Microsoft Vs. Amazon: Valuing The Cloud(2020.01.17)

2020.01.17

https://seekingalpha.com/article/4317612-microsoft-vs-amazon-valuing-cloud?dr=

1&utm_medium=email&utm_source=seeking_alpha%3Fsource%3D2800%3Aread_now#alt2

 

아마존은 클라우드 시장에서 점유율이 가장 높으나, 점유율은 하락하고 있다.

단 점유율은 하락했지만 매출은 2019년9월30일까지 9개월간 연률 36.7%로 증가했다.

하지만 마이크로소프트의 클라우드 서비스 '애저'는 연율 59%로 성장했다.

 

Summary

Amazon and Microsoft lead the very lucrative cloud market, which generates substantial cash flows

for investors yearly.

While they're both titans of the cloud industry, one offers the more compelling value proposition today.

I value their cloud businesses, then place these businesses in broader valuation contexts for Amazon and Microsoft, respectively.

Finally, I choose a winner, based on both qualitative and quantitative factors.

Source: www.knowarth.com

Introduction

 

With valuations at record highs, capturing the secular cloud computing growth trend is not nearly as easy as throwing money at "cloud stocks". Further, the largest cloud stocks with the strongest, most predictable cash flows are not "pure plays". That is, the three most dominant cloud players, i.e., Amazon (AMZN), Microsoft (MSFT), and Alphabet (GOOG) (NASDAQ:GOOGL), have lucrative cloud businesses embedded within their conglomerate business models. This leads to substantially diluted returns on these cloud plays, relative to the explosive growth of their respective cloud businesses in isolation. Today, I will provide an analytical framework, by which we can determine where we should put capital to work, with the hopes thereby of beating the market.

 

Outline

 

1. Valuing And Comparing AWS and the Intelligent Cloud
2. Valuation Comparisons
3. Concluding Remarks
4. Buy/Sell Recommendation

 

AWS Vs. the Intelligent Cloud (Azure)

 

Market Share

 

클라우드 시장 점유율

 

 

Source: Gartner, Goldman Sachs

 

As can be seen above, Amazon has retained their noteworthy grasp on leadership of the cloud computing market. However, their market share has actually begun to decline.

아마존은 클라우드 시장에서 점유율이 가장 높으나, 점유율은 하락하고 있다.

 

 

 

 

Source: Gartner

 

Despite Amazon's market share declining, their AWS revenues have actually continued to grow at a rate of 37.6% yoy during the 9 months ended Sept. 30, 2019 (which is the latest period for which we have data). Azure has seen the greatest growth in market share as late, and for the 9 months ended Sept. 30, 2019, Azure grew at 59%, while expanding their margins.

아마존은 점유율은 하락했지만 매출은 2019년9월30일까지 9개월간 연율 36.7%로 증가했다.

하지만 마소의 애저는 연률 59%로 성장했다.

 

Growth Rate And Margins

 

Company	매출성장률(yoy '18-'19)	영업이익 성장률	영업이익률
AWS	37.6%	-19.14%	26.34%
Azure	59%	Unspecified expansion in margins	N/A

 

Source: Amazon 10-Q (Quarter Ended Sept. 30, 19) & Microsoft 10-Q (Quarter Ended Sept. 30, 19)

 

Azure continues to grow at breakneck speeds, although this growth is slowing.

 

"In the same quarter a year ago, Microsoft reported Azure growth of 76%, and followed that up with quarterly growth rates of 76% and 73%, but the rate dropped to 64% in the previous quarter (Ended Jun. 30, 2019)..."

1년전 애저의 매출 성장률은 76%였고, 올해 전년 동기대비 분기 성장률은 76%와 73%였다.

하지만 직전 분기(2019년6월말 분기) 성장률은 63%로 떨어졌다.

 

Valuing AWS and Intelligent Cloud Individually

 

With the above operating margin information, we can surmise some semblance of value for these companies by discounting their future cash flows to their present value. I will start with Amazon.

 

AWS Valuation

 

Assumptions	Values
Project Average Cash Flow Growth Rate (10 yr)	20%
Terminal Growth Rate	2%
Discount Rate (90yr Annualized Return of SPY)	9.8%
Initial Cash Flow Per Share	$16.036
Fair Value	$779.96

 

Source: Amazon 10-Q (Quarter Ended Sept. 30, 19)

 

I see this number as relatively conservative, as it places AWS at a valuation of around $400B, which is around 13x sales. With 37.6% growth currently, 13x sales for the most dominant cloud platform on earth seems reasonable. Further, at the end of 10 years, AWS will likely be more valuable than Amazon is, in their totality, today.

