(This is a reprint of my SeekingAlpha article, which is now behind a pay walled.)
- Amazon’s AI investments and capabilities are underappreciated by the market.
- AI is key to driving Amazon’s competitive advantage over time.
- Amazon’s recent pullback due to higher investments is unjustified, thus creating an attractive buying opportunity.
Everyone who follows the tech space knows that artificial intelligence (“AI”) is one of the hottest area of investment. From my anecdotal experience, if you ask market participants to list who they think is the current leader in AI, most will say Google (NASDAQ:GOOGL) (GOOG), then followed by perhaps Microsoft (MSFT) or NVIDIA (NVDA). Being labeled an “AI” company helps these stocks attract incremental investors. However, it surprises me how few market participants recognize Amazon’s (AMZN) leadership in AI.
In my view, though impossible to quantify exactly, Amazon’s AI investments and capabilities should sustain and increase its competitive advantage over time, leading me to believe that the stock has a much longer runway than what investors are giving it credit for. If I am correct, this also means bad news for Amazon competitors – this is particularly true in the retail space where competitive have invested little in AI technology by comparison.
Unlike tech peers, Amazon does not tout its AI capabilities to investors, which is likely the main reason why Amazon is not as closely associated with AI. For evidence of my assertion, let’s look at Q2 earning calls.
Looking at Google’s Q2 call, the first meaningful sentence that came out of the CEO’s mouth is about AI: “Google continues to lead the shift to AI driven computing.” I was going to count the number of times AI or machine learning was mentioned, but that would be futile exercise since the deeper meaning of the CEO’s message is that AI touches everything that Google does. One cannot separate AI from the rest of Google’s business.
Looking at Microsoft’s Q2 call (CYQ4), Nadella, MSFT’s CEO, began by briefly summarizing earnings and then described FY17 as “a tremendous year of customer momentum with Cloud, AI, and digital transformation”. While Nadella speaks of AI less frequently than Google’s CEO, he made it very clear how important AI is to Microsoft by stating “the core currency of any business going forward will be the ability to convert their data into AI that drives competitive advantage.”
NVDA is, of course, viewed as one of the best ways to invest in AI in the public equity markets on the hardware side. NVDA’s CFO – the CEO did not have prepared remarks – talked about AI almost immediately by stating “data center revenue grew more than 2.5 times, reflecting momentum behind artificial intelligence”. And of course, the CEO talked about AI in his response to the 1st analyst question: “…you have to perform AI on it instantaneously so that you could avoid inappropriate video from being streamed to large audiences…”
If you are familiar with Google, Microsoft and NVIDIA conference calls, all this emphasis on AI is nothing new, so it is no wonder that most market participants associate these companies with AI.
When people think of Amazon, they think of retail disruption, logistics, and AWS. Few recognize what a giant Amazon is in AI for the simple reason that they do not talk much about it to investors. First one all, in its typical highly-efficient style, Amazon opened up their Q2 call without prepared remarks, so unlike Google, Microsoft and NVIDIA, there is no opportunity to brag about their AI capabilities. In the press release, the only direct mention of machine learning and AI came in bullet number 20: “AWS customers continue to ramp their use of Amazon Machine Learning and Artificial Intelligence services…”
Even sell side analysts do not fully appreciate how important AI is to Amazon. For example, in the Q2 earnings call last month, AI was only mentioned towards the end of the call and it came from a sell side analyst: “As you continue to scale operations and you bring data to bear and robotics and Kivas and AI machine learning, are you finding that kind of new fulfillment center optimization curve is accelerating?” The response from the Director of Investor Relations was essentially a non-response, simply saying “we’re getting more efficient.” Jeff Bezos wasn’t there to let investors know how he truly feels.
According to Paysa, who analyzed “millions of data points”, Amazon is far and away the biggest spender on AI talent. Amazon is spending at almost double what Google is spending, who came in at #2, followed by Microsoft at #3, Facebook at #4 and NVIDIA at #5. We can also see Amazon’s commitment to AI through Jeff Bezos’s letters and interviews. For example, in Jeff Bezos’s latest letter to shareholders, Bezos wrote:
“These big trends are not that hard to spot (they get talked and written about a lot), but they can be strangely hard for large organizations to embrace. We’re in the middle of an obvious one right now: machine learning and artificial intelligence… At Amazon, we’ve been engaged in the practical application of machine learning for many years now… much of what we do with machine learning happens beneath the surface.”
Amazon’s AI capabilities should increase its competitive advantage on multiple fronts. For example, Amazon said Kiva robots have cut operating expenses by about 20%, or roughly $22 million in cost savings for each fulfillment center. AI also drives Amazon’s product recommendation engine, which should lead to higher conversion rate and better customer satisfaction. Amazon is also leveraging AI to get into customers’ homes through Alexa (which is the software in home devices such as the Amazon Echo), which should increase purchase frequency. Lowering costs, increasing customer satisfaction, and increasing traffic are all essential elements of Amazon’s flywheel strategy.
Amazon’s stock has been weak since reporting Q2 earnings for what I believeto be unjustified reasons. The market seems concerned with Amazon’s increased investments, which compressed Q2. Consensus estimates projects that Amazon’s 2017 operating margin will contract to 2.0%, down from 3.1% in 2016. While this looks troubling on the surface, the margin compression is driven by investments in infrastructure and, as I have pointed out in this article, investments in key technologies such as AI, which has gone largely unnoticed. These investments should increase Amazon’s competitive advantage over time, which should be welcomed by investors. Thus, I view Amazon’s recent pullback as a buying opportunity.