Should Amazon Investors Be Worried About an AWS Slowdown?

If you thought Amazon's AWS segment was invincible, think again!

Jul 28, 2014 at 4:50PM

Never mind's (NASDAQ:AMZN) widened second quarter EPS loss, investors should really be worried about the first signs of trouble for its dominant Amazon Web Services business, or AWS. Up until this point, Amazon has dominated the cloud services business. However, as large technology companies like Microsoft (NASDAQ:MSFT) and Google (NASDAQ:GOOG) (NASDAQ:GOOGL) make a run for Amazon's 30% market share of the cloud infrastructure services market, is it wise for investors to be worried?

Recent fundamental signs of trouble
According to Synergy Research, Amazon's AWS owned approximately 30% of the cloud infrastructure service market to end the first quarter , giving it a revenue-run rate over $4 billion. While accounting for less than 5% of total revenue, Evercore estimated that AWS was worth $50 billion, or 30% of the company, due to its market-controlling presence in an industry growing at a 50% annual rate. AWS head Andy Jassy has said often that it could one day exceed $60 billion in annual revenue, which further validates the enormous valuation placed on AWS .

Amazon's AWS growth rate of 67% in the first quarter exceeded the industry average, gaining the company more market share and continuing its run of dominance. Real threats have risen in recent months, however. In the second quarter, investors saw that Amazon may not be as invincible in the cloud as we previously thought.

In the fateful second quarter, revenue for the segment rose just 38% year-over-year to $1.17 billion, and was down 3% versus the first quarter . As for the cloud market, there are no poor quarters, just 50% annual growth. Hence, Amazon lost market share.

Pricing becomes more competitive
Amazon claimed on its conference call that usage of AWS grew 90% over last year . If that's true, why did revenue grow just 38%?

The answer to this question is tied to pricing competition, as tech giants try hard to impose on Amazon's turf in the cloud business. Notably, Google cut the price for its cloud computing services and cloud app platform by 32% and 30%, respectively . Google has comparable services to Amazon, and with these cuts most of its services became cheaper than AWS.

Google controls just 5% of the overall market, or less than $200 million quarterly. However, with the AWS being equated to a $50 billion business, it makes sense that Google would want to increase its presence as cloud services grow significantly larger year-after-year.

Of course, Amazon did respond to Google with 30% price cuts of its own.

The growth of Microsoft
While Amazon and Google fight over pricing, the industry's second largest player, Microsoft, is gaining ground on Amazon quickly. During the first quarter, Microsoft's market share was 9% after it reported year-over-year sales growth of 154%. Then, in the second quarter, Microsoft said on its conference call that both cloud platforms Office 365 and Azure saw sales growth of more than 100% over the year prior .

In other words, now that we know the performance of AWS, Microsoft's cloud business grew 150% faster. As a result, when Synergy Research's data from the second quarter is released then we can almost assume that Microsoft made a big jump in market share. We can also assume that it poses a real threat to challenge Amazon's AWS segment.

Foolish thoughts
Clearly, Amazon has the most to lose in the cloud. According to its second quarter report, the company did not capitalize in the way we've seen in previous quarters. Meanwhile, Google and Microsoft are growing at a faster clip. While their revenues are insignificant at this point, the cloud business as a whole is going to become enormous, as some analysts project a peak market in excess of $130 billion globally .

Companies with the most market share will gain the most. In the years ahead, the cloud will be significant to the valuation of all of the top players within the space. This bodes well for Microsoft and Google, but for Amazon, its market share may have nowhere to go but down.

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Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends, Google (A shares), and Google (C shares). The Motley Fool owns shares of, Google (A shares), Google (C shares), and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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