "Buy" and "Hold", depending on market developments and my assessment of the company's nearest prospects. In my last article, published just over a month ago, I provided my earnings preview and maintained my "Buy" rating ahead of the Q2 2024 report. At the time, I anticipated that Amazon had a good chance of exceeding market expectations for EPS, driven by "momentum in AI, cloud technologies, and the recovery of the retail sector in general." As it turned out, AMZN did surpass the EPS consensus forecast; however, its actual revenue fell short of expectations, which led to increased pessimism and a slight correction in the stock price immediately following the report. After the quick recovery rally, the stock is still down ~8% since my last call, significantly underperforming the broader market: In my today's article, I'd like to focus on the recent financial and operational results and examine what has changed in Amazon's fundamental story. Let's explore whether the correction we saw recently truly warrants the attention of long-term investors. On a consolidated basis, Amazon reported revenue of $148.0 billion for Q2 FY2024 - that's a 10% increase YoY and a 3% sequential growth from Q1 FY2024. This was within Amazon's previously announced guidance range but slightly below analysts' consensus expectations (a miss of ~$780 million, which is indeed like a drop in a bucket for AMZN). What's noteworthy, Amazon posted a significant jump in GAAP EPS to $1.26, nearly doubling from $0.65 in the previous year and beating consensus by ~$0.24 (or by 23.76%, according to Seeking Alpha Premium). Let's look at the individual segments to figure out where this growth came from. AWS's revenue went up by 18% YoY to $26.3 billion, while its operating profit surged 74% YoY to $9.3 billion (35.36% margin), driven by "increasing demand for generative AI services." During the earnings call, the CEO Andy Jassy highlighted 3 key trends driving AWS growth: 1) companies shifting from cost optimization to new workloads, 2) infrastructure modernization, and 3) the growing interest in AI. Yes, we may say that AWS's margins have decreased slightly compared to the previous quarter. However, despite contributing just 18% of total sales, I still consider this segment crucial for forecasting the company's future growth due to Amazon's current position in this market niche. "With over 100 availability zones across 31 geographic regions, AWS holds more than 34% of the global cloud computing market share", according to Cloudzero's recent data. Amazon also remains committed to its ambitious plans to invest substantial amounts in third-party startups to continue developing its ecosystem and further solidify its status as a market leader. So, I believe that a significant portion of the forecasted growth that many analysts anticipate for the U.S. cloud computing market will primarily drive AWS's continued expansion and help sustain relatively high margins. The main Amazon segment's revenue (North American retail) grew by 9% YoY to $90.0 billion (61% of total sales), while international retail revenue increased by 7% to $31.6 billion. The company's overall retail operations saw strong growth from third-party merchants, with sales from this segment rising 12% YoY, while sales at physical stores increased by 4%. Online store sales, which include Amazon's wholly owned products, grew by 5% YoY to $55.4 billion, though this segment's share of total revenue has decreased as Amazon diversifies its revenue streams. North America is now in focus as the segment's margins continue to shrink due to investments in areas such as Kuiper/satellites. Management also pointed to expected seasonal margin pressure in Q3 due to lower Prime Day margins, preparation costs for the vacation season in the 4th quarter, and higher Thursday Night Football. But anyway, it seems to me that Amazon should manage to maintain its margins, albeit without a rapid expansion. So overall, I don't think investors should be too worried about these two segments. What remains unchanged is the company's ability to generate substantial free cash flows. Despite total capital expenditures reaching $30.5 billion in the first half of 2024 - higher than initially forecasted and a point of concern for some analysts and investors due to planned increases in CAPEX in AWS infrastructure and artificial intelligence in 2H - the FCF, adjusted for certain categories, amounted to $49.5 billion in Q2 (on a TTM basis). This is a significant amount, even for Amazon. Meanwhile, the number of shares outstanding has increased by less than 1% over the past year, which is quite modest in my opinion - this increase is more than compensated for by the strong growth in cash flow and earnings that we observed above. The guidance for