Amazon Web Services could be worth $600 billion by itself. Here's why Wall Street analysts think a spinoff won't happen any time soon

Troy WolvertonDec 22, 2018, 00:26 IST

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Amazon is going to spin off Amazon Web Services, its market-leading cloud-computing unit, as a separate company, marketing guru Scott Galloway predicted recently at Business Insider's IGNITION conference.
Galloway, who correctly predicted the company's acquisition of Whole Foods, thinks the spinoff of Amazon Web Services will happen in the next two years.
Many of the financial analysts who cover the company agree that it's likely to happen - but most don't think it will occur any time soon.
Amazon isn't under any immediate pressure to separate out AWS, and the unit is posting outstanding results as a part of the e-commerce giant, they note.

A business professor who successfully predicted Amazon's purchase of Whole Foods thinks one of the company's next big moves will be to spin off its wildly successful cloud-computing business.

Some of the people who keep the closest tabs on Amazon think he might be onto something - although many quibble about the timing.

Amazon Web Services could easily stand on its own, Wall Street analysts who cover the company say. But many add that Amazon has no real incentive to spin off its cloud business any time soon, particularly not in the two-year time frame the professor - Scott Galloway of New York University's Stern School School of Business - is forecasting.

"AWS has gotten to size that would definitely allow it to have a very successful [spinoff]," said Youssef Squali, an analyst who covers Amazon for SunTrust Robinson Humphrey. But, he continued, "I don't believe Amazon feels any urgency to do it."

Indeed, in an interview last month with CNBC, Andy Jassy, the CEO of AWS, said he didn't see a spinoff happening anytime soon.

"I'll never say never about anything," Jassy said. But, he continued, "We just don't see a huge reason to do [it]."

The spinoff will be motivated by fear and greed, Galloway said

For his part, Galloway said Amazon has two compelling reasons to separate out AWS - greed and fear. Amazon could unlock potentially hundreds of millions of dollars of value by spinning off its cloud unit; on its own, AWS would likely be one of the ten most valuable companies in the world with a valuation of up to $600 billion, he said. Meanwhile, Amazon, like other big tech companies, is facing increasing scrutiny and mounting pressure from regulators and policymakers over its market power.

Read this: The business school prof who predicted Amazon would buy Whole Foods now says an AWS spinoff is inevitable - and the standalone company could be worth $600B

Jin S. Lee/Business Insider

An AWS spin-off would prophylactically diminish that threat," said Galloway, who teaches marketing and first made his prediction at Business Insider's IGNITION conference earlier this month.

Some analysts and investors practically salivated at the idea of Amazon setting up AWS as a standalone company. Cloud computing is one of the hottest areas in the tech industry right now, but there's no easy way for people or institutions to narrowly invest in the core part of the sector. All three of the biggest cloud computing players - AWS, Microsoft Azure, and Google Cloud - are part of much bigger companies.

An AWS spin-off would not only give investors a pure-play cloud computing company to bet on, but it would allow them to buy into the dominant player in the space. Portfolio managers and money managers that don't follow tech closely but want to have a stake in the space would automatically buy shares of AWS, said Dan Morgan, a portfolio manager with Synovus Trust and a longtime tech investor.

"That would be huge," he said. He continued: "There would be tremendous demand for it."

AWS could benefit from cutting its close ties to Amazon

AWS could also see a business boost from the move. The cloud business is arguably already losing business because of its connection to Amazon.

Microsoft and Google's cloud arms have courted Amazon's retail competitors by noting that they don't have the same potential conflict of interest as the e-commerce giant. And Walmart, which signed a partnership deal with Microsoft earlier this year, has reportedly been urging its vendors to stop using AWS.

But Microsoft and Google have their own potential conflicts of interest thanks to the other parts of their business outside of their cloud units, said Scott Mushkin, a financial analyst who covers Amazon for Wolfe Research. But an independent AWS could lure business from all comers - potentially boosting its growth.

"A free-standing AWS could say we're a neutral party with pretty much everything," he said.

