UPDATED 16:49 EDT / JULY 27 2017

CLOUD

As its cloud growth eases, Amazon suffers a big miss on profit

This time, the cloud didn’t save the day for Amazon.com Inc.

Thanks to big spending on fulfilling e-commerce orders and on technology and original shows for its video operation, the tech giant saw its second-quarter profit plunge 77 percent, to $197 million or 40 cents a share.

Revenue of $38 billion, up 25 percent, beat analysts’ expectations of $37.2 billion, but the profit fell way below the average forecast of $1.40 a share. Investors didn’t panic, knowing Amazon’s customary swings in profitability over the years, but they knocked shares down more than 3 percent in after-hours trading.

During regular trading, shares fell 0.65 percent to $1,046, dipping Amazon’s valuation a hair below the $500 billion mark shared by Apple Inc., Alphabet Inc., Microsoft Corp. and Facebook Inc. Amazon’s shares were up about 40 percent on the year before today, making founder and Chief Executive Officer Jeff Bezos the world’s richest person for a few hours before he ceded the title back to Bill Gates.

Amazon said fulfillment costs rose 33 percent from a year ago and spending on technology and content jumped 43 percent. Some of those costs involve building out the Amazon Web Services cloud computing operation. But cloud profits in recent quarters have driven upside surprises in overall company profit.

Not this time. AWS did provide a modest upside with $4.1 billion in revenue in the quarter, up 42 percent from a year ago and just over analysts’ estimates. It also produced $916 million in operating profit, up 28 percent. That more than made up for $288 million in losses on the retail side, where U.S. operations made $436 million but international operations lost $724 million. Moreover, the absolute dollar increase in the quarter still set a new record for the company.

However, as AWS reaches a $16 billion annual revenue rate, cloud growth continues to slow, from 58 percent a year ago to 43 percent in the first quarter, when it became 10 percent of overall revenue, and now 42 percent. AWS is facing stronger competition from the Azure cloud especially, revenue from which Microsoft Corp. said earlier this week nearly doubled from a year ago, and from others such as Google Inc. and Oracle Corp.

“Despite what many say, cloud won’t be a winner-take-all market,” said Peter Burris, chief research officer at the analyst group Wikibon, owned by the same company as SiliconANGLE. “Having said that, original position will matter, and AWS is in a strong original position.” Wikibon forecasts that AWS will drive revenue to $40 billion by 2022.

“We are seeing great customer adoption” of AWS, Amazon Chief Financial Officer Brian Olsavsky said on the earning conference call. “Usage in all of our large services is increasing. Momentum in the business is very strong.”

Investors tend to agree. “While AWS is seeing increased competition from MSFT and GOOG (among others), we think its lead there is well established,” Macquarie Capital analyst Ben Schachter wrote in a report earlier this week.

Charging hard

AWS has kept charging hard. In April, it debuted a wide range of new services intended to make it easier for large enterprises to develop cutting-edge applications and move them to its cloud. In particular, they included faster access to data in databases and ways to create applications using machine learning. Amazon also has added more high-profile cloud customers lately, including Snap Inc. (though Google is the larger cloud supplier to the maker of the Snapchat app), Dunkin’ Brands Group Inc., Zillow Group and BP.

The company said it expects a wide range of potential operating income in the current quarter, from a loss of $400 million to a profit of $300 million — either way, quite a bit lower than the profit of $575 million a year ago. Amazon’s third quarter usually is a low point for operating income because the company’s gearing up for the holiday quarter, Olsavsky said. Net revenue is forecast at between $39.25 billion and $41.75 billion, or up 20 to 28 percent from a year earlier. Estimates don’t include the recently announced acquisition of Whole Foods Markets Inc., which hasn’t closed yet.

Despite investors’ disappointment today, they generally appear to see limited downside, despite Amazon’s longtime penchant for keeping its retail profit near or below break-even. “The company is ramping hiring of software engineers and sales staff (particularly for AWS and advertising) and we expect the accelerated investments to continue for the foreseeable future,” Schachter wrote in a note to clients. “Basically, the long-term opportunities are bigger than ever and so are the investments.”

Cowen & Co. analyst John Blackledge also called out another potential growth market in a note to clients last week: advertising. Thanks to Amazon’s unmatched trove of data on what customers actually buy, he foresees “solid growth within Amazon’s nascent ad business, which is inherently much higher margin than the core business or AWS.” EMarketer expects Amazon ad revenues to rise from $1.5 billion this year to $2.4 billion by 2019. And UBS recently estimated that based on fiscal 2018 projected ad sales, the ad business could be worth between $26 billion and $29 million.

Photo: Robert Hof

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