George Salmon, Equity Analyst 2 August 2019
Amazon has just turned 25. And it’s fair to say it’s come a long way since its humble beginning as an online bookstore.
Here’s a closer look at some of the key steps of the journey, and assessment of how the group sits now.
The house that Jeff built
Founder Jeff Bezos will have known that even in the good years, the majority of small businesses fail.
Nonetheless, Bezos put $10,000 of his own money into making his plans for a new online bookstore, sketched out during a cross country drive from New York to Seattle, a reality. And as we’ll see, that refusal to be intimidated by the prospect of failure was key to the transformation from brave new bookstore to world’s biggest retailer.
By 2000, Amazon had ticked off several notable achievements.
The group cornered the books market, enjoyed a successful stock market floatation, and expanded into CDs, DVDs and other electricals.
The dotcom crash hurt the shares, but in the years after, two revolutionary features helped the group bounce back.
The first was the third party marketplace. Originally launched to directly connect buyers and sellers of niche books, Marketplace proved immensely popular, with over 250,000 transactions in its first 4 months.
These days, Marketplace accounts for more than half of the products sold on Amazon. And the group doesn’t just charge sellers to use the site, it earns extra fees by managing, monitoring and distributing orders on behalf of sellers.
While the fulfilment business ensures Amazon’s business-to-business customers are closely tied to its services, the launch of Prime in 2005 does the same for retail customers. Members pay a monthly fee and receive free and unlimited deliveries for a year. Having paid that initial fee, why would you go elsewhere?
Today, it is thought there are more than 100m Prime members in the US alone. Monthly payments get them access to music, TV and offers, in addition to the fast track delivery service.
While these successes mean the US retail business is finally starting to deliver profits, its importance is dwarfed by a part of Amazon that certainly wasn’t in the original operating plan. It might even be one you’ve never heard of.
AWS - a wonderful surprise
Amazon Web Services (AWS) is the cloud computing division that allows businesses the world over to access computing power on a flexible basis, and eliminates the need for expensive servers.
This service-led business commands much higher margins than the retail division, and generated 57.9% of the group’s half year profits.
AWS was kind of stumbled upon by accident. In searching for a way to overcome IT headaches, Amazon created its own cloud computing systems. This provided an advantage, but it was when the group realised it had the potential to solve others’ data needs that AWS really took off.
Today, there are more than 1 million partners signed up, from huge Fortune 500 companies to tiny start-ups.
It’s likely the retail business will keep expanding, and investors will be pleased to hear the AWS growth story is far from over. Amazon is making bold strides into exciting growth areas like Artificial Intelligence and machine learning, and released 1,957 new products and services last year alone.
However, since Bezos has always ensured a spirit of innovation is at the core of Amazon we’d be surprised if other key areas don’t develop too. One area to keep an eye on is the fast growing advertising business. Amazon doesn’t provide much detail on it yet, but the group did confirm second quarter revenue increased 37% year-over-year, to $3bn.
Bezos also makes an interesting point on the potential for failures.
As a company grows, he wrote, the law of large numbers means everything needs to scale, including the size of failed experiments. Hence the Fire phone that lost the group $170m in 2014. ‘If the size of your failures isn’t growing, you’re not going to be inventing at a size that can actually move the needle.’
We think he makes a good point. But it does highlight the possibility, indeed the probability that the group’s growth trajectory won’t be entirely smooth from here on.
There’s also the potential for competition rulings to impede growth. Authorities on both sides of the Atlantic have stepped up their interest in big tech companies. Worries you might be too powerful is clearly one of the ‘nicer’ risks to have, but fines and restrictions are possible so it’s a risk nonetheless.
Overall, we think Amazon looks well placed to deliver the growth its price to earnings ratio of 64 demands. However, investors should heed Bezos’ words and remember there are no guarantees.
Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.
This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.