Amazon | Fundamental Analysis - Price Action | LONG

Ever since Amazon began disclosing Amazon Web Services (AWS) revenues and operating profits in 2015, more and more experts have been waiting for the tech titan to spin off its expanding cloud business.

As longtime Amazon fans, some have regularly resisted the thought for a single reason. AWS generates higher-margin revenue than Amazon's retail business, so it actually provides most of Amazon's revenue growth by boosting the development of its retail ecosystem through extensive discounts, cheap hardware devices, physical stores, and other loss-making strategies.

But over the past year, experts have slowly started to get a grip on the idea of spinning off AWS from Amazon. Let's take a look at a few reasons why Amazon should consider a spin-off - and whether it could actually happen.

First and foremost, Amazon has a hidden growth engine.

According to eMarketer, Amazon is the third-largest online advertising platform in the U.S. after Facebook and Google, and Alphabet, but the company has not yet begun to separately report its advertising revenue or operating profit.

Alternatively, Amazon's advertising business estimates for the lion's share of the "other" segment, whose revenue grew 82% year over year to $14.8 billion in the first half of 2021 and accounted for 7% of Amazon's total revenue. By comparison, AWS revenue grew 35% year over year to $28.3 billion in the first half of 2021 and accounted for 13% of Amazon's total revenue.

Amazon has not yet disclosed the operating profit of its "other" segment, but market-leading ad platforms typically generate higher revenues than cloud infrastructure platforms.

For instance, Facebook, which derives almost all of its revenue from advertising, finished last quarter with an operating margin of 43%. AWS, the only major public cloud infrastructure platform that consistently generates revenue, finished last quarter with an operating margin of 28%.

Thus, Amazon's advertising business is likely operating at higher margins than AWS and generating much higher sales growth. Meantime, AWS faces stiff competition from Microsoft Azure and Google Cloud, and it may be forced to take a recent price cut for third-party cloud platforms (3% for both platforms, compared to 5% for AWS).

So, considering the above-mentioned, it does make sense for Amazon to spin off AWS while it is still developing and count more on its fast-expanding advertising business in the future.

Second, this spin-off might appease antitrust authorities.

AWS gives Amazon a giant advantage over most other retailers because its higher-margin revenue supports the expansion of the Prime ecosystem with lower-margin strategies. That's why many large retailers choose to use Azure or Microsoft's Google Cloud instead of supporting the growth of Amazon's biggest revenue engine.

AMZN also suffers consistent tension from antitrust regulators in the U.S. and abroad over the dominance of its e-commerce marketplaces. AWS, which Canalys estimates control 31% of the global cloud infrastructure market, is also under scrutiny from regulators, and it could face scrutiny if more retailers complain about the synergy between Amazon's retail business and AWS's profit-making business.

An active spin-off of AWS could appease regulators, make AWS more attractive to Amazon's retail competitors, and give Amazon more room to expand its advertising business.

Finally, this way AWS would no longer need to support the retail business.

AWS supports Amazon's revenue growth, but Amazon's retail business also prevents AWS from realizing its true growth potential. An AWS separation would allow the cloud company to invest in its own future growth without the burden of supporting Amazon's less profitable retail sites and stores.

Such a spin-off would be comparable to eBay's separation from PayPal in 2015. In such a spin-off, each eBay shareholder received one new share of PayPal for every share of eBay they owned.

Amazon CEO Andy Jassy, who led AWS before succeeding Jeff Bezos in July, has earlier denied calls for an AWS spin-off. However, a separation makes more sense each quarter as Amazon's advertising business expands and the company increasingly faces antitrust hurdles. Therefore, most would agree that Amazon could spin off AWS soon, and investors should welcome the move.