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Watch out, advertisers – here comes Amazon

Watch out, advertisers – here comes Amazon

Amazon is the second largest commerce platform in the world – the gold medal goes to Alibaba – but until recently very little has been made of its advertising business. This could all be about to change as it sets out to capture a greater share of the global advertising dollar.

It should come as no surprise to readers to learn that Google and Facebook together control over two-thirds of US digital ad spend and half of global digital advertising.

Against these two giants, Amazon’s advertising business looks like a minnow. The company first started breaking out its “Other” revenue item, which includes advertising revenue and other items such as co-branded credit cards, in 2016. “Other” revenue grew by 73% in 2016 and 53% in the first half of 2017, and is now Amazon’s fastest growing business with $3.6 billion revenue in the trailing twelve months. Although we don’t know exactly how much of that relates to Amazon’s advertising business, the entire sum represents less than 2% of global digital ad spend. That is a miniscule share of global advertising for the dominant commerce platform outside of China.

Now, the accelerating displacement of traditional retail channels by Amazon has brands scrambling to rethink not only their relationship with the e-commerce juggernaut, but also the allocation of their advertising budget dollars.

Consider that Alibaba, which is the largest commerce platform in China (and the world), controls nearly one-third of China’s digital ad spend. Setting aside the different business models – Alibaba is an advertising business with a social commerce platform while Amazon is a commerce platform with an advertising business – the platforms that capture the greatest consumer wallet share should over time capture a greater share of advertising budgets.

Ad giant WPP recently said that more than half of US consumers now began their product searches on Amazon, compared with 28% on search engines and 16% on retailer websites. Amazon has the best data on consumer purchasing habits available anywhere (ex-China) which, coupled with the high purchase intent of customers performing Amazon searches, should provide brands with the best targeting and highest ROI on their ad dollars.

If we think about the economics of the advertising business, its hidden value to Amazon becomes even more compelling. Consider that Facebook generates gross margins in the high 80% range. If Amazon’s advertising gross margin is similar, it would be multiples higher than the gross margin of its retailing business.

The contrast is even greater at the operating margin level. Amazon already incurs operating costs associated with running its e-commerce websites. The incremental cost of placing more ads on said websites should be much lower, and we would expect the operating margin of the advertising business to be an order of magnitude higher than Amazon’s low-single-digit consolidated margins.

Sir Martin Sorrell, the CEO of WPP and arguably the most important advertising executive in the world, has stated on record that Amazon is the thing that keeps him awake at night. Amazon’s advertising business may seem insignificant today, but if it can eventually capture more than a fraction of global advertising spend, it could add tens of billions to the company’s value.

The Montgomery Global Fund and Montaka own shares in Amazon (NASDAQ: AMZN).

Daniel Wu is a Research Analyst at Montgomery Global Investment Management. Prior to joining Montgomery in June 2016, Daniel was an analyst in the investment banking divisions of UBS and Goldman Sachs, where he covered the Infrastructure, Utilities, Technology and Media sectors.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.


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    • The cash flow from operations suggests they’re making huge returns. They are no doubt in need of “large continuing investments to meet an expanding market
      opportunity”. Shareholders have to ask what would the cash flow be now if they ceased the reinvestment and compare that to the present value of the future cash flows if they continue to reinvest at present rates…

      On Equity of $19bln and Sales of $95bln the company earned net income of $2.3b which amounts to a NPAT margin of just 2% and an ROE of 11.9%. But thanks to items like depreciation and amortisation of $8bln, $6.7bln spent on PP&E, the cash flow figure is much higher than reported profit. Cash flow from operations was $16.4bln (an ROE of 84%). And we haven’t addressed the $16.1bln spent on technology and content.

      If you thought that a company earning near 100% return on equity, and compounding 100% of retained earnings at that rate, might be worth somewhere between 55 and 70 times its equity – then its current market cap of 49 times equity might not be that expensive. of course we have never seen this kind of multiple of equity described as cheap so we are either in new territory or we’ve suspended reality completely.
      The flip side is that its only AFTER the company has demonstrated both an ability to take market share, and reinvest to the goal global dominance, that retail investors and their exchange traded funds have piled into the stock, driving its price vertically. Their enthusiasm presumes nothing can go wrong. As Howards Marks said it is the “pursuit of the new, untrammeled by knowledge of past.

      I have no doubt there will be bumps along the road.

      From the 1997 Annual Report – Amazon’s investment philosophy:

      Because of our emphasis on the long term, we may make decisions and weigh tradeoffs differently than
      some companies. Accordingly, we want to share with you our fundamental management and decision-making
      approach so that you, our shareholders, may confirm that it is consistent with your investment philosophy:
      • We will continue to focus relentlessly on our customers.
      • We will continue to make investment decisions in light of long-term market leadership considerations
      rather than short-term profitability considerations or short-term Wall Street reactions.
      • We will continue to measure our programs and the effectiveness of our investments analytically, to
      jettison those that do not provide acceptable returns, and to step up our investment in those that work
      best. We will continue to learn from both our successes and our failures.
      We will make bold rather than timid investment decisions where we see a sufficient probability of
      gaining market leadership advantages. Some of these investments will pay off, others will not, and we
      will have learned another valuable lesson in either case.
      • When forced to choose between optimizing the appearance of our GAAP accounting and maximizing
      the present value of future cash flows, we’ll take the cash flows.
      • We will share our strategic thought processes with you when we make bold choices (to the extent
      competitive pressures allow), so that you may evaluate for yourselves whether we are making rational
      long-term leadership investments.
      • We will work hard to spend wisely and maintain our lean culture. We understand the importance of
      continually reinforcing a cost-conscious culture, particularly in a business incurring net losses.
      • We will balance our focus on growth with emphasis on long-term profitability and capital management.
      At this stage, we choose to prioritize growth because we believe that scale is central to achieving the
      potential of our business model.
      • We will continue to focus on hiring and retaining versatile and talented employees, and continue to
      weight their compensation to stock options rather than cash. We know our success will be largely
      affected by our ability to attract and retain a motivated employee base, each of whom must think like,
      and therefore must actually be, an owner.

      As an aside they also said in the 1997 report We established long-term relationships with many important strategic partners, including America
      Online, Yahoo!, Excite, Netscape, GeoCities, AltaVista, @Home, and Prodigy”. How many of those strategic partners are around today???

  1. This article is spot on, yet I still cannot quantify fair value for Amazon.

    I know there is a higher than average probability that the future is bright for Amazon, and that there are likely enormous profits coming in the future. From a structural point of view I love Amazon. But with growth rates so extreme and potentially volatile, (and knowing that early growth in segments does not equate to future growth) how do you begin to value the company!?

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