Q3 EBIT came in below market expectations, which triggered discussions among investors about Amazon's investment strategy and current profitability. Nevertheless, the midpoint of the forecast range for operating profit indicates an 18.3% YoY growth in FY2024. In my opinion, this is a very impressive result. I believe the results for Q2 FY2024 were quite good. Firstly, AWS increased its top-line growth rate to 19% in Q2, compared to 17% in the 1st quarter, benefiting from various tailwinds, and I think we should continue to see this trend going forward. Secondly, the consolidated EBIT was actually higher than consensus expectations (according to Goldman Sachs data, proprietary source), and consolidated EBIT margins also looked quite good. Despite a slowdown in growth and some stagnation in retail, I see some signs of stable consumer demand, which is a positive indicator for the next several quarters at least. The conclusions I made above are confirmed by changes in EPS forecasts for the next few quarters and years ahead. According to Seeking Alpha, after the publication of the second-quarter report, analysts' opinions were divided regarding the Q3 (with 19 estimates for a decrease and 13 for an increase). However, upon closer examination, we see that no one is seriously reducing estimates. While there's a 1-4% decrease, for example, for Q3-Q4 FY2025, we actually observe almost ideal positive changes in the EPS forecast by looking several years ahead: Thus, the overall picture of forecast changes from Wall Street analysts seems bullish to me, even though concerns about the company's retail segment have grown, and the stock has fallen quite noticeably since the publication of Q2 results. Last time, I valued Amazon using DCF modeling, which showed an undervaluation of ~23.7%. Now, taking into account the latest financials, let's update my model. Compared to last time, I've adjusted my input data regarding revenue growth by incorporating the current consensus forecasts. I've also clearly reduced my forecasts for future operating profit margins: I'm deliberately making my model more conservative than before to avoid bias. Overall, I haven't changed other operating metrics much, as their inputs didn't seem to be significantly affected by just one quarter. Here's what I have in an intermediate form: In just over a month, the risk-free rate has fallen by almost 50 basis points. Therefore, even if I don't change my input data for the market risk premium and the cost of debt, I get a WACC that is 0.5% lower than last time (9.1% vs. 9.6%). I assume that the terminal value of Amazon should be calculated the same way as the last time, with the stock trading at 44x its enterprise value to free cash flow multiple. Thus, even with modified assumptions regarding EBIT margins for FY2025-2028, the stock still appears to be undervalued, though by a more modest amount than I previously calculated. As I mentioned last time, I may be wrong in my bullish stance on Amazon today. If Jeff Bezos continues to sell his shares, of which he still has many left, the pressure on Amazon's stock price may persist. In addition, the stock's large institutional and insider holdings, such as the 934.3 million shares held by insiders and the large investments by mutual funds (Argus Research proprietary source, May 2024 data), suggest a potential vulnerability in case there's a meltdown in the market. In addition to this risk, there's also the danger that cloud competitors such as Microsoft's (MSFT) Azure could force AWS to lower its prices, which could significantly impact its profitability and overall future sales growth. Furthermore, given the company's vast ecosystem, there are potential risks of malfunctions, outages, or cyber-attacks that shouldn't be overlooked as potential risk factors. Despite the obvious risks surrounding the company today, I believe that long-term investors should remain calm. Management's approach to diversifying the business over the last few years is starting to pay off, with consolidated revenue continuing to grow quarter after quarter. I think the share of the company's cloud/AI business will increase as artificial intelligence plays a larger economic role both in the US and globally. Amazon will likely continue to play an important role as one of the most innovative companies and a market leader in this area. My valuation model shows that Amazon shares are still undervalued. Wall Street analysts are still very positive, despite the pessimism about certain segments of the company, and their EPS forecasts continue to rise. Therefore, I'd like to reassure long-term investors: even if the selling continues today, I think the recent dip in stock price is a gift for those who want to hold Amazon shares for longer than 5-10 years.

