Amazon: Value Hiding in Plain Sight (Best Ideas 2023 Preview)

This article is authored by MOI Global instructor Edward Chang, portfolio manager at Pledge Capital, based in New York.

Edward is an instructor at Best Ideas 2023.

Amazon needs no introduction in the value investing community. Berkshire bought a stake back in 2019. It may have one of the widest moats in the world.

After falling $100 from the highs, the stock now trades where it did in 2018. Since then, they have built Amazon Ads into one of the biggest digital ad players in the world. AWS has grown from twenty billion in revenue per annum to eighty. 3PL marketplace revenue has nearly tripled. They have added one hundred billion in 1PL ecommerce sales. Subscriptions, which is mostly the prime membership, has grown from fourteen billion to thirty-five.

If you value the cloud and the ad business separately, at four to five times revenue or sixteen to seventeen times EBIT, it will imply the rest of the company trades at the lowest valuation in history – around 0.6x sales. Including the Great Recession. You do not need to make herculean assumptions to project strong five-year investment returns.

Amazon bulls are battered. The debate is now centered around the quality of the ecommerce business. On the sell-side, analysts are beginning to question if the cloud is maturing. Many investors are even hoping Bezos will come out of retirement. It is not often a blue-chip company with Amazon’s moat declines 55% in a year. I believe this is a great long-term buying opportunity.

What attracts me to the stock, is in part the culture that Bezos has built during the tenure. The door desk mentality differentiates Amazon from the rest of the internet giants. Culturally, I believe they are better prepared for a sustained period of belt tightening. The company’s customer obsession will also get it through tough economic times and emerge out of the other side stronger. Andy Jassy, the CEO of Amazon, has gone through this before and had a front row seat as Jeff Bezos’ shadow during the tech bubble. He watched Amazon launch the 3PL business, which threatened 1PL sales but delighted customers with low prices and helped Amazon turn a profit. Amazon’s customer obsession can still be witnessed in the strategic changes being made to position the company for the next 5-years.

With Amazon’s core ecommerce business, customer obsession shows in the launch of Buy with Prime. This new service brings Prime benefits to the far corners of the web. While some of us have heard of some of the brands or sites in the long tail of built on Shopify, Wix, or WordPress, most of us have not. These sites lack the trust Prime and Amazon have developed with consumers. Amazon is now offering to share the trust it earned with prime members with external website. Amazon will provide prime services on other websites. This could greatly expand the value proposition of its popular membership program. It also helps merchants, by boosting their conversion and by providing ecommerce fulfilment and shipping services.

With AWS, customer obsession is showing in the company’s pivot from a builder (or developer) first mindset to a focus on both partners & builders. Earlier in the cloud transition, AWS could please the customer by adding more features and tools for developers to build cloud applications. As we move into the next stage, AWS’ large portfolio of tools and features confuse customers in the early majority. Fortune 500+ companies typically work with consultants or system integrators, and AWS is strengthening its go-to-market with these partners to help the end customer find the right solution.

AWS’ investments to strengthen its partnership with independent software vendors also fulfill the same purpose. It is another example of the company’s customer obsessed culture. The ISVs used to view Amazon as a competitor or frenemy, who offered low-cost versions of their software. Amazon and many ISVs had rocky relationships, because Amazon copied features or even offered services built on the open-source software of other companies. Over the last year, AWS has invested to strengthen these relationships. There is no one size fits all, and what works for one set of customers may not work for another set of enterprise customers. Customer obsessed strategic moves will help AWS capitalize on the next leg into the cloud.

Amazon has made extremely large investments into fulfilment and continues to invest heavily into AWS. Investments to enable next-day delivery of a greater number of SKUs around the world, have required them to densify their logistics network by opening sortation centers and delivery stations. Amazon has also needed to make a major investment in working capital, to fill these sites and get product closer to their end customer. AWS is amid a large capex cycle, as the company seeks to fulfill long-term agreements made with customers looking to move more of their IT infrastructure into the cloud. Ultimately, we believe these investments will pay off for shareholders.

Around ~15% of retail sales have moved online and ~10% of IT spending has moved into the cloud. Ecommerce and cloud will not capture 100% of their respective markets, but there is still plenty of room for both businesses to grow. Amazon’s customer obsession gives me confidence that management will make the right strategic moves to widen its moat and enable the company to capitalize on its long-term opportunities.

At Pledge Capital, we look for companies that are investing to strengthen their position through some sort of fundamental inflection point. We typically invest in small and mid-cap businesses. However, the large declines in the FAANG stocks have created some compelling opportunities. We especially like Amazon’s long-term prospects given its culture and recent strategic moves. This is a great time for long-term investors.