Amazon Unlikely To Spin Off AWS Cloud Unit

Charles Babcock| Informationweek

Amazon Web Services has always been different from its parent, Amazon.com. The latter, of course, is a retail operation that generated a mammoth $61.1 billion in sales in 2012. AWS, on the other hand, is a new kind of wholesaler, distributing compute cycles from cloud data centers at rock bottom prices and generating a more modest estimated $2.1 billion in sales.

So will these two dissimilar businesses remain under the same roof forever? Timothy Horan, an analyst at investment firm Oppenheimer & Co., said in a research report that it’s “inevitable” that Amazon will spin off Amazon Web Services.

A Horan-authored research report was quoted Feb. 11 in Investor’s Business Daily as saying such a move was “inevitable” due to potential conflicts between AWS and other Amazon.com customers and the greater value that AWS would have if it stood alone in the marketplace.

“We believe an ultimate spinoff of AWS is inevitable due to its channel conflicts and the need to gain scale,” Horan wrote. “We see the business as extremely valuable on a stand-alone basis, possibly even operating as a REIT,” he wrote. REITs (real estate investment trusts) are companies that own income-producing real estate, a description that matches Amazon Web Services’ cloud data centers. REITs are not strictly defined; in addition to commercial real estate, such as office buildings and warehouses, REITs own hospitals, hotels and timberland.

Other online retailers that wish to use a cloud service often end up using Amazon’s, even though Amazon.com, the retail operation, is a direct competitor. “To date, public cloud users, including online retailers, have had few alternatives (to Amazon) when utilizing the cloud,” Horan wrote. That means if an online retailer loses customers due to its e-commerce system’s poor performance, that retailer can’t assume that AWS did anything to affect its performance, even though it’s a competitor and might be in a position to do so.

Likewise, AWS entered the video distribution business in 2012 even though one of its largest cloud customers is Netflix. Amazon’s Prime Instant Video is now stocked with 36,000 titles, including popular television series The Closer, Falling Skies and Pawn Stars, after recent deals with Warner Bros., Turner Broadcasting, Domestic Television Distribution and A&E Networks.

Amazon.com is selling its own brand of Kindle Fire tablets online, even though other tablet retailers use its AWS services to sell tablets as well. Horan predicted the tensions between the various Amazon business units and their customers or outright customer defections “will pressure Amazon to create two separate companies that are more horizontally segmented.”

Amazon itself is aware that the financial community perceives it as competing on business with some of its own best customers, such as Netflix. But so far, the AWS-Netflix relationship has held firm. Netflix has stood by Amazon during highly publicized outages in 2011 and 2012 at its most heavily trafficked regional data center, U.S. East, in Northern Virginia.

During an interview at the Amazon user conference Nov. 29 in Las Vegas, Amazon CEO Jeff Bezos brought up the issue himself in an attempt to lay it to rest. He cited AWS’s close partnership with Netflix since the launch of its own video service. “We (Amazon.com) may compete on Prime Instant Video, but we bust our butts every day for Netflix on the AWS side.” If it will do so for Netflix, it will do for any other customer, he said.

Netflix IT managers decided in 2010 to stop building data centers to keep up with its rapidly expanding customer base and rely instead on Amazon Web Services. Much of its membership growth occurred in the 2010-2012 timeframe, so it can be viewed as dependent on AWS to sustain the expansion.

Oppenheimer’s Horan looked at the revenues of Amazon Web Services competitor Rackspace and projected AWS sales will increase from around $2 billion in 2012 to $10 billion in by 2016. At that rate, AWS would have a value of $101 billion by 2018, he claimed, basing the figure on a comparative valuation of Rackspace, with its smaller market share.

Other analysts consider that wildly optimistic and place a lower value on a future AWS. Ben Schacter, an analyst for the Macquarie Group, an investment fund manager in Sydney, Australia, sees AWS’s sales growing to $6.2 billion in 2014 and $8.8 billion in 2015 as it starts enlisting large enterprise customers. Schacter said AWS would be worth anywhere from $19-$30 billion as a standalone company in 2014.

Amazon.com itself has never commented on the AWS spinoff speculation and declined to do so for this story. But high level Amazon.com officials, including Andy Jassy, senior VP and a close Bezos lieutenant, have made it clear they think AWS is worth more than its current level of sales would indicate on Wall Street.

In December, Jassy told London’s The Telegraph that the Web services division was growing fast and could move Amazon past its largest rivals, including Google and Apple. “At the highest levels of this company, we believe that it’s quite possible that AWS ends up being the largest business in Amazon. We believe (that) passionately,” he said.

“We don’t say to ourselves, ‘What we’re really doing is trying to build the largest technology company in the world.’ We just happen to think … [it] has the chance to be the largest technology company.”

If Amazon aspires to be one of the largest technology companies in the world, it won’t spin out AWS. On the other hand, Amazon.com’s stock price has risen continuously over a string of eight quarters where profits have shrunk and losses have grown. Bezos is believed to be building out a company for the future, not seeking short-term profits. But if investors lose confidence that his vision is going to work, Amazon may have to spin out a valuable asset as a public entity to maximize its value and raise capital for the company. There’s no sign that that day is anywhere near yet.

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