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☁️ Amazon: The 'AWS of Everything'
How the company's customer focus is paying off across all segments
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Amazon's share price surged 15% in the week following its Q3 earnings report, reflecting another strong quarter with trailing free cash flow swinging from a $20 billion deficit to a $21 billion surplus within a year.
Wall Street's focus may be on Amazon Web Services (AWS) and AI tailwinds, yet we’ll examine why advertising might already eclipse AWS as a bottom-line contributor.
AWS was born from Amazon's internal need to manage vast computational workloads. It democratized scalable cloud infrastructure, showcasing Amazon's knack for turning operational challenges into lucrative opportunities.
Now, after building an unparalleled operations network, Amazon is leveraging this expertise as a service, potentially replicating its AWS playbook in other domains.
Today, we’ll cover the following:
Amazon Q3 FY23.
Recent business highlights.
Key quotes from the earnings call.
What to watch: Ads, Kuiper, and the antitrust trial.
1. Amazon Q3 FY23
Here is a bird’s-eye view of the income statement.
💻 Online store (40% of overall revenue): Amazon.com +7% Y/Y.
🏪 Physical store (3%): Primarily Whole Foods Market +6% Y/Y.
🧾 3rd party (24%): Commissions, fulfillment, shipping +20% Y/Y.
📱 Subscription (7%): Amazon Prime, Audible +14% Y/Y.
📢 Advertising (8%): Ad services to sellers, Twitch +26% Y/Y.
☁️ AWS (16%): Compute, storage, database, & other (B2B) +12% Y/Y.
Other (1%): Various offerings, small individually -3% Y/Y.
Revenue grew +13% Y/Y to $143.1 billion ($1.5 billion beat).
North America grew +11% Y/Y to $87.9 billion.
International grew +10% Y/Y fx neutral to $32.1 billion.
Gross margin was 48% (+3pp Y/Y).
Operating margin was 8% (+6pp Y/Y).
AWS had a 30% margin (+4pp Y/Y).
North America had a 5% margin (+5pp Y/Y).
International had a 0% margin (+6pp Y/Y).
Cash flow (trailing 12 months or TTM):
Operating cash flow TTM was $71.6 billion (+81% Y/Y).
Free cash flow TTM was $21.4 billion compared to an outflow of $19.7 billion in Q3 2022, primarily driven by the improvement in operating cash flow and, to a lesser extent, a decline in purchases of property and equipment by 15% to $50.2 billion.
Cash, cash equivalent, and marketable securities: $64 billion.
Long-term debt: $61 billion.
Q4 FY23 Guidance:
Revenue growth between +7% and +12% Y/Y (analysts expected +12% Y/Y).
Operating margin between 4% and 7%.
So what to make of all this?
Amazon had a stronger-than-expected quarter, with overall revenue once again well above consensus (which was already raised by $2 billion last quarter).
The Q3 performance of AWS outpaced concerns, and the accompanying commentary provided optimism. As most of Amazon's valuation relies on AWS's long-term potential, any surprise for this high-margin segment can lead to significant stock price fluctuations.
Advertising delivered an impressive +26% Y/Y growth, accelerating from +22% Y/Y in Q2 FY23, primarily driven by sponsored products.
Operating margin improved by six percentage points, driven by cost efficiencies for the non-AWS segments. Regionalization was an essential factor, with shorter distances and fewer touches leading to reduced delivery costs. It was the sixth consecutive quarter of margin improvement for the North American segment.
The non-AWS businesses are now firmly profitable. AWS makes up 63% of Amazon’s operating profit. Beyond cost efficiencies, the rapid rise in advertising revenue (a very high-margin business) also contributed to the margin expansion.
Free cash flow TTM improved for the fifth consecutive quarter. Management expects CapEx to drop to $50 billion in FY23 (from $58 billion in FY22). Lower fulfillment and transportation CapEx will be partially offset by increased infrastructure CapEx related to AWS and Generative AI efforts.
