Share prices of Amazon (NASDAQ: AMZN) are up 22% over the last month. The company’s second-quarter earnings report showed the retail side struggling to return to pre-pandemic growth levels, while the Amazon Web Services (AWS) cloud business posted strong 33% growth in revenue over the year-ago quarter, and it’s not done yet.
During the earnings call, Chief Financial Officer Brian Olsavsky said, “AWS continues to grow at a fast pace, and we believe we’re still in the early stages of enterprise and public sector adoption of the cloud.”
AWS makes up 13% of Amazon’s total revenue, but it has emerged as the company’s most important growth driver. As it contributes more to Amazon’s bottom line, Redburn analyst Alex Haissl estimates the long-term value of just AWS could be worth double Amazon’s overall current market cap of $1.4 trillion.
While a timeline wasn’t given as to when AWS might reach a value of $3 trillion, there are good reasons to believe Haissl is right.
AWS generates consistent growth
AWS’ second-quarter growth represented a deceleration over the previous quarter’s 37% year-over-year increase. However, Amazon believes AWS will continue to perform well in a weak economic environment.
AWS has been a very consistent performer. The segment posted a 34% revenue increase in the fourth quarter of 2019, before slightly decelerating to 33% in the first quarter of 2020. That was over two years ago, and AWS is still growing in line with that trajectory.
The consistent rate of growth is rooted in the value AWS brings organizations. It frees up capital to invest more in product development so that companies can focus on their unique offerings instead of building new data centers, which ties up billions of dollars. That’s the basic value cloud computing brings to a business.
Amazon is riding a wave of spending on technology infrastructure coming out of the pandemic. Companies investing in cloud services are not concerned about the state of the economy because these are long-term investments that are crucial for their competitiveness for decades to come.
How big is the cloud market?
The runway for cloud growth could stretch out for years. One sector that is starting to ramp up investment in cloud services is the government. Total federal cloud spending more than doubled over the last five years to $8.1 billion through Aug. 2021, according to Deloitte Insights, and it’s still growing in 2022.
In addition to governments and non-profits that are adopting AWS, Amazon also reported signing new agreements with existing customers during the quarter, including Delta Air Lines, video game maker Riot Games, and Jefferies Financial Group.
Worldwide spending on public cloud services is expected to reach $482 billion, according to Gartner, up from $145 billion in 2017. By 2023, the public cloud services market is expected to reach nearly $600 billion.
Amazon gained one point of market share in the second quarter, according to Synergy Research, and continues to hold a large lead over competitors Microsoft and Alphabet.
AWS could generate $288 billion in annual revenue in 10 years, which assumes an annualized rate of growth of 15%. Based on AWS’ current operating margin, the segment would generate $88 billion in operating profit, or earnings before interest and taxes (EBIT). A $3 trillion value would imply an enterprise value-to-EBIT ratio of 34, which is not unusual for a high-growth, high-margin business.
It’s possible AWS could grow faster than 15% per year, which would make it easier to justify a $3 trillion future value. Either way, the estimate by Redburn analyst Alex Haissl seems reasonable on the surface, and it’s enough to suggest that Amazon’s shares offer compelling value at current price levels.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. John Ballard has positions in Amazon. The Motley Fool has positions in and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Jefferies Financial Group Inc., and Microsoft. The Motley Fool recommends Delta Air Lines and Gartner. The Motley Fool has a disclosure policy.