Amazon's cloud competitors showed accelerating growth in Q3 while AWS didn't. That's OK

Published Wed, Nov 18 20202:12 PM EST

Key Points

Although Amazon Web Services' sequential revenue growth underperformed that of competitors in the third quarter, it did show strength in another metric, remaining performance obligation.
One Amazon investor believes the company can still increase AWS' operating margin.
An industry analyst said Microsoft will probably end up with a little more market share this year, while Amazon will lose some.

Every day, Amazon Web Services, which companies count on to remotely store data and run applications, produces millions of dollars in operating income for Amazon. As the segment's revenue grows, so do its operating income and Amazon's overall net income, generally. In other words, it's important for AWS revenue to keep increasing. In the third quarter, as the coronavirus raged on, the annualized AWS revenue growth rate came in at 29%, which was unchanged from the second quarter. In the same period Amazon's top cloud competitors, Alibaba , Google and Microsoft , all increased revenue growth sequentially by about 1 percentage point. Amazon's cloud is larger than any other cloud, with a 45% share of the market in 2019, according to technology industry research company Gartner. It's more mature than other clouds, and so revenue growth will be slower. Still, AWS did not see the gain that its peers did, at a time when many companies have adopted cloud infrastructure to keep employees working while offices stay closed to reduce spread of the virus. That's not necessarily a major problem for Amazon investors. That's because Amazon continued boosting the amount of revenue it can recognize in the future. It also helps that AWS has been getting more profitable in recent quarters, not less. And while it appears that Microsoft will gain some market share this year, Amazon will likely remain dominant in the cloud market. Amazon shares have climbed 69% since the beginning of the year, while Microsoft shares have gone up 35% and shares of Google parent Alphabet are up about 31%. In 2018 Amazon began disclosing its remaining performance obligation, which is the amount of revenue it has not been recognized for contracts that are more than a year long in their original terms, primarily for AWS. For example, if AWS signs a five-year deal worth $100 million with a company and in the first quarter of the five-year period the company used $5 million worth of cloud services, the other $95 million is part of Amazon's RPO. Backlog, another term for RPO, is a more important metric than revenue, Jefferies analysts led by Brent Thill wrote in a note distributed to clients earlier this month. "The point we're making is cloud has accelerated," Thill told CNBC in an interview. "You see it in the numbers, you can see it in the backlog, and it's good." Amazon's RPO stood at $44.8 billion at the end of the third quarter, up 63.5% year over year, accelerating slightly from 63.4% in the second quarter. Microsoft's RPO, which includes contracts for the Azure public cloud and other offerings, was larger, at $111 billion, with year over year growth accelerating to 24.7% from 22%. Alphabet has only disclosed RPO since the fourth quarter of 2019, so year-over-year calculations cannot be made yet. Thill and his colleagues have a buy rating on Amazon, Alphabet and Microsoft. He said AWS' revenue growth might have held steady instead of rising because the company has made concessions to help customers challenged by the pandemic. That can involve discounting or a relaxing of payment terms for customers Amazon doesn't want to lose, he said. AWS declined to comment. On Monday longtime AWS customer Airbnb revealed that it had received an extension of a hosting contract, presumably with AWS, that will result in the company having to spend $1.2 billion over the course of eight years, rather than five years. Amazon's revenue growth performance as of late hasn't been enough to turn away Evercore Wealth Management, a division of Evercore with $9.6 billion in assets under management and about $160 million worth of Amazon stock at the end of the second quarter. The Amazon was holding was only smaller than the group's Apple and Microsoft holdings. "We're still really positive long term on the cloud business in general as an industry and on Amazon more in particular," said Andrew Huang, a San Francisco-based vice president who manages high-net-worth individuals' portfolios. He said the revenue growth pattern comes down to the law of large numbers. Amazon started disclosing AWS revenue and operating income in April 2015. The sales growth got the attention of Evercore, which invested in Amazon in the summer of 2016. Huang said he likes to monitor AWS' operating margin, which has widened since 2016 as the Amazon unit has added customers. "We believe they can expand the margin of AWS over the next year or so as they bring on new services," he said. In January Alphabet will disclose operating income of the Google Cloud business for the first time. The segment includes the Google Workspace productivity app portfolio in addition to the Google Cloud Platform that competes with AWS, so it won't be possible to directly compare the unit's profitability with that of AWS. Still, Huang said, "hopefully it's good competitive pressure for AWS." Amazon's biggest threat is probably Microsoft, Huang said, because many companies have long relied on Microsoft software. Across the board, though, the cloud providers have benefited from the emergence of the pandemic, said Raj Bala, a Gartner research director who follows the cloud infrastructure business. He said Gartner was bombarded with calls from clients to figure out the best way to set up virtual-desktop infrastructure in public clouds so employees could use internal applications while working from home. "There are enterprises that are making significant commitments to these cloud providers during the pandemic," he said, including some AWS deals that exceed $100 million per year. While transportation companies have struggled in recent months, he said companies in other industries, such as consumer goods and financial services, have kept right on spending in the cloud. He said he doesn't expect the 2020 market share numbers to look extremely different from the 2019 numbers. "It will probably be the same sort of pattern from 2018 to 2019," he said. "Across infrastructure as a service Microsoft had some of the highest gains, and, of course, on a percentage basis, AWS decreased a little bit, but whether Microsoft's gains are coming at AWS' expense or it's just the entire market that's increasing is an argument we can have." WATCH: Jacobs: Remain very bullish on cloud computing space, as it's been critical during the pandemic

Andy Jassy, CEO of Amazon Web Services, speaks at the 2019 CERAWeek by IHS Markit conference in Houston, Texas, on March 11, 2019.

Aaron M. Sprecher | Bloomberg | Getty Images

In the third quarter, as the coronavirus raged on, the annualized AWS revenue growth rate came in at 29%, which was unchanged from the second quarter. In the same period Amazon's top cloud competitors, Alibaba, Google and Microsoft, all increased revenue growth sequentially by about 1 percentage point.

Amazon's cloud is larger than any other cloud, with a 45% share of the market in 2019, according to technology industry research company Gartner. It's more mature than other clouds, and so revenue growth will be slower. Still, AWS did not see the gain that its peers did, at a time when many companies have adopted cloud infrastructure to keep employees working while offices stay closed to reduce spread of the virus.

That's not necessarily a major problem for Amazon investors.