Amazon Uses Their Size Effectively (NASDAQ:AMZN)

An 11-year basketball deal with Prime Video is a key example showing how sports leagues want to work with Amazon given their distribution footprint. Per my May article, Amazon's (NASDAQ:AMZN) AWS keeps growing with generative AI. Since that time, the 2Q24 earnings have come out, along with a July 24 Prime Video announcement about an 11-year basketball deal. My thesis is that Amazon uses their size effectively. The basketball deal is a sharp example of Amazon using their scale and reach, but we also see them using these attributes effectively in other areas. Looking at the 2Q24 earnings release, we see advertising was up 20% Y/Y and AWS had a 19% gain: For decades, Amazon has been one of the biggest e-commerce destinations outside China, and they've continually used their size to their advantage. Customers can be wary about using their credit cards online, but they've tended to be more comfortable with Amazon because of their size and their trusted brand. Another benefit of Amazon's size is selection - customers have a plethora of product choices. Amazon is always increasing the dollar amount of goods moving through their ecosystem, especially in the 3P segment. I like to make comparisons to Walmart (WMT) and Target (TGT) where growth is more tepid. Shopify (SHOP) is a completely different business model, but I like making comparisons with their ecosystem as well: It would be nice to include Costco (COST) in the graph above, but their quarterly fiscal calendar is confusing, having 12 weeks for the first three periods and 16 or 17 weeks for the final period (their fiscal year ends on the Sunday closest to August 31). In the fiscal year through September 3, 2023, Costco had operating income of $8.1 billion on revenue of $242.3 billion, which was composed of $237.7 billion in net sales plus $4.6 billion in membership fees. Unlike Walmart and Target, Costco is known for making much of their operating income from membership fees. A July 31 Fast Company article says the NBA wanted to do a recent 11-year deal with Amazon, because of the reach and infrastructure that Amazon possesses (emphasis added): According to The Athletic, the gist of the NBA's legal argument is that even if Turner matches the dollar figure of Amazon's offer, it hasn't - more importantly, it can't - match Amazon's offer in terms of reach. Turner primarily broadcasts games on basic cable, whereas Amazon is an "over the top" distributor that bypasses traditional distribution channels (like cable and satellite providers) and streams directly to consumers. In the NBA's view, Amazon's infrastructure makes it simpler for more people to find and consume its product, and thus renders Turner's bid legally insufficient. Regarding the above deal, TNT Analyst Charles Barkley is quoted by The Athletic, saying only large-sized streamers like Amazon and Netflix will be able to afford sports rights in the future: "It's going to all go to streaming in 11 years," Barkley told The Athletic. "I think this is just a cash grab, but they needed streaming because in 11 years nobody's going to be able to afford these rights but streaming." AI feeds on data, and no e-commerce destination outside China collects more customer data than Amazon. They continue to improve their advertising system while making AI investments and leveraging their data. Per an August 2023 Yahoo Finance article, Amazon has a bright future with advertising because they have vast amounts of data and they've taken their time to make the right types of investments (emphasis added): " Hands down, data is the North Star and the core strength of Amazon's ad business," Friedland told Yahoo Finance. "They took the time to invest in robust closed-loop-reporting technology and that pays in spades." AWS, Microsoft Azure (MSFT) and Google Cloud are the only cloud companies outside of China with enough size to make the massive capex investments required to compete on a global scale. Answering a Mark Mahaney question in the 2Q24 call, CEO Andy Jassy said 90% of global IT spend is still on premises, so we have tremendous growth ahead with conventional computing. Additionally, the AI growth should be prodigious (emphasis added): I think that - the one other thing I would say about that, too, Mark, is that - the business today, as I mentioned, it's a $105 billion revenue run rate business, about 90% of the global IT spend is still on premises. And if you believe that equation is going to flip, which I do, there's a lot of growth ahead of us in AWS as the leader in all those dimensions I mentioned. But I also think that generative AI itself and AI as a whole - it's going to be really large. I mean it is not something that we originally factored when we were thinking about how large AWS could be. The economics for Microsoft Azure are somewhat obfuscated, but Google Cloud discloses their operating income and AWS has much better margins today. AWS also had significantly better margins than Google in the past, when AWS revenue was at the level we see from Google Cloud today: The FT shows the enormous capex requirements mentioned above for the hyperscale cloud companies: Per the points made above, Amazon's size makes their ad business extremely valuable because they collect massive amounts of data, and they have the ability to make meaningful investments. Additionally, they are in the right type of advertising market which is low in the funnel where purchases can be measured as opposed to just clicks. In February 2022, Amazon Director of Software Development Mike James testified in the Google (GOOG) (GOOGL) case, saying shopping ads are lower in the funnel than text ads. Obviously, shopping ads are Amazon's bread and butter, so