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Analysts Mull Whether AWS Should Be Spun Off

In the wake of Amazon.com's earnings report last week, in which the company broke out earnings for Amazon Web Services (AWS) for the first time, analysts are debating whether the retail giant should spin off its cloud business.

Over recent quarters, Amazon.com investors have grown increasingly impatient with the drag that AWS has imposed on Amazon.com's overall profits. Amazon.com has been under pressure to give a more detailed breakdown of AWS revenues and profitability.

Amazon.com's first-quarter earnings report last week gave investors welcome news: AWS is a $5 billion business and growing. The cloud subsidiary posted $1.57 billion in revenue for Q1, a 49 percent year-over-year increase. Based on analyst estimates, that would put AWS on a $6 billion run rate.

The most surprising revelation from Amazon.com's earnings report was that AWS is profitable, with a margin of 17 percent. Macquarie analyst Ben Schachter told The Wall Street Journal that AWS "is significantly more profitable than we expected." 

Noting the 15 percent jump in the company's stock on the news, Finro Equity analyst Lior Ronen was among a number of others suggesting that Amazon.com spin off AWS. In a Seeking Alpha blog post, Ronen said that based on AWS' Q1 revenue, the segment is on a $6.9 billion annual revenue run rate, based on 11 percent quarterly growth. Assuming a price-to-sales ratio ranging from 7 to 10, AWS is worth between $48 billion and $69 billion, Ronen estimated.

"By spinning AWS, Amazon will be able to create two tech giants -- one focused on e-commerce and online retail business and the other on cloud computing and IaaS services," he said. "Amazon could leverage the two companies to create a whole that is bigger the sum of its parts: AWS could focus on its niche, develop new revenue streams, and invest further in its technology, while Amazon could do the same on its e-commerce platform. That is the only way Amazon could create a sustainable growth for the long term and employ the advantages it has in both businesses."

But Equity analyst James Brumely was among those skeptical about AWS' long-term prospects. In a separate Seeking Alpha post, Brumely argued cloud services becoming more commoditized will put pressure on future AWS margins. Brumely also said that Google and Microsoft will continue to put pressure on Amazon.

"Even as exciting as unexpected operating profits are for the Amazon Web Services (AWS) arm of the e-commerce giant, it doesn't change the fact that the company still lost money last quarter, nor does it change the fact that margins for AWS are more likely to continue to shrink rather than widen as cloud-computing continues to become commoditized," he said.

Furthermore, the 17 percent margin isn't as impressive as it seems, Brumely argued, pointing to the fact that 291 of the companies in the Fortune 500 have operating profits of 15 percent or higher. More alarming, he said, is the fact that AWS' 17 percent margin represents a marked decline from last year's profit of 23 percent during the same quarter.

"What happened?" he asked. "In simplest terms, Amazon (in a very Amazon-esque manner) has decided to become and remain the low-price leader with the cloud-storage world, and didn't worry about making much -- if any -- profit in the business. As turns out, it still made some operating profit as a cloud-computing provider, but it's making progressively, relatively less as time moves along."

The findings from Amazon.com's AWS stats may be vague, but it's a noteworthy step, not just for investors but for buyers of cloud infrastructure services who -- while looking to bet the best deal possible -- surely don't want to see their provider lose money indefinitely.

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About the Author

Jeffrey Schwartz is editor of Redmond magazine and also covers cloud computing for Virtualization Review's Cloud Report. In addition, he writes the Channeling the Cloud column for Redmond Channel Partner. Follow him on Twitter @JeffreySchwartz.

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