AWS Is Surprisingly Profitable: Now What?

It's been a long time coming for Amazon.com investors who have grown increasingly impatient with the drag its cloud computing business has imposed on profits but the company last week gave them some good news. Under pressure to give a more detailed breakdown of revenues and profitability of its Amazon Web Services subsidiary, the company caved and promised it would share that information commencing with last week's Q1 2015 earnings report.

In its first disclosure on AWS, Amazon said its cloud computing subsidiary is a $5 billion business that's growing. Specifically, it posted $1.57 billion in revenue for the period, a 49% year-over-year increase. Based on analyst estimates that would put AWS on a $6 billion run rate, according to Redmond's new sister site AWSInsider. The most surprising revelation from Amazon's earnings report was that AWS is profitable. AWS had a margin of 17 percent. Macquarie Analyst Ben Schachter told The Wall Street Journal that AWS "is significantly more profitable than we expected." 

Noting the 15% jump in the company's stock on the news, Finro Equity Analyst Lior Ronen today was among a number of others suggesting that Amazon spin off AWS. In a Seeking Alpha blog post Ronen said based on AWS' $1.57 billion revenue for the quarter AWS segment is on a $6.9 billion annual revenue run rate, based on 11% quarterly growth. Assuming a price-to-sales ratio ranging from 7 to 10, AWS is worth between $48 billion and $69 billion, Ronen predicted.

"By spinning AWS, Amazon will be able to create two tech giants -- one focused on e-commerce and online retail business and the other on cloud computing and IaaS services," he said. "Amazon could leverage the two companies to create a whole that is bigger the sum of its parts: AWS could focus on its niche, develop new revenue streams, and invest further in its technology, while Amazon could do the same on its e-commerce platform. That is the only way Amazon could create a sustainable growth for the long term and employ the advantages it has in both businesses."

However Equity Analyst James Brumely was among those skeptical about AWS' long-term prospects. In a separate Seeking Alpha post, Brumely argued that as cloud services become more commoditized it will put pressure on future margins for AWS. Brumely also said that Google and Microsoft will continue to put pressure on Amazon. "Even as exciting as unexpected operating profits are for the Amazon Web Services (AWS) arm of the e-commerce giant, it doesn't change the fact that the company still lost money last quarter, nor does it change the fact that margins for AWS are more likely to continue to shrink rather than widen as cloud-computing continues to become commoditized," he said.

Furthermore, the 17% margin isn't as impressive as it seems, he argued, pointing to the fact that 291 of the companies in the Fortune 500 have operating profits of 15% or higher. More alarming, he said, is the fact that its 17% margin represents a marked decline from last year's profit of 23% during the same quarter.

"What happened?," he asked. "In simplest terms, Amazon (in a very Amazon-esque manner) has decided to become and remain the low-price leader with the cloud-storage world, and didn't worry about making much -- if any -- profit in the business. As turns out, it still made some operating profit as a cloud-computing provider, but it's making progressively, relatively less as time moves along."

The findings from Amazon's AWS stats may be vague but it's a noteworthy step not just for investors but for buyers of cloud infrastructure services who -- while looking to bet the best deal possible -- surely don't want to see their provider lose money indefinitely. And just as competitors tend to respond to pricing moves of one another, it'll be interesting to see if Microsoft, Google, IBM and others follow suit.

Posted by Jeffrey Schwartz on 04/27/2015 at 7:50 AM