Rivian boost: Amazon had a $1.2 billion unrealized gain from its investment in Rivian (see “Other” in the top right of the income statement visual). Short-term stock movements drove this gain, so it’s best to focus on operating metrics.
Revenue guidance for Q4 was a bit soft, between $160 and $167 billion compared to $167 billion estimated by analysts.
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2. Recent business highlights
AWS market share and margins
AWS added $0.9 billion sequentially, indicating a faster sequential growth.
According to Synergy Research Group estimates, cloud infrastructure spending grew +18% Y/Y to $68 billion in Q3 2023 (showing no slowdown compared to Q2 2023). So AWS sightly trailed the rest of the market.
Amazon maintained a 32%-34% market share in the past five years. Microsoft and Google gained market share a the expense of other participants, but the overall pie is growing for all participants.
Azure was the fastest-growing of the big three in the latest quarter, with a +28% Y/Y growth in constant currency, compared to +22% Y/Y for Google Cloud and +12% Y/Y for AWS in the same quarter on a GAAP basis.
In the past few quarters, existing AWS customers have focused on cost-cutting initiatives. One of the benefits of outsourcing cloud infrastructure is precisely to scale up or down based on the current needs. These optimizations also affected Azure and Google Cloud Platforms. It could create more favorable comps in the coming quarters, and revenue growth could re-accelerate.
Have we hit “peak optimization”? Time will tell. What we do know is that the sequential revenue increase at AWS indicates a forward growth of 16% Y/Y if the company can maintain the same momentum moving forward, which is encouraging.
In addition, new needs emerging from Generative AI are expected to generate new workloads. As explained in our review of Microsoft’s earnings, AI was responsible for three percentage points in Azure’s revenue growth. Andy Jassy did not isolate any AI-related growth for AWS, but he might once the number becomes meaningful.
An update on the three layers of the AI stack
CEO Andy Jassy always provides an update on Amazon’s position within the three layers of the AI tech stack: 1) Infrastructure, 2) Models, and 3) Apps.
So, let’s revisit them.
1) Infrastructure Layer (Trainium and Inferentia)
Amazon has been developing customized machine learning chips like Trainium for training and Inferentia for inference. And their future development will benefit from a $4 billion investment in AI startup Anthropic. Jassy provided more color on the deal:
“Leading LLM maker Anthropic chose AWS as its primary cloud provider and will use Trainium and Inferentia to build, train and deploy its future LLMs. As part of this partnership, AWS and Anthropic will collaborate on the future development of Trainium and Inferentia technology. We believe this collaboration will be helpful in continuing to accelerate the price performance advantages that Trainium and Inferentia deliver for customers.”
2) Models Layer (Bedrock)
Building Large Language Models (LLMs) is cost-prohibitive. So Amazon wants to let AWS customers access LLMs and customize them with their data with all the security and privacy features managed for them.
This middle layer is essentially ‘LLM as a Service.’ Amazon Bedrock lets customers run foundational models, customize them, and create agents for automated tasks and workflows. Jassy explained:
“Amazon Bedrock offers customers access to leading LLMs from third-party providers like Anthropic, Stability AI, coherent AI 21 as well as from Amazon's own LLMs called Titan, where customers can take those models, customize them using their own data but without leaking that data back into the generalized LLM.
[…] We've announced the imminent addition of Meta's Llama 2 model to Bedrock, the first time it's being made available through a fully managed service.”
3) Apps Layer (CodeWhisperer)
The top layer has everyone’s attention because these are the apps we hear about all the time, like Chat-GPT or Bard.
Amazon CodeWhisperer, an AI-powered coding companion competing with Microsoft’s GitHub Copilot, is seeing early signs of success. Its latest feature allows the coding companion to be familiar with the customer’s proprietary code bases.
