- Amazon is reporting Q1 2018 earnings soon, and we are excited to learn more about its emerging advertising business.
- Amazon’s digital advertising is not broken out in filings, and is not well covered by the media, but the company is becoming a serious contender in this space.
- We believe this unappreciated business could be worth $300 per share, or 20% of Amazon’s current value.
Amazon (AMZN) announced that it will report Q1 2018 earnings and host a call on April 26th, after the market close. We recently published an article, Trump Is Going Postal, But Amazon Will Win, which goes over Trump’s high profile attack on Amazon’s USPS deal and what this means to investors. In short, we think it is a big nothing. However, we are excited to learn more about Amazon’s emerging advertising business, which has been gaining momentum without a lot of fanfare from the broader investment community.
Amazon Advertising Has Been A Quiet Growth Driver
First, what is Amazon advertising? Amazon’s filings does not tell you much, so here is how Amazon’s CFO described the business during its 4Q17 earnings call:
And on advertising, I would say our strategy is to make the customerexperience additive by the ad process. We want customers to be able tosee new brands and have easier time discovering products that they’relooking for. For brands, we think the value proposition is that we can find ways for them, especially emerging brands, to reach new customers. Sowe’re working with advertisers of all types and sizes to help them reachour customer base and the goal of driving brand awareness, discoveryand better purchase decisions by the customer.
Amazon’s advertising business is not individually broken out, but it is understood that, by 2017, nearly all of the “Other” revenue line item consists of advertising revenue, along with co-branded credit card agreements and other sources too small to disclose. As you can see from the chart above, advertising revenue has been growing faster than the overall business and becoming an increasingly significant part of Amazon.
Investors who closely follow Amazon earnings calls will notice that advertising is gaining increasing attention from both management and analysts. For example, in the 4Q16 earnings call, only one analyst asked about the advertising business, and the CFO described it as being “very early in the advertising space.” By 4Q17, three analysts asked about advertising, and the CFO’s tone became much more positive, talking about advertising under the same breath as AWS:
Advertising was also a key contributor as we’re continuing to make the offerings more valuable, both to customers and advertisers alike, and that was particularly strong in North America, although not in the North America segment. I would also point out, AWS had a strong quarter, accelerating growth versus Q3 and also expanding operating margins by 100 basis points. So particularly in North America, I would say, the strong top line volume combined with increased advertising revenues and also very clean operational performance.
Amazon’s advertising business has only recently received a little media coverage, although nowhere near as much as its various other initiatives. These media coverage are easy to miss, though I’d urge investors to take a serious look. For example, this December 2017 article by Digiday.comhighlights some rather compelling data about Amazon’s advertising business, which suggests that this start-up is already viewed as a peer to tier one advertising platforms such as Google and Facebook:
Large ad companies have been vocal about their support for Amazon as well. According to this December 2017 WSJ article, for 2018, WPP (WPP) plans to increase ad spending on Amazon by 40-50% from (implying ~$300M in ad spending), Publicis (OTCQX:PUBGY) plans to increase spending by 50% to $300M, and Omnicom (OMC) plans to double ad spending to $200M.
And in case you missed, OMC, during its recent Q1 2018 earnings call, had some powerful things to say about Amazon advertising:
And really, importantly, when you see everybody’s focus is on Google andFacebook, and we don’t think that’s an issue or as much of an issue assome people make it out to be, just look at our presentation. But Amazonis coming over the hill. Amazon certainly poses a big threat on search andadvertising to, let’s say, Google and Facebook. There is head-to-headcompetition coming there. Amazon already, according to Kantar,generates, what, 55% of search emanates in someway or another fromAmazon. And voice is going to become increasingly important, particularlyin– Amazon has sort of carpet bombed the voice real estate with Alexa. Idon’t know what their market share homes are, but it seems to me to beextremely high.”
Why Investors Should Care
In the previous section, I hope I made it clear that Amazon’s advertising business, although new and relatively small, should not be taken lightly. So, how big is this opportunity in terms of shareholder value? Let look at this question from two different angles.
One way to look at Amazon advertising’s valuation is by comparing it to a comp’s valuation at various stages of their development.
Let’s go through one example. In 2016, Facebook grew total revenue by 54% and traded at a TTM EV/Sales valuation of between 19-12 times. Using our projected ad revenue for Amazon in 2018 of $6.4 billion and applying a 15.5x multiple (mid-point of Facebook’s range), we arrive at $205 per share by the end of 2018, or an additional 13% from Amazon’s current market value. 13% of additional market value from a business that isn’t even broken out is not bad, but this is only the beginning, so such a valuation is unjustifiably myopic.
If we look further out, for example, Facebook is expected to grow 2019 revenue by 27% and is currently trading at 6.3 consensus 2019 sales. This growth rate is comparable to our projected 2023 growth for Amazon advertising. If we discount it back by 4 years using an 8% discount rate (a somewhat low rate to reflect our very conservative growth deceleration assumption) to make it comparable to 2019 and apply FB’s multiple, we get $300 per share, or 20% upside from Amazon’s current price. Now we are talking!
But there are no good reasons to believe that Amazon advertising growth will be decelerating at 5% a year, which implies that it is less scalable than Facebook or Google. Since it is similar to and directly competitive with Google and Facebook’s advertising business, it is clear that the opportunity to create shareholder value is much larger than the conservative valuation exercises above.
For example – and now we are dreaming BIG – since ~ 90% of Alphabet and Facebook’s revenue comes from advertising, and since the combined market value of each company is $1.23 trillion, Amazon advertising’s “market value TAM” is ~ $1.1 trillion. Creating an additional $1.1 trillion in market value from its advertising business alone (or ~$2,300 per share) is of course merely a fantasy at this moment, but even if 1/3 of that “market value TAM” is addressable, that gives Amazon the potential to create ~$760 per share in additional shareholder value from advertising alone.
Amazon has lot of irons in the fire, but advertising is perhaps the most underappreciated and simultaneously most lucrative opportunity in its portfolio.