they can compete well against companies like Google and Meta (META) who are bigger overall with respect to digital advertising. The August 5, 2024, Memorandum Opinion court document for the Google case recognizes this fact, noting Google estimates that as of 2023, Amazon's ad revenues are larger than Google's in retail advertising. The document goes on to say Amazon was growing twice as fast as Google in this area as of 2021 (emphasis added): These "product page" ads likely generate substantial revenue for Amazon, whose ad business is growing rapidly. ( Google record from January 2021 estimating that Amazon's "US ads business is nearly the size of Google's US retail ads business today, and is growing at over twice Google's rate."). Outside of the AWS segment, we need to look at the North America segment and the International segment differently. In the 1Q24 call, CFO Brian Olsavsky talks about the way emerging countries bring down the overall margins for the International segment: I would say the established countries of Europe, Japan, as well as the U.K. are following a lot of the same trajectory as in the United States. They are profitable in their own right. They are adding selection, they're adding new features like grocery there, adding to their Prime benefits, and a lot of the work that we do in the United States carries over there. The second group is the emerging countries. And of course, we've launched 10 new countries in the last 7 years. Later in the 1Q24 call, CEO Andy Jassy talks about the way the International cost structure will improve in the future as it starts to catch up to the US in terms of inexpensive same-day facilities: And our same-day facilities are our least expensive facilities in the network. We still have a fraction of the number of those that we will have in the U.S. that we'll have in other parts of the world, which will, again, both change our cost structure while increasing speed. Looking at 2Q24, the North America segment had operating income of $5,065 million on sales of $90,033 million while the International segment had operating income of just $273 million on sales of $31,663 million. On a trailing twelve month ("TTM") basis, the North America segment had operating income of $20,816 million or $10,048 million + $14,877 million - $4,109 million on sales of $369,775 million or $176,374 million + $352,828 million - $159,427 million. Meanwhile, the International segment had TTM operating income of $662 million or $1,176 million + $(2,656) million - $(2,142) million on sales of $135,978 million or $63,598 million + $131,200 million - $58,820 million. Through July 31, Walmart had TTM operating income of $28,237 million or $14,781 million + $27,012 million - $13,556 million on revenue of $665,035 million or $330,843 million + $648,125 million - $313,933 million for an operating margin of about 4.25%. Outside of AWS, I'm optimistic that Amazon can eventually have a steady-state operating margin of at least 5%. If we apply this to $505.8 billion, which is the sum of the $369.8 billion TTM North America sales plus the $136 billion TTM International sales, then it implies a steady-state TTM operating income of over $25 billion. I think the non-AWS business is worth 40 times this amount +/- 5% implying a range of $950 to $1,050 billion. The AWS operating income run rate is $37,336 million, based on the 2Q24 figure of $9,334 million. I think the segment is worth 20 to 30x this run rate, which gives us a range of $745 to $1,120 billion when rounding to the nearest $5 billion. One of the reasons I give the non-AWS segment a higher accrual multiple than the AWS segment is because the capex economics of the AWS segment might end up being more like a railroad, where depreciation and amortization never match maintenance capex. The 2Q24 10-Q shows 10,495,566,881 shares as of July 24 such that the market cap is $1,890 billion based on the August 21 share price of $180.11. The stock is in my valuation range and I think it is a hold for long-term investors. Disclaimer: Any material in this article should not be relied on as a formal investment recommendation. Never buy a stock without doing your own thorough research.

Why Amazon Always Wins: Explaining The Economics Of The Rings Of Power Series (AMZN)

Despite the lack of important financial data, estimates suggest Amazon's investment in the series could result in significant returns if we understand Amazon's economics correctly. Amazon.com, Inc.'s (NASDAQ:AMZN) Prime Video will release season two of "The Lord of the Rings: The Rings of Power" series on August 29. As summer winds down in the Northern Hemisphere, let's have some fun trying to solve a problem with very little confirmed financial data. That is, let's see what the impact of this huge investment could be on Amazon's financials. We have already done a similar exercise for the series' first season (not to brag, but it was one of my most appreciated contributions to SA). Now, things have developed (and have become more expensive), so I found myself jotting down a few numbers to understand what is going on and why Amazon seems to splurge hundreds of millions (if not billions) on this series. After all, while fans of the saga may be eagerly waiting for new shows to come out (to then often being disappointed by the outcome), we, as investors, need to understand whether Amazon's endeavor can turn into a profitable investment or not. We are before a so-called Fermi problem, that is, an estimation problem because Amazon doesn't disclose enough financials to help us make easy calculations. For example, we don't know the exact number of Prime subscribers, and we also ignore how many new members the series added to the Prime ecosystem. Surely, Amazon