Overall, Amazon’s existing market share in cloud infrastructure is a critical advantage in the AI arms race. Jassy explains:
“It's also worth remembering that customers want to bring the models to their data, not the other way around. And much of that data resides in AWS as the clear market segment leader in cloud infrastructure.”
3. Key quotes from the earnings call
CEO Andy Jassy provided vital insights and recent priorities.
On the benefit of the regional organization:
“Our move earlier this year from a single national fulfillment network in the US to 8 distinct regions represented one of the most significant changes to our fulfillment network in our history. This change has gone more smoothly and made more impact than we optimistically expected.”
It was the second full quarter with the new regional organization in the US. The two main benefits are shorter distances and fewer touches. In short, Amazon is getting products to its customers faster, and it’s doing so at a lower cost. And that’s good news because speed matters. Jassy highlighted the rising popularity of consumables and everyday essentials, illustrating that customers spend more when delivery is faster.
On future efficiency and cost-saving measures:
“We've also identified several substantial changes to our inbound processes that we believe could have a significant impact on our cost to serve and speed of delivery. We have a long way before being out of ideas to improve cost and speed.”
On AWS workload optimizations:
“While we still saw elevated cost optimization relative to a year ago, it's continued to attenuate as more companies transition to deploying net new workloads. […] . But we're seeing the pace and volume of closed deals pick up and we're encouraged by the strong last couple of months of new deals signed. For perspective, we signed several new deals in September with an effective date in October that won't show up in any GAAP reported number for Q3 but the collection of which is higher than our total reported deal volume for all of Q3.”
This is the most critical soundbite of the call. The idea that AWS is regaining momentum will remain the focal point on Wall Street. Showing sequential reacceleration was a good start, but the potential for accelerating growth in future quarters is critical.
On the untapped growth at AWS:
“We have a $92 billion revenue run rate business where 90% of the global IT spend still resides on premises. And if you believe like we do, that equation is going to flip. There's a lot more there for us.”
AWS is the clear leader in a market expected to grow at an 18% CAGR through 2028. So Amazon is well positioned to continue to ride that big wave.
On Prime Video:
“Prime Video continues to be an integral part of the Prime value proposition where it's often one of the top 2 drivers of customers signing up for Prime. We also have increasing conviction that Prime Video can be a large and profitable business in its own right as we continue to invest in compelling exclusive content for Prime members […] Beginning in early 2024, Prime Video shows and movies will include limited advertisements. We aim to have meaningfully fewer ads than linear TV and other streaming TV providers. If customers prefer and add free option, we plan to offer that for an additional $2.99 per month for US members.”
According to Nielsen, Prime Video captured 3.6% of US TV Time in September (+0.7pp Y/Y). The NFL content alone was responsible for a 0.2pp bump.
Prime Video captured nearly half of Netflix’s market share in US TV time (and more than Disney+ and Max combined). That’s not surprising when you consider that there are an estimated 125 million US Prime members. For context, Netflix had 77 million paid memberships in North America at the end of September.
By adding ads to its existing plan, Amazon will instantly get maximum reach across its current audience. By asking members to pay more to get rid of ads, the initiative is guaranteed to be revenue-accretive. While many Prime members are not interested in Prime Video, power users are likely under-monetized.
On Buy with Prime:
“Buy with Prime […] enables third-party sellers with direct-to-consumer websites to offer Amazon Prime members the same fast payments and delivery options they receive on Amazon.com.
We recently announced the capability for sellers to integrate Buy with Prime with their Shopify account, making it easier for Shopify merchants to manage their businesses with inventory pricing and promotions automatically synced in one place.”
Amazon’s partnership with Shopify has been a significant development this summer. While Shopify handles the payment, Amazon gets to expand its reach among Shopify merchants natively on the app.
4. What to watch looking forward
The “AWS of logistics”
Amazon's launch of "Buy with Prime" marked an ambitious step towards becoming the logistics equivalent of AWS. The strategy mimics the successful AWS model: tackling a complex internal challenge — in this instance, a sophisticated operations network — and transforming it into a scalable service for other businesses.
