Amazon (AMZN) is the world's largest online retailer, selling everything from books to shampoo, but the company's Prime service may be more important to its future than anything else consumers buy.
Going into Amazon's second quarter earnings, Deutsche Bank analyst Ross Sandler, who rates shares buy with a $400 price target, noted that "Prime is arguably the most valuable and important growth trend for Amazon, representing around 50% of company [gross merchandise volume] today."
He estimates that Prime has 32 million customers, a number Amazon has never publicly confirmed. If Amazon does indeed have over 30 million users, that would be around 45% year over year growth. Though Sandler estimates that Prime negatively impacts Amazon's margins, the high gross merchandise volume it drives overcomes the margin compression.
The 32 million figure is roughly in line with what research firm Consumer Intelligence Research Partners found. According to a June survey, CIRP estimated that 27 million, or around 44% of domestic customers use Prime, and there's an incredible loyalty rate. Around 95% of those surveyed will “definitely” or “probably” renew their membership.
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Amazon Prime started in 2005, as a free two-day shipping service for Amazon consumers, but it has expanded into so much more, part of the reason why Sandler thinks Prime could reach 100 million users by 2020, and "be worth over half of AMZN’s market cap." Prime, which now costs $99 a year, up from $79, also offers access to Kindle book libraries, thousands of movies and television shows, akin to Netflix, and Amazon's streaming music service, in addition to the free two day shipping.
Sandler notes that Prime users spend around $2,500 a year on goods, compared to just $330 for non-Prime users, making them nearly 8 times more valuable from a gross merchandise volume standpoint. One caveat to this is that early Prime adopters are more valuable than newer ones, because they spend more.
Even though Prime's Consolidated Segment Operating Income (CSOI) margins could remain extremely low for years due to the products people buy on Prime, the company's longer term objective, of being all things to all people, make Prime an important tradeoff for Amazon and its shareholders.
"Some investors are temporarily frustrated by AMZN’s consistent philosophy in investing for the future at the expense of today’s margins," Sandler penned in the note. "However, we estimate a LTV (lifetime-value) for Prime customers at over $1000 in contribution profit, obviously a metric that the company is focused on vs. near term margins. At current pace, Prime could reach 100 million customers by 2020, and even at 70% of the LTV capture it would amount to $70B in value, or nearly half of AMZN’s market cap today."