Amazon: Does Disruption Equal Opportunity?

Amazon's (NASDAQ: AMZN  ) valuation, upside, and business strategy have been argued, questioned, and criticized by a very large retail and institutional investor base. Yet, despite these questions, Amazon keeps ticking higher, now fast-approaching $400 after many of these investors screamed "sell" at $200. The company's core business is e-commerce, but it's Amazon's disruptive nature and new ventures, including technology that might make the stock a great long-term investment.

Amazon's diversity
Amazon's ability to successfully innovate is simply remarkable. The company began as an online book store and quickly transformed itself into the largest e-commerce company in the U.S. Now, the company is preparing to launch a nationwide grocery business, a space that's equal in size to retail.

However, what many investors don't realize, and what is often forgotten, is that Amazon also controls a large piece of the cloud infrastructure business. Amazon operates a segment called Web Services, or AWS, which includes cloud infrastructure and app platforms, also known as laaS and PaaS, respectively.

According to Evercore, AWS's annual sales in 2013 will be $3.5 billion, or 5% of Amazon's total business. However, the firm predicts that AWS will become much more relevant to Amazon's top-line in the years ahead, accounting for approximately 13% of its business by 2015.

Hence, for a company that's expected to grow at a rate greater than 20% for the next two years, AWS is becoming a real growth driver. Synergy Research estimates that AWS is growing at an annual rate of 55%, outpacing the industry's 45% growth and stealing market share from Amazon's peers.

The wrath of Amazon
When Amazon was established, Barnes & Noble's days became much darker, and when Amazon entered retail, others such as Best Buy and Wal-Mart were forced into deep discounting to match the low prices. The bottom line is that Amazon is extremely disruptive, and many companies operating in AWS's path might soon feel the wrath of Amazon. Let's examine a few companies that should be worried.

First, there's Salesforce.com (NYSE: CRM  ) , a major player in the cloud app platform business with its program Heroku, which builds real and mobile apps. On Heroku, more than 2.7 million apps have been developed.

To put this in perspective, Salesforce.com's other program, called Force.com, used for report writing and to expand functions of existing apps, has about 400,000 apps developed. Therefore, Heroku is very important to Salesforce.com. Heroku owns a market-best 18% share of the cloud app space. However, Amazon is on Heroku's heals with a 17% share, and is growing significantly faster. Thus, Amazon might soon become the leader in this space.

While cloud app development is one piece of the Amazon puzzle, Heroku is a major piece of Salesforce.com, suggesting this is a trend to watch if you are long in Salesforce.com. Amazon's growth might soon put pricing pressure on Salesforce.com.

Affecting the large and stable
It's not just cloud companies facing Amazon, but also large, well-established tech giants like International Business Machines (NYSE: IBM  ) . Last week, hedge fund manager Stanley Druckenmiller called IBM a great short, saying Amazon's AWS is killing IBM.

Druckenmiller argues that every dollar earned by cloud services such as AWS is a dollar lost for on-premise IT companies like IBM. Clearly, IBM attempted to address the problem of Amazon by acquiring web hosting company SoftLayer. However, Synergy Research estimates that web hosting grew just 3% year-over-year in the third quarter, versus more than 50% growth for AWS.

This suggests that IBM made a bad bet in this space, and that the acquisition does nothing to stop Amazon from stealing additional market share in the IT space. While many give IBM the benefit of the doubt, this increased competition and cloud preference might explain why the company's sales have declined, including 4.2% in its most recent quarter.

Final Thoughts
Many people argue that Amazon is too expensive and is a good shorting opportunity, but it seems that too few investors realize the disruptive nature of Amazon's business.

The company clicks on all cylinders in whatever industry it chooses to control. AWS is just another example that adds to books and retail. This fact makes me extremely cautious regarding the future of large grocery chains when Amazon's food business is fully operational.

For example, how can you own Kroger right now with Amazon in the business? Kroger's stock has traded higher by 67% in the last year. With revenue growth of 4% to 5%, its gains have been mostly related to margin expansion. However, with Amazon's history of selling goods at breakeven prices, we must entertain the idea that grocery companies like Kroger might be forced to lower prices, which could then weigh on its stock.

With that said, many analysts see Amazon's operating margin of less than 1% and proclaim that the stock is too expensive. However, Amazon might just be the most disruptive company in history because it has upset multiple industries. Since no one knows what industry Amazon might choose to pursue next, this fact makes Amazon a strong long-term investment opportunity.

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  • Report this Comment On December 02, 2013, at 12:45 PM, Decoy0527 wrote:

    I think that both Amazon and SalesForce are strange companies run by strange guys. Why in the world, at this stage of their developement, would they not consider profits to be a prioity? And why would investors be buying shares in a company in which the CEO is so cavalier about the lack of profits? Companies have a life span and both may run out of time before they earn a nickel. Strange,at least to me.

  • Report this Comment On December 02, 2013, at 12:46 PM, BrianNichols wrote:

    I like it. Why get Wall Street excited about high margins then have to sacrifice them to grow? Just look at AAPL last year.

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