Jasy touched on the newly launched Supply Chain by Amazon:
“Supply Chain by Amazon, a fully automated set of supply chain services where Amazon can pick up inventory from manufacturing facilities around the world, ship it across borders, handle customs clearance and ground transportation, store inventory in bulk, manage replenishment across Amazon and other sales channels and deliver directly to customers, all without sellers having to worry about managing their supply chain.”
Amazon is leveraging its scale and expertise, turning cost centers into profit centers by setting processes and standards and turning them into a service.
The Amazon Playbook:
Make significant investments to solve a complex problem.
Convert the solution into an accessible and affordable service for businesses of all sizes.
This approach not only cements Amazon's position in logistics but also transforms potential competitors into customers and, in some cases, partners, as seen with Shopify.
Is advertising a more significant contributor than AWS?
Amazon's advertising revenue reached $12.1 billion in Q3, representing:
28% of Alphabet's Search advertising revenue (+6% pp Y/Y).
36% of Meta's advertising revenue (+5% pp Y/Y).
While Amazon remains a distant third, it’s catching up.
How big of a deal is advertising today for Amazon’s bottom line?
Meta has an operating margin well above 60% on its advertising business (excluding the losses relative to Reality Labs). So, it’s not far-fetched to assume Amazon is seeing very high margins here. Out of $12.1 billion in advertising revenue in Q3, Amazon may have generated nearly $8 billion in advertising profit—making it a more significant contributor than AWS and its $7 billion operating income.
Despite economic headwinds, Amazon’s advertising arm shows resilience, particularly with performance-based ads and initiatives like Thursday Night Football (13 million customers watching weekly, with ratings up +25% Y/Y).
In short, Amazon is winning with direct response and brand marketing because of its massive reach and relevance. Jassy explained:
“While we see companies being more cautious on the ad side and the top-of-funnel products, things like display and a little bit of video, we're still seeing a lot of strength in the lower-funnel ad products like sponsored products.
And I think in these types of economies, we have fared pretty well in part because we have a number of owned and operated properties that have very large volumes that advertisers and brands want to get in front of.”
I have suggested in previous articles the sustainable nature of the moat around Amazon’s ad business. The most glaring risk comes from regulators more than competitors.
The FTC and 17 states are suing Amazon for allegedly maintaining its monopoly through unfair practices that stifle competition and lead to higher consumer prices.
Restrictive rules for third-party sellers
Obligatory use of Amazon's fulfillment services for Prime eligibility
Price manipulation via "Project Nessie."
Amazon refutes the allegations, claiming the lawsuit lacks merit and that its practices promote healthy competition and benefit consumers.
The lawsuit's outcome could lead to reduced prices and more competition, with possible significant alterations to Amazon’s Prime service.
Winning antitrust lawsuits is historically difficult, but the FTC may present a strong case given the tangible consumer impact.
The case is at an early stage, with possibilities of settlement or dismissal, and a trial could be years away. Nevertheless, the case signals growing regulatory challenges for Amazon that could affect its long-term business model, revenue, and costs.
AWS is gearing up for growth as it overcomes workload optimization hurdles and leverages AI advancements.
Advertising maintains its robust growth trajectory, reinforcing Amazon's market position.
Amazon is on a clear trajectory to replicate its AWS model across a broader spectrum, eyeing the title of ‘AWS of Everything.’
Navigating regulatory scrutiny will be crucial for Amazon to sustain its competitive lead and continue its expansion.
That’s it for today!
Stay healthy and invest on!
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Disclosure: I am long AMZN, GOOG, and META in the App Economy Portfolio. I share my ratings (BUY, SELL, or HOLD) with App Economy Portfolio members.
Author's Note (Bertrand here 👋🏼): The views and opinions expressed in this newsletter are solely my own and should not be considered financial advice or any other organization's views.