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4 Things To Know About Amazon.com's Most Profitable Business

By Leo Sun - Aug 2, 2016 at 7:43PM

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AWS continues to leave its cloud competitors in the dust.

Amazon ( AMZN 1.11% ) stock recently hit all-time highs after it announced a solid second quarter earnings beat on the top and bottom lines. Revenue rose 31% annually to $30.4 billion, besting estimates by $850 million. Net income soared from $92 million a year earlier to $857 million, or $1.78 per share, crushing expectations by $0.67.

Image source: Getty Images.

But the real highlight of that report was the growth of AWS (Amazon Web Services), the market-leading cloud platform which has now become Amazon's most profitable segment. Let's examine four key facts about this business which investors should know.

1. 58% sales growth

AWS revenue rose 58% annually to $2.89 billion and accounted for nearly 10% of Amazon's top line. That's a slight slowdown from 64% growth in the first quarter, but it's still an incredible pacefor the largest cloud platform in the world. AWS finished the quarter with an annual run rate of $11.5 billion, easily topping the $10 billion target that CEO Jeff Bezos set last year.

Microsoft's ( MSFT 0.98% ) cloud business has an annual rate of $12.1 billion, but most of that revenue comes from SaaS (software as a service) solutions like Office 365 and Dynamics CRM (customer relationship management), which don't compete against AWS. Microsoft's platform play against AWS is Azure, a hybrid IaaS (infrastructure as a service) and PaaS (platform as a service) platform.

Microsoft doesn't disclose how much revenue Azure generates, but Forrester Research claimed that it had a run rate of $1.6 billion last October. Azure's run rate might be about $3 billion today (assuming that it's growing at a similar rate as AWS), which puts it at a distant second behind Amazon in the cloud platforms race.

2. 135% operating income growth

AWS' operating income rose 135% year-over-year to $718 million, accounting for 56% of total operating profits. This represents a slowdown from 210% growth in the first quarter, but AWS' operating margins expanded both sequentially and annually.

Period

Q2 2015

Q3 2015

Q4 2015

Q1 2016

Q2 2016

Operating margin

16.9%

25.0%

28.6%

23.5%

24.9%

Data source: Amazon quarterly reports.

Those operating margins were notably lower than the margins from the third and fourth quarters of 2015, but that slight contraction was attributed to higher investments in expanding AWS' availability regions and services.

3. New services and coverage regions

Amazon launched its sixth AWS region in the Asia Pacific in Mumbai, India during the quarter -- bringing its total coverage to 35 availability zones across 13 technology infrastructure regions. It plans to add nine new availability zones in four regions next year.

Amazon also added 422 new services and features to AWS within the first half of 2016. That figure represents a much faster rate of expansion than the 722 services and features it added to AWS throughout all of 2015. One new feature enables customers to create larger file systems within Amazon's public cloud, while another boosts the amount of available memory for Big Data applications.

It also announced that more major customers were running SAP's "business critical" applications within AWS. That relationship complements AWS' status as Salesforce's "preferred" cloud platform for its core Sales Cloud, Service Cloud, and App Cloud services. AWS also achieved the new FedRAMP High compliance certification, which enables U.S. government agencies to store highly sensitive applications like medical, financial, and law enforcement records in the AWS Cloud.

4. Tapping into the hybrid cloud market

AWS is a public cloud service, since all its content and workload is stored off-site. However, many older and larger companies which aren't ready to move all their infrastructure or data to the cloud prefer "hybrid" cloud installations, which store newer data on-site while backing up older data to the cloud. Research firm Markets and Markets estimates that the hybrid cloud market could grow from $33.3 billion to $91.74 billion between 2016 and 2021. AWS customers currently use a "Direct Connect" service to link AWS to private cloud solutions from companies like Microsoft and EMC's VMWare.

During the conference call, Amazon Senior VP and CFO Brian Olsavsky stated that upcoming investments would "make integrating with AWS seamless for those companies that have a hybrid IT environment," and introduce next-gen services like "data analytics, mobile, Internet of Things, (and) machine learning offerings" to those customers. In other words, AWS could keep Microsoft and VMWare cornered in the private cloud as it remains the "best in breed" option in the public cloud.

The key takeaway

It's become very tough for rivals like Microsoft, Alphabet, and IBM to match the sheer scale of AWS' operations. The unit's growth is far from peaking, and its weight on Amazon's bottom line will keep increasing and offsetting the lower margins of its marketplace business -- which will generate stronger and steadier profits for Amazon investors.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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