Netflix Gets on Amazon's Cloud

"There once was a store in Seattle
Embarking on new business that'll
Refashion the way
You run business today;
Herding computers like cattle."
-- Anders Bylund, 2010

Strange times make for strange bedfellows. Take for example digital media maven Netflix (Nasdaq: NFLX  ) and e-commerce veteran Amazon.com (Nasdaq: AMZN  ) . After years of sparring face to face in their quests to entertain America with movies in a variety of formats, Netflix is now a pretty big Amazon customer.

What, Netflix buys DVDs online now?
Uh, no. According to The New York Times, Netflix has just embarked on a two-year project to "move most of its Web technology -- customer movie queues, search tools and the like" to an Amazon-powered infrastructure. Netflix VP of Engineering Kevin McEntee explains that this unexpected switch allows Netflix to "focus our innovation around finding movies, rather than building larger and larger data centers."

And so Netflix moves into the cloud. It didn't have to be Amazon's cloud, since there are credible alternatives to the Amazon EC2 cloud-computing service from well-respected vendors like Microsoft (Nasdaq: MSFT  ) and Rackspace Hosting (NYSE: RAX  ) . But Amazon operates its service on a scale that blows everybody else out of the water.

Industry observers estimate that Amazon has about 40,000 server systems dedicated to running the EC2 cloud. That's more than Facebook, which is the second-busiest site on the Internet. It's close to the entire server farms found at Rackspace and Akamai Technologies (Nasdaq: AKAM  ) , and that 40,000 figure does not include the computing horsepower Amazon uses to run its own day-to-day operations.

Cloud kabobs?
The kind of virtual machine hosting you get from EC2 has the potential to make the traditional data center an endangered species. You pay Amazon only for the server time actually used rather than hauling out the wallet to cover hardware costs, tech support, and other incidentals. Disaster recovery is built in, as Amazon mirrors your data across a couple of its data centers. Systems management becomes a desk job, because it's up to Amazon to make sure that all the cables and cards are plugged in the right slots.

Cloud computing is not an easy sell in corporate America, though. IT directors are sweating over issues like privacy and security. How can you trust that your data is safe when it's sitting on somebody else's system? But, as McEntee says, "It's in [Amazon's] interest to make us successful in the cloud. That's why we felt comfortable." EC2 is a big deal for Amazon, and CEO Jeff Bezos expects this amusement on the side to eclipse the mainline e-commerce operations one day. I've been saying as much for years, dude.

Is this a big deal?
EC2 contributes a vanishingly small portion of Amazon's $24.5 billion in annual sales today, with estimates ranging from $200 million to $700 million. But the service is enjoying monthly growth of about 10%, says InformationWeek. Read that again: 10% monthly growth. That's more than 100% yearly growth.

Netflix's joining the party adds credibility to Amazon's cloud services, possibly turning up the heat under that simmering pot. Only 0.3% of the top 500,000 websites indexed by Web traffic analytics firm QuantCast run on an EC2 infrastructure, leaving tons of room for expansion. And again, that's just one market. These machines also do scientific number crunching for NASA and run some services for the federal government. 3M (NYSE: MMM  ) uses Microsoft's Azure cloud to analyze images for marketing campaigns. I could go on.

So don't be surprised if Amazon one day starts breaking out hard data for EC2 and its sister services in financial reports, or splits into two companies to simplify the schizophrenic operations before the e-commerce division becomes the side show. Some might say that the latest win is a sign of Amazon gobbling up Netflix, but don't forget that Netflix is also cozying up to Microsoft and others right about now. An Amazon buyout would surprise me, to say the least.

What have we learned today?
Cloud computing is serious business for Amazon. As much as I appreciate VMware (NYSE: VMW  ) for the role its virtual-computing products play in the cloud-computing universe, I believe that Amazon is the bigger opportunity right now for investors looking to capitalize on cloud-computing stocks. Amazon has the luxury of a retail buffer against the vagaries of this new market, and the value of EC2 and related services is probably not accounted for in today's share price. Amazon is sneaking up on people.

With that in mind, I just snuck over to CAPS to place a thumbs-up vote for Amazon, betting that the company will outperform the market over the next few years. You can follow my size 13 footsteps and cast any vote you like on Amazon. Or share your insight on Amazon and cloud computing in the comments section below on this page.

Fool contributor Anders Bylund owns shares in Akamai and Netflix, but he holds no other position in any of the companies discussed here. He would like to apologize for the crappy limerick, but this is National Poetry Month, after all. 3M and Microsoft are Motley Fool Inside Value selections. Akamai Technologies, Rackspace Hosting, and VMware are Motley Fool Rule Breakers picks. Amazon.com and Netflix are Motley Fool Stock Advisor recommendations. Motley Fool Options has recommended a diagonal call position on Microsoft. Try any of our Foolish newsletters today, free for 30 days. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.


Read/Post Comments (4) | Recommend This Article (29)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 21, 2010, at 1:48 PM, militauro wrote:

    Diggin this article. This is why I feel comfortable with this stock even with its high valuation. Amazon is on a mission.

  • Report this Comment On April 22, 2010, at 1:18 PM, EquityBull wrote:

    EC2 is awesome. We use it. It will grow and grow. Amazon commerce is awesome. I shop on Amazon all the time and am a big fan. Amazon stock price is not so awesome. You are paying a huge premium for future earnings. I believe the price is well above fair value by any metric and opening a position here yields no margin of safety.

    I think a price in the 60 to 80 range would yield a margin of safety and represent a good entry point. If the market pulls back it will take amazon with it and that may produce an opportunity. However at this price even with EC2 opportunity the stock is way ahead of itself. 72 PE and 48 times cash flow just too rich for low margin retailer. Hosting on cloud will be commodity like all other hosting always has been. Amazon has scale but competes in low margin business and even with 2012 estimates around $5 it is pricey here today

  • Report this Comment On April 22, 2010, at 1:18 PM, EquityBull wrote:

    EC2 is awesome. We use it. It will grow and grow. Amazon commerce is awesome. I shop on Amazon all the time and am a big fan. Amazon stock price is not so awesome. You are paying a huge premium for future earnings. I believe the price is well above fair value by any metric and opening a position here yields no margin of safety.

    I think a price in the 60 to 80 range would yield a margin of safety and represent a good entry point. If the market pulls back it will take amazon with it and that may produce an opportunity. However at this price even with EC2 opportunity the stock is way ahead of itself. 72 PE and 48 times cash flow just too rich for low margin retailer. Hosting on cloud will be commodity like all other hosting always has been. Amazon has scale but competes in low margin business and even with 2012 estimates around $5 it is pricey here today

  • Report this Comment On April 29, 2010, at 4:48 PM, FOOLTOCROSS wrote:

    interesting article..learned something new.

    Ec2...AWS...huuummmmm.

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