knows. But it keeps these numbers private. The premiere of the first season hit a record 25 million viewers in the first 24 hours and the whole show has been seen by at least 100 million people worldwide, with more than 24 billion minutes streamed. However, reports came out that the completion rate (people who watched the entire series of 8 episodes) was only 37% in the U.S., while overseas it reached 45%. Ideally, 50% is the threshold to consider a series successful. This is why in 2022, the series only ranked #15. Amazon Prime had invited viewers to be patient, as the first season was a bit considered as a setup for the next four seasons, although the last three episodes already picked up a faster and more engaging pace, ramping up the spectacle. The last episode saw a 55.7x increase in viewership, boding well for the upcoming season. The second season seems to finally deal with the big events many fans are waiting for and the premiere of the first two episodes could spark new interest once again. In any case, while we have to wait to see how the new season will be accepted by the public, we already know Amazon has started filming season three, meaning that the project will go forward. So, Amazon believes it will earn a decent return. Let's then look at some numbers and see for ourselves what to make of this investment. We already know Amazon spent $250 million to buy the rights to the appendices of the The Lord of the Rings. Season one saw its costs coming in at around $465 million. The studios were then moved from New Zealand to the U.K. and this may make film shootings a bit cheaper. But I am expecting the second season didn't cost less than $400 million. This means that Amazon has probably already spent over $1 billion just for the rights and the first two seasons. By the end of the five seasons, we could well see an overall investment of $2-$2.5 billion. Amazon's Head of Global TV Vernon Sanders said the financial bet had more than paid off, after season one. While we should actually expect him to say something like this because of his role, chances are that what he states to support this is true saying in an interview with Deadline that the show ... broke records for most global viewers in its first day (25 million) and overall (more than 100 million), for minutes streamed (24 billion) and signups worldwide during its launch window, attracted younger viewers (record number of adults 18-34 for a Prime Video original) and affluent audiences (40% coming from households with income greater than $100,000) - and beyond, boosting Amazon's sales of J.R.R. Tolkien books on which the series was based. So, the returns on this bet come from two revenues: new Prime subscriptions and a boost in Tolkien book sales. Unfortunately for us, Amazon doesn't disclose its statistics about Prime members very often. We know that it hit 200 million subscribers worldwide in 2020. But since then, there has been no new officially confirmed number. Chances are Amazon is either waiting to hit the 250 million or the 300 million landmark before releasing a new update. So, we don't even know how many new subscribers Amazon gained thanks to the first season of the show. What we do know is that in Q3 2022, Amazon reported a jump in subscription services from $8.15 billion for the same quarter of the prior year to $8.9 billion. This is a 9% growth. In Q3 2021, the YoY growth of subscriptions was 24%. But this was Covid-time. However, in Q3 2023 Amazon reported 14.2% growth in subscription revenues. So, both of these comparisons don't help us visualize whether or not the premiere of season one had a material impact on subscriptions. Actually, Q3 2022 seems to have been rather weak, subscription-wise. Online stores went better. In Q3 2021 they increased by 3%. In Q3 2022, they were up 7%. But this was also a period of high inflation, and it is difficult to say that a boost in LOTR books was the reason for this result. In the Q3 2022 earnings call, Brian Olsavsky (Amazon's CFO) disclosed that: In the first two months since its launch, Rings of Power has driven more Prime sign-ups globally than any other Amazon Original. As we said, in Q3 2022, Amazon's subscriptions increased 9% to $8.15 billion. Considering the then-average fee to be in the range between $90 and $100, and considering the negative FX impact, I concluded that in that quarter Amazon could have added around 2.5 million new subscribers, which was more than enough to repay the investment. In fact, I estimated that Amazon needed one million new subscribers to repay its investment. Here many may be puzzled: one million new subscriptions don't generate $1 billion in revenue, but just over $100 million per year. How can this repay Amazon? Amazon would need 5.1 million new U.S. subscriptions to repay just the first season and the rights. How is one million a satisfactory number? This leads us to the key concept we have to understand: customer lifetime value (CLV). Since many watchers of the series belong to the younger cohorts, we can reasonably expect them to be alive for at least a decade. All Amazon is doing is building an ecosystem that draws more and more groups of customers in to the allure and please them with all the benefits the membership offers. Once one signs up for Amazon Prime, the retention rate is around 93%, which is very high and positions Amazon Prime just above Costco's incredibly resilient and growing retention rate. In other words, Amazon doesn't need to see its investment repaid in just one year thanks to its subscriptions. It is not a box-office business. Amazon wants to add members because of the stickiness of its ecosystem. As a result, Amazon knows each Prime member will stay around for a long time and