Amazon – Published 12/12/17

Amazon seeks Prime position in battle for best content

Amazon (NASDAQ:AMZN) or more accurately, the company’s Prime Video arm, is one of the US mega corporations currently joining the battle for content, in particular Video on Demand (VOD).

Amazon’s Q3 results were stunning. Revenue was $42.47bn, up from $42.14 and North America grew strongly. Amazon’s shares are up 30% this year. Operating margin is still thin but the company is clearly succeeding in its push to grow market share. Nowhere is this more evident than in content provision.

Spending on content doubles

The company doubled its spending on content in later 2016 and the budgets are continuing to rise. They have to – because the competitors for original TV and video include not only the large TV and film studios but Netflix and Facebook both of which have their cheque books out.

In the past, Amazon Prime Instant Video has been subject to some confusing marketing from Amazon. A recent survey concluded that under half of Prime subscribers were accessing video through the service which has been seen as a nice-to-have giveaway for subscribers to the delivery service. But that hasn’t stopped Amazon from continuing to make major investments in it. Amazon is not quite so open as Netflix about its budgets but analysts are quoting an estimated spend of $4.5bn this year – not far behind Netflix.

Amazon has been dramatically scaling up the amount of original content in its Prime Instant Video listings, tripling these titles in the latter part of last year. They are promising that their ability to scale up across their huge user base will enable them to beat the competition.

However, they have a way to go. At the moment Netflix has nearly 50 million US subscribers, Amazon only about half that.

Both Amazon and Netflix are finding that such is the demand for content, they are having to compete with broadcast networks and cable as well as online streaming services. The cards are stacked in the content providers’ favour. There is nothing more likely to drive up prices both for outright purchases, and for licences, than several bidders with deep pockets, all after quality content.

Amazon aiming at global markets

And strategically, Amazon clearly has its sights set on non-US global markets, where Netflix is much stronger. Prime Video is now available in more than 200 countries and this is an advantage to Amazon where it holds global rights to content. It can assign a portion of the cost of the rights, to the country where the content is being consumed. This is a much better arrangement for the company, than agreeing country-by-country rights with third party content owners.

Amazon is fighting hard by pricing its VOD service significantly below Netflix in foreign markets. It’s effectively hoping to offer new markets compelling content plus online retail and delivery, for less than a Netflix subscription.

Will consumers choose both?

Some commentators feel that there is room for both services and that there’s quite a lot of overlap with a substantial number of subscribers taking both. According to research by FutureSource, quoted in Digital TV Europe, in the USA, UK and Germany, the number of subscribers paying for both Netflix and Amazon Prime Video, is rising. Around 50% of Netflix subscribers in the UK and USA also have Amazon Prime Video.

Why this apparent willingness to pay twice over? We’re back to content again. People will pay for the content they want to see, and since that isn’t restricted to one streaming service, they are apparently willing to add and pay for, another.

“FAANG effect” impacts UK creative industries

FAANG stands for FaceBook, Apple, Amazon, Netflix and Google. They’re all after high quality original content and this is beginning to create shortages in UK media production. The industry will have to gear up with more skills training, extra infrastructure and increased production facilities.

However, investors are now much more interested in the sector because the huge market for high quality content plays to many of the UK’s strengths. In addition, more funding is becoming available as banks and others look to lend into the sector, on the basis of strong global demand. Some banks are now offering to take receivables from streaming services such as Amazon Prime Video and lend against them which will help smaller independent production companies.

It looks as though FY 17-18 will be a great year for the UK, media and entertainment industry and for its investors. What’s more these opportunities are going to continue to be available, so growth is sustainable in the long term.

Management

Head of Amazon Studios resigns

CEO Jeff Bezos continues to impress with his vision for the company; however things haven’t entirely been plain sailing of late. True, he’s supported by Chief Financial Officer Brian Olsavsky, an Amazon finance long-termer since 2002. David Zopolsky is currently secretary, senior vice president and general counsel at Amazon – he’s been with the firm even longer – since 1999.

This stability is needed, given the volatility in the media sector. Head of Amazon Studios, Roy Price, resigned in October 2017 amid sexual harassment claims. Jeff Bezos wants to see more leading shows from his media arm. So at this key point, with Facebook launching its new Watch service, and Netflix going all out for content, the company finds itself needing to find a dynamic new studio head.

Financials

Amazon’s Q3 results showed revenue of $42.47bn against analyst expectations of $42.14bn. North American retail sales grew strongly, rising 35% to $25.4bn. The Whole Foods purchase, completed at the end of August, contributed $1.3bn to the total. International sales rose to $13.7bn, an increase of 29%.

But it was Amazon Web Services (AWS) that really drove growth, with an increase in sales of 42% – not quite as good as Q2 when the increase was 55%, but few investors will be complaining. The cloud computing side of the company is now its most profitable division, representing 11% of the company’s earnings. Amazon makes almost no profit on its retail business. However AWS has a profit margin of 26%, so it’s a key driver of profitability across the business.

Q3 earnings per share (EPS) had been forecast by analysts to be 3 cents – the number actually came in at 52 cents. That said, operating expenses grew so strongly – 45% up from a year ago – that operating profit actually dropped in all three divisions – retail, Whole Foods and AWS. Overall, the margin was just 0.8% – it hasn’t been this low since 2014. Amazon doesn’t pay a dividend.

The share price spiked 7% when the Q3 results were announced and has risen further since. It’s currently trading at over $1160 – near its all time high, putting the company on a P/E of 293 with a market capitalisation of $560bn.

Net operating cashflow dipped into negative territory briefly during the year but was $3.85bn at the end of last quarter.

Amazon’s Return on Investment (ROI) has declined from 6.13 % to 3.88 % over the last year. However, a strong Q4 performance should go some way to improving that ratio. Amazon is upbeat, forecasting earnings of between $56-60bn in Q4 – analysts’ predictions are $54bn.