Is Amazon.com, Inc. Really Worth More Than Wal-Mart Stores, Inc.?

Neither the announcement that health insurer Anthem will acquire rival Cigna in a deal valued at $54 billion, nor a blowout earnings report from Amazon.com (AMZN 1.30%)(see below) is enough to lift the broad market into the black on Friday morning. The Dow Jones Industrial Average (^DJI 0.69%) and the broader S&P 500 (^GSPC 1.20%) were down 0.66% and 0.64%, respectively, at 1:05 p.m.EDT. The Nasdaq Composite was down 0.48%.

Source: Andrew Mager.

Amazon and Wal-Mart: A bad comparison
In the wake of the 18% pop in Amazon.com's stock price in after-hours trading yesterday, one statistic did not go unnoticed. The headlines were breathless: "Amazon now worth more than Wal-Mart (WMT -1.75%)" trumpeted The Wall Street Journal's MoneyBeat. To journalists and pundits, the observation must have been irresistible, as it appears to symbolize the passing of the torch from bricks-and-mortar retailers to the juggernaut of e-tailing.

However, there are a couple of ways in which that headline is either false or misleading. First, as a Financial Times journalist who is clearly a student of corporate finance noted: "It is not accurate to say that Amazon is worth more than Wal-Mart. To make such a statement, all claims on the respective companies need to be evaluated." 

Indeed, USA Today's headline that "Amazon just surpassed Walmart in market cap[italization]" is rigorously correct. However, Wal-Mart chooses to finance itself with net debt of roughly $43 billion, while Amazon has net cash of nearly $6 billion. Thus, the FT writer rightly concludes: "A decent amount of Wal-Mart value resides among creditors and so on an "enterprise value" basis, Wal-Mart is still king (for now)." 

However, there is a broader, less technical point that is perhaps more interesting, as it provides some insight into Amazon's future prospects and the sources of its value: Comparing Amazon.com to Wal-Mart isn't an apples-to-apples comparison, because Amazon isn't just a retailer.

Consider that in the latest quarter, Amazon Web Services (AWS), the company's cloud computing platform and services, contributed less than 8% of consolidated revenues, but more than a third of "segment operating income," the arithmetic sum of the operating incomes of North America, international, and AWS (not to be confused with consolidated income from operations, which accounts for other items, including a whopping stock-based compensation expense). 

Furthermore, AWS is growing a lot faster than the other businesses: Revenues were up 81% year over year, while operating income quintupled. Compare that to the North America segment, at which revenues grew by "only" a quarter (international is the clear laggard, posting just 3% year-over-year revenue growth). 

So just how much is AWS worth on a stand-alone basis? 

I estimate Amazon Web Services' trailing-12-month earnings before interest and taxes (EBIT) at $855 million. Shares of Rackspace Hosting trade at 30 times earnings before interest and taxes (EBIT), with those of VMware at 37 times; applying a 33.5 multiple (the average of the two) to my estimate yields a value of nearly $29 billion, or roughly 11% of Amazon's market capitalization today. 

I think that figure likely underestimates Amazon Web Services' value, because the business is growing faster than Rackspace or VMware and it is already the dominant cloud computing provider.