will spend - on average - over twice as much as non-Prime members spend. Some estimate the CLV of a Prime member to be close to $2,300 compared to $916 for non-Prime members. Two years ago, my calculations were a bit different and I considered the CLV of a new Prime member - net of the acquisition cost - to be around $930. In any case, considering inflation and Amazon's growth, we could consider the CLV to be estimated at around $1,500. It is probably higher, but it is better to be conservative when dealing with a situation where many assumptions need to be made. This means that by adding just 667k subscribers, Amazon gains a CLV of $1 billion. Since Amazon likely added more than this number of customers two years ago, thanks to the series, we can understand why the bet paid off. This season will then be much easier because Amazon doesn't even need to amortize the rights cost (even though it could). In this light, $400 million spent for the series doesn't look as much of a big deal, in terms of content spending. By the way, Amazon spent $19 billion on content (video and music) in 2023 while Netflix spent around $17 billion. The whole series of the three movies was produced with $281 million. This simply helps us understand we are before a different kind of scale when considering streaming services versus legacy entertainment companies. Back to our estimates. True, this time it seems easy for Amazon to earn a decent return. But there is one objection: Amazon has already made a lot of LOTR fans subscribe thanks to season one, so this new season won't be able to bring in many more subscribers. Probably, it is true. But the two-year lag between one season and the other surely gives time for younger customers to grow and become possible new subscribers. However, the main thing to consider is that, between season one and season two, Amazon has launched its ad-supported tier - or, better, - it has offered the chance to upgrade to an ad-free tier by charging $2.99 a month. Each hour of streaming has around three minutes of ads which makes us think those three minutes are worth at least $2.99 because Amazon is willing to give them up against that extra revenue. Just in Q2 2024, Amazon added $2 billion in advertising revenue YoY, with sponsored ads driving the majority of the advertising revenue. This means Amazon is just in its early innings of exploring the possibilities given by its video advertising business. Unfortunately, once again we don't know how many Prime members upgraded to the ad-free tier and how many are sticking with ads. But we know that season one of The Rings of Power captured around 1.25 billion minutes of viewing time in September 2022. This means 20.8 million hours. Considering that now Amazon earns at least $2.99 per streamed hour, we have over $60 million in extra revenue that could come in if season two performs as the first one. In other words, 15% of the content spend will be refunded in just one month of streaming. It is impossible to know the impact of extra sales of items related to the Middle-Earth fandom. Still, here, once again, we should expect not only an increase in sales but an increase in advertising revenue on Amazon.com as well. As per Statista, Amazon is the fastest-growing ad-selling company and is on track to increase its market share from 2021 through 2026 by almost 70%, adding 7 percentage points while Google and Meta are expected to lose 4.5 and 2.3 pps respectively. As we can understand, this is higher margin revenue because it leverages existing assets. Moreover, Amazon is probably the most appealing platform for ads because it is a marketplace, meaning that when we are on the website we are already looking for something to buy. This makes me think Amazon's ad conversion rate is probably the highest in the industry. The consequence is that customers are willing to pay Amazon more to display their ads because of their effectiveness. After I learned Amazon's economics behind this endeavor, I bought my first shares of the company and have since added anywhere between $80 and $160. I didn't buy it because of AWS, I didn't buy it because of its ads, I didn't buy it because of its marketplace. What made me buy it is understanding its whole and unique ecosystem. The second reason that makes me stay long and keep buying Amazon is its scale. This year Amazon has proven to investors that it can rapidly grow its TTM FCF 6.6x ($6.7 billion in Q2 2023; $51.5 billion in Q2 2024) by simply reducing its investments in properties and other assets a little. The company has also informed investors that capex this year will be higher than anticipated because of AI-related spending. So, I am expecting the company to report $55 billion in TTM FCF by the end of the year. But, if Amazon wants to make its FCF explode, it can do so in just a few quarters. Right now, it trades at a 2.8% FCF yield, which is decent for a growing company. But we should remember that before the Covid-related investment cycle, not lengthened by the need for AI infrastructure, Amazon was spending $12-$16 billion in capex per year. Considering it can end this year making well over $110 billion in operating cash, I believe we are before a $100 billion FCF company. This suddenly makes Amazon's FCF yield 5%, which shows the company is not expensive. Of course, many ask when Amazon will turn into profit mode only. But I am not too concerned about it. Eventually, Amazon will become a cash cow, but we should not underestimate the size and the profitability it will have reached once it gets there. As a result, I rate Amazon as one of my most convincing picks and still rate it as a buy and consider it one of the best stocks to buy, hold for the long term, and hand over to one's heirs.