Amazon's massive cloud business failed to live up to expectations for the first time - but investors aren't worried

Amazon's cloud service, Amazon Web Services, has grown into a massive $12 billion annual revenue business, just 10 years after its launch.

AWS, in fact, has done so well that it's never missed street estimates since 2015, when Amazon first started breaking out its numbers.

But it finally hit the wall in Amazon's most recent quarter. It fell 2% short of the $3.6 billion street estimates, failing to meet Wall Street's lofty expectations for the first time.

Still, most investors remain confident in AWS's future. And some of them believe AWS saw stronger growth last quarter than what it appears to be, pointing to a rather typically overlooked part of Amazon's business: unearned revenue.

Unearned revenue

Unearned revenue is the amount of money that has not been recorded as revenue - yet. For example, if you sign a $1,200-a-year contract, only a quarter of the amount (or $300) gets recorded as revenue in the first quarter, with the remaining $900 going to unearned revenue. Each passing quarter, another $300 would get added to revenue, while the same amount would get reduced from unearned revenue.

In the fourth quarter, Amazon had $4.8 billion in unearned revenue. That's a $600 million jump from the previous quarter, an unusually big spike compared to recent quarters. It increased $350 million sequentially in the third quarter and just $90 million in the second quarter of 2016.

Part of Amazon's unearned revenue comes from its annual Prime memberships, but according to Deutsche Bank's estimates, a "healthy portion" of the increase came from AWS contracts. That means AWS has hundreds of millions of dollars in backlog revenue just sitting on its balance sheet waiting to get recorded in the near future.

"It likely points to stronger-than-realized growth at AWS," RBC Capital's Mark Mahaney wrote in a note Friday.

Bigger, longer deals

Mahaney writes the jump in Amazon's unearned revenue could be explained in two ways. AWS is signing up bigger multi-year contracts with large companies, while ramping up the number of users for Reserved Instances, its discount program that requires prepayment and longer contract commitments.

AWS did disclose major contracts in its earnings release, with companies like Capital One, Workday, and Salesforce. It's unclear how many Reserved Instances customers AWS has, but Credit Suisse writes it should account for a big part of Amazon's unearned revenue.

Mahaney says if this trend continues, investors could start paying more attention to AWS's billings, a metric that's considered a better forward-looking indicator because it combines the change in unearned revenue with the actual revenue figure. Most of AWS customers are believed to be on a pay-as-you-go basis currently.

In any case, AWS continues to be one of the biggest success stories in tech. Given AWS still saw a whopping 47% year-over-year growth last quarter, despite seven prices cuts and significant currency headwinds, speaks for itself.

"Given AWS' momentum and dominant market share, we expect growth to remain strong and help contribute meaningfully to overall profitability," Mahaney wrote.