How Big Can The Amazon Web Services Business Grow In The Future?

Amazon's ( AMZN ) stock has risen by over 40% over the last six months on solid earnings growth in the quarterly results. Moreover, the results in the Amazon Web Services (AWS) segment (which were reported separately for the first time) surpassed expectations on both the top-line as well as bottom-line, helping drive the recent momentum in the company's stock's price. In Q1 2015, net sales in the AWS segment rose by 49% annually to $1.57 billion, and operating margin came in at 16.9%.

As the leader in the cloud infrastructures services market, Amazon Web Services will continue to power the company's earnings in the coming years, in our view. Hence, we have forecast the segment to comprise for around 23% of our valuation for the company's stock and have forecast its annual revenue to cross $15 billion in the long-run (by 2019). This is based on the assumption that the cloud infrastructure and platform market could grow at around 30% CAGR to reach $43 billion by 2018 (according to Goldman Sachs and cited below). While the competition is expected to rise in the industry, we believe Amazon will continue to account for the leading share in the market, helped by its first mover advantage.

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How Big Is The Cloud Infrastructure And Platform Spending Market?

The cloud infrastructure and platform market mainly includes Infrastructure as a Service (IaaS) as well as Platform as a Service (PaaS). While IaaS acts a base layer and includes cloud infrastructure such as servers, storage, network and operating systems, PaaS comes above that layer and provides platform for the easy creation of software. PaaS includes database, operating system, middleware as well as management tools.

Spending on cloud infrastructure and platform could rise from $16 billion in 2014 at a CAGR of 28% to $43 billion by 2018, according to Goldman Sachs. Consequently, the share of cloud infrastructure and platform in enterprise IT spending is forecast to increase from 5% in 2014 to 11% by 2018. This will be driven by the increasing shift of IT budget from traditional in-house delivery methods towards versions of cloud computing, as a means to save costs and generate new revenue streams.

How Is The Competitive Landscape In The Industry ?

Helped by first mover advantage, Amazon Web Services commands the leading market share in the cloud infrastructure services industry - its share increased to 30% in Q4 2014 (according to Synergy Research Group). Other prominent players in the industry include heavyweights such as Microsoft, Google and IBM. Given the huge financial resources of these other players, we expect the competition in the industry to intensify in the coming years.

While the market witnessed intense price-based competition in the first half of 2014, the same slowed down during the second half of the year. We believe Amazon will continue to occupy the largest share of the industry going forward, given its ability to quickly innovate and reduce prices. At the same time, we expect the EBITDA margins in the AWS segment to rise in the coming years, with maturity in the business model and faster top-line growth in the industry.

Our $360 price estimate for the company's stock represents near-20% downside to the current market price.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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