Azure Valuation

 

Unfortunately, Microsoft doesn't break out Azure, as Amazon does with AWS, in their financial reporting. So, we are left only with their "Intelligent Cloud", which includes properties such as:

 

• Server products and cloud services, including Microsoft Azure; Microsoft SQL Server, Windows Server, Visual Studio, System Center, and related CALs; and GitHub.
• Enterprise Services, including Premier Support Services and Microsoft Consulting Services.

 

Intelligent cloud grew at 27% for the 9 months ended Sept. 30, 2019, and their operating income grew 33%. Since I am a believer that we are actually in the beginning innings for cloud-based computing, I will be generous with the 10-yr assumed cash flow growth rate of their Intelligent Cloud business. Interestingly, the Intelligent Cloud sports an operating margin of ~40%, which is significantly higher than Amazon's AWS. As is Amazon's M.O., this may be a byproduct of Amazon suppressing margins in favor of growth.

 

Intelligent Cloud Valuation

 

Assumptions	Values
Project Average Cash Flow Growth Rate (10 yr)	20%
Terminal Growth Rate	2%
Discount Rate (90yr Annualized Return of SPY)	9.8%
Initial Cash Flow Per Share	$2.21
Fair Value	$103.57

 

Source: Microsoft 10-Q (Quarter Ended Sept. 30, 19)

 

As can be seen, Intelligent Cloud alone accounts for most of Microsoft's present valuation. At $103.57 per share, the present fair value for the Intelligent cloud is $790B.

 

Interestingly, due to AWS's margin compression, its valuation is 50% less according to a DCF model, which the street might very well be employing, wrongly from my perspective. So, while the Intelligent Cloud wins on the surface, the reality may be that AWS is either compressing their margins due to growth initiatives, or Microsoft's margins will experience compression in the future. I'm inclined to believe the former, and therefore, AWS should be worth, as of today, closer to $1T than to 1/2 of $1T.

 

Total Valuation Comparisons

 

1. Free cash flow generation
2. Price to free cash flow
3. Discounted cash flow models
4. Sum of the parts analysis

Free Cash Flow Generation

 

Presently, Microsoft generates a 50% higher free cash flow yield, but that is explained in the rate at which free cash flow has grown for the companies over the last 5 years and the rate at which it is projected to grow in the coming decade.

 

 

 

Source: YCharts.com

 

As the old saying goes, "You get what you pay for.", and if you want stronger growth, you'll pay for it in buying Amazon, as we see below.

 

Price to Free Cash Flow

 

 

 

Source: YCharts.com

 

At present, Amazon is the technically more expensive buy, but as we will see in the discounted cash flow models, there's a reason for this premium.

 

Discounted Cash Flow Model: Amazon

 

Assumptions	Values
Total Sales Growth (2018 to 2019)	20%
FCF Growth Rate (Past 4 years)	28.35%
FCF Projected Growth Rate (10 years)	25%
Terminal FCF Growth Rate	2%
Discount Rate (90yr Annualized Return of SPY)	9.8%
Initial FCF Per Share	39.92
Fair Value	$2780.48

 

Source: Data From YCharts.com

 

There were a few noteworthy assumptions included in the above model. one, a 25% FCF growth rate for 10 years is certainly generous by anyone's standards; however, I believe AWS will grow into the aforementioned nearly $1T valuation, thereby creating significant margin expansion for Amazon throughout the 2020s. Further, they ha

ve other means for margin expansion, such as their ads platform and subscription services, as well as the yet recognized Alexa ecosystem, which will be monetized at some point throughout the 2020s.

 

 

 

While sales will almost certainly slow to the mid teens during the 2020s, margin expansion will continue as Amazon's higher margin businesses take flight in earnest. With expanding margins and an eventual plan to return capital to shareholders, Amazon will have outpaced the market by 2030 from today's price (around $1850).

 

Discounted Cash Flow Model: Microsoft

 

Assumptions	Values
Total Sales Growth (2018 to 2019)	12.9%
FCF Growth Rate (Past 4 years)	11.08%
FCF Projected Growth Rate (10 years)	20%
Terminal FCF Growth Rate (%)	2%
Discount Rate (90yr Annualized Return of SPY)	9.8%
Initial FCF Per Share	4.99
Fair Value	$242.64

 

Source: Data From YCharts.com

Microsoft's margins have been growing sizably as of late, with Q3 operating income growing at 27% yoy. With high margin businesses such as LinkedIn and Azure growing at 25% and 59% yoy, respectively, we should continue to see robust free cash flow growth as a result. Hence, despite revenues remaining steady in the mid teens for Microsoft's overall business, I went with 20% free cash flow growth for the next decade, and 2% thereafter.

