Amazon vs Microsoft

In the next 5 to 10 years, which business will perform better

Berkshire Hathaway announced last week that they are buying around 1B worth of Amazon stock. It let me wondering why is Berkshire Hathaway buying this business instead of other companies in the tech space.

In this post, I’m going to take a closer look at Amazon’s business and compare it to Microsoft’s business and see which one seems a better investment in the next 10 years.

Amazon and Microsoft are conglomerates of a few different big businesses under their umbrella. Especially, Amazon always runs a few different experiments testing different businesses models. Depending on the result of these investments in each business, Amazon might keep investing its money.

As Jeff Bezos says:

“If you double the number of experiments you do per year you’re going to double your inventiveness.”

In order to invest in other areas, Amazon had zero net income until recently. That means that Amazon had enough ideas to invest in the future. On the other hand, Microsoft has been generating profits for over a decade.

But besides the point of having enough ideas or not, let’s look at these two different businesses and break them down to understand why or why not someone should invest in them based on their future earnings.

Let’s analyze Amazon and Microsoft side by side.

Microsoft grew its bottom line by 1.4B and Amazon grew its bottom line by 1.8B

Amazon

Overall Amazon had around 232B of revenue in FY18 and earnings of 9.8B.

Looking at the breakdown of its revenues, Amazon generates money from a few sources: Online stores, third-party seller services, physical stores, AWS, subscription services, and other revenues

Let’s analyze each one of the sectors, the growth of each one of them, and their earnings.

Online Stores

Amazon generated around 122B of revenue in its online stores in FY18. It’s well known that Amazon doesn’t generate any earnings in this segment of its business. Growth in its online stores is decelerating. This business is growing at around 18% YoY.

Third-Party Seller Services

Amazon generated 42B of revenue through its third-party services in FY18. This area also doesn’t generate profits as well. Amazon third-party sellers s growing at a 20% YoY.

For online stores and third-party seller services, Amazon keeps innovating and it has a huge moat. There are around 100M people that have Amazon Prime and pay around $119 per year for its membership.

With that cash in hand, Amazon is able to invest in its delivery service. In the near future, Amazon is promising to deliver products in one day for Prime subscribers. It is investing around 800M in the next quarter to bring one-day shipping to its subscribers. Competition is way behind. Amazon is the leader in online commerce by far. It has around 48% of the market share.

It won’t be too far out when Amazon delivers goods the same day as customers request their product. We will see if that changes behavior for customers.

This area won’t be a driver for profits for Amazon for some time, but it will be a huge defensible market for them for a long time. The only real competitor in this market is Walmart and they only hold 4% of the market share.

Amazon Web Services

That is the most interesting area inside Amazon. AWS represents around 25B of revenue and it’s growing 36% YoY. Operating income for this area represented around 30% of its revenue or 7.5B for FY18.

Physical stores

Physical stores represented around 17B in FY18. This area doesn’t generate profits. This mostly represents revenue that comes from Whole Foods. In FY16, when Whole Foods was a standalone company, it generated around 0.2B of earnings in a year. It would be surprising if they increased earnings by a wide margin.

Subscription services

This represents around 14B per year. This area of revenue is basically tied to how much users pay for Amazon Prime. With around 100M Amazon Prime subscribers, Amazon charges around $120 per year per user, that means that the bulk of the revenue comes from Prime

Other Revenues

This area generates around 10B of revenue and it is growing at around 117% per year. This area is mostly represented by ads but includes other small businesses. Ads generate around 4.6B of revenue for FY18. Ads don’t cost much for Amazon.

This area is mostly profits, but it is not growing as fast as in the past. The sky is not the limit. Revenue for this area is growing 36% YoY.

This is the biggest share of Amazon’s earnings. But this area is not growing as fast it was in the past. If that is the future of Amazon earnings, then earnings won’t grow as fast as it did in the past.

Breaking it down

Amazon’s net income in the first quarter of 2019 was around 3.6B. Around 70% of its earnings are represented by AWS, and the rest comes from its ads business. Amazon ads business growth is slowing down at 36% YoY and AWS is growing at 50% YoY.

Microsoft

In FY18, Microsoft generated around 100B of revenue and earnings of 16B but it wrote-off around 14B in its second quarter.

Microsoft, like Google, came late to the cloud business, but Microsoft has been crushing this business, unlike Google.

Since Satya took the reign, it seems that it has been investing in the right areas. Microsoft has divested from Nokia and started changing its strategy in a few other areas. Under Satya, Microsoft has bought a few companies, including Github and LinkedIn. These two acquisitions will be of great value for Microsoft. The sum of the parts is greater than the whole

Let’s take a look at its different businesses and analyze how they are doing. Microsoft revenue can be separated into these 3 different divisions:

Azure (Intelligent Cloud)

One of the biggest drivers of revenues for Microsoft is its cloud business. Azure generated around 26.7B of revenue in FY18. Microsoft is growing the fastest between all competitors. Of that, it seems that Microsoft generates around 7.7B of earnings or 10B of operating income. This area is growing at a 30% YoY.

Productivity and Business Processes

This area generates around 40B of revenue for Microsoft. The operating income for this area represented around 15B in the last year. It is the largest portion of Microsoft’s revenue. This area consists of products like Office and Office 365. Microsoft has been increasing its user base of Office 365 users consistently at a rate of around 15% to 30% (including both Office and Office 365). This area includes LinkedIn. Let’s take a closer look at it.

LinkedIn

Revenue growth and number of users over time

In FY18, Linkedin’s revenue was around 5.3B and it produced 0.6B of earnings. LinkedIn’s revenue is growing at 29% YoY. This trend will probably continue. Linkedin has around 260M MAU and almost 500M registered users. That’s 1/8 of what Facebook user base.

If LinkedIn keeps growing at 30% YoY, they might reach 1B users in 5 years. LinkedIn has not seen a direct threat to its business in years. LinkedIn has a big moat: its network effect. LinkedIn’s revenue and earnings will grow at a faster pace than its user growth.

Personal Computing

In FY18, this area generated around 43B of revenue and 12B of operating income. It includes the sales of the Windows Operating System, Surface revenue, Xbox and Search. The growth in this area varies by area from 12% to 20% YoY.

All in All

Microsoft and Amazon’s cloud businesses generate around the same amount of revenue and they are growing at a similar pace. Amazon generates the rest of its earnings from its ads business, generating around 4B of earnings every year. Microsoft’s personal computing generates 3x more earnings than Amazon’s ad business. Even if Amazon’s growth kept at the same rate as it is and Microsoft’s personal computing area didn't grow, it would take 4 years for Amazon to generate as many earnings in Ads as Microsoft generates in its personal computing division.

Amazon’s market cap is now around 920B and Microsoft’s market cap is around 980B. If you look at the potential earnings for the next decade, it seems that Microsoft has a much better foothold. As Benjamin Graham says:

“In the short run, the market is a voting machine but in the long run it is a weighing machine”

If Berkshire Hathaway is buying Amazon’s business, why is it not buying Microsoft?