Amazon could spin off AWS not just to realize the full value of its cloud unit, but to demonstrate the worth of the other parts of its business, Mushkin said. The conventional thinking has been that without AWS, Amazon wouldn't be profitable. But that's no longer the reality, he said. Outside of AWS, Amazon's got highly profitable business in the form of its advertising efforts and its marketplace for third-party sellers, among other areas.

"Amazon's making lot of money in a lot of places these days," said Mushkin, who's even more bullish on the idea than Galloway, speculating it could happen in the next six to 12 months. Spinning off AWS, he continued, would be a "very bullish signal from the powers that be that Amazon ... is fine all by itself."

"It does have the potential to release a lot of value."

Other analysts doubt a spinoff will happen anytime soon

Other analysts agree that Amazon will eventually set up AWS as a separate, standalone company. At some point, it will just make sense, they say. Just not now.

Squali, for example, thinks a spinoff won't happen for another three to five years. Tom Forte, a financial analyst who covers the company for D.A. Davidson, thinks it won't happen until Amazon's highly profitable marketplace accounts for some three-quarters of its retail sales, up from about 53% today.

"I do see a potential scenario where [a spinoff] could happen at a point in time in the future," Forte said.

Forte and those who share his outlook think the main reason why it won't happen anytime soon is that there's no catalyst for it - there's nothing going on in the world that would light a fire under Amazon to take such a drastic move.

Typically, companies spin off units because they're under pressure to do so, usually from shareholders upset by an underperforming stock. Those investors often make the argument that the company has hidden gems that the market isn't seeing, and whose value will only be fully realized if the company separates them out as independent businesses.

But Amazon already breaks out the revenue, operating margin, and growth rate of AWS, so its relatively easy for investors to value it, noted Colin Sebastian, a financial analyst with Baird. What's more, Amazon's stock has outperformed both the broader market and most of its peers in recent years.

"I disagree that [a spin-off] is likely in the near term," Sebastian said. He continued: "It's not like we have a situation where the stock has underperformed significantly."

"I think the Street has a fairly good handle on AWS," he added.

Amazon doesn't seem to be holding back AWS yet

What's more, at this point, the argument that AWS's ties to Amazon are hampering its business is more theoretical than actual, Sebastian said. Amazon has made a point of maintaining a separation between its retail business and AWS to reassure retail and other rivals, he said. And to some degree that's worked; one of AWS's more prominent customers is Netflix, even though its streaming video service directly competes with Amazon's Prime Video offering.

Andy JassyMike Blake/Reuters

But the proof is in the pudding - even in spite of the supposed conflict, AWS has been consistently growing its revenue at an annualized rate of more than 40% in recent quarters.

"I don't see that impact," Sebastian said. "You can't see it in the numbers that it's having trouble landing enterprise clients."

Similarly, some analysts discount the notion that Amazon will separate AWS because of regulatory pressure. The company is still a fraction of the size of Walmart and it doesn't dominate any particular retail segment, said Anthony Chukumba, a financial analyst with Loop Capital Markets.

Even if it did, the government typically raises antitrust concerns about companies only when they start or threaten to raise prices on consumers. But Amazon is renowned for cutting prices and forcing competitors to do the same, Chukuma noted.

"The government's not really on their trail," he said. "It has no real reason to be on their trail."

Amazon and AWS have a symbiotic relationship

And at least for now, both Amazon and AWS benefit from their mutual ties, many analysts say. Amazon is AWS's biggest customer. It contributes to AWS's scale. It frequently asks for improvements and new features on AWS that end up benefiting all of the cloud service's customers, Sebastian said. But Amazon itself also benefits from the innovation and feature AWS develops for its other customers.

"It's a very symbiotic relationship," he said. If Amazon were to carve off AWS and set it up as its own independent company, he continued, "it wouldn't have nearly the same level of benefit."

To be sure, even those who are dubious that Amazon will spin off AWS anytime soon acknowledge changing circumstances could force its hand. The biggest potential spur for such a move would be a significant and sustained drop in its stock price, they say.

As Galloway notes, that's not some far-out possibility. Amazon's shares have historically - and even recently - seen big swings. Just in the last three months, the company's stock has fallen more than 30%.

"I think this will happen on the back of stock market underperformance," he said. He continued: "The stock price is the biggest lever of this decision."

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