 

Quick Note About Microsoft's Capital Return Programs

 

They have been relatively shareholder friendly over the last decade via the execution of a decade worth of share buybacks and consistent increases to their dividend. In the last decade, Microsoft has executed share buybacks that have led to a 12.3% reduction in their total shares outstanding. Additionally, there seem to be no plans to halt this pattern of buying back shares, as Microsoft's board of directors recently authorized another $40B worth of shares to be bought back in addition to the remaining $7B leftover from their previous $40B share repurchase program.

Source: Microsoft 10-Q (Quarter Ended Sept. 30, 19)

Implementing Margin of Safety

 

There are a couple ways to determine a margin of safety, and a little discretion on the part of the investor is necessary in doing so. We could arrive at our fair value by simply discounting the share price, which we estimated, by 25% or a number sufficient for your own taste, or by increasing our discount rate to a number equivalent to our own required rate of return and then some.

 

We will choose a discount rate ~20% in excess of the above "assumed" discount rate (9.8%). Hence, with a margin of safety, we arrive at the below valuation for Microsoft and Amazon.

 

Assumptions	Values
Total Sales Growth (2018 to 2019)	12.9%
FCF Growth Rate (Past 4 years)	11.08%
FCF Projected Growth Rate (10 years)	20%
Terminal FCF Growth Rate	2%
Discount Rate With Margin of Safety	12%
Initial FCF Per Share	4.99
Fair Value	$175.84
With Effects of Buyback (-13% of share count over 10 yr)	$202.00

 

Source: Data From YCharts.com

 

Of note, I project free cash flow at an average of 20% annually for the next 10 years to account for the growth of high margin properties, such as Intelligent Cloud (Azure) and LinkedIn and subdued CAPEX growth (as opposed to current CAPEX growth of around 25% annually).

 

At a discount of 12%, and when factoring in the effect of Microsoft's share repurchase programs, I find a fair value to lie somewhere in the realm of $202 as of today.

 

 

Assumptions	Values
Total Sales Growth (2018 to 2019)	20%
FCF Growth Rate (Past 4 years)	28.35%
FCF Projected Growth Rate (10 years)	25%
Terminal FCF Growth Rate	2%
Discount Rate (90yr Annualized Return of SPY)	12%
Initial FCF Per Share	39.92
Fair Value	$1,988.14

 

Source: Data From YCharts.com

 

As you can see, the companies remain undervalued in light of the unrealized growth of their higher margin businesses that will continue throughout the 2020s. We will discuss the results of the above models in further detail in the buy/sell recommendation.

 

 

Buy/Sell Recommendation

 

AWS and the Intelligent Cloud are poised to become $1T businesses over the next decade, in light of their current cash flow growth rates and overall secular technological trends. However, capturing their 37% and 59%, respectively, growth rates will be tempered by the conglomerates in which they are nested.

 

While I rate both Amazon and Microsoft as "bullish", I do so with a specific caveat. Will these stocks beat the market over the next decade? It is very likely they will; although, the "alpha" may only be a few percentage points, i.e., 11% annualized returns for SPY vs 15% annualized returns for AMZN or MSFT. Notwithstanding, I rate both of these companies a buy, as we are most likely still in the first or second innings of their intelligent cloud services platforms, Microsoft's LinkedIn, and Amazon's AI consumer service, i.e., Alexa. Moreover, Satya Nadella and Jeff Bezos are two of the greatest CEOs we've ever witnessed, and their tenures don't seem to be expiring anytime soon.

 

It wouldn't be hard to imagine a future financial scenario, over the course of the next decade, where these companies triple or quadruple their revenues, and correspondingly their operating cash flows. At some level of maturation, their CAPEX growth won't increase at the rate at which it has been growing, leaving a pocket of time when returning capital to shareholders becomes a priority to the extent that it has become a priority at Apple. That is, there will simply be too much money for these companies to properly steward into company specific investments; therefore, they will execute even more generous captial return programs.

Now, as for which I would choose today: there won't be a profound difference in an investor's rate of return for either stock. Amazon's beta will not be as extreme as it's been over the last 20 or so years. Instead, both companies' betas will be closer to 1. With that being said, I would choose Amazon, despite their lower operating margins and higher present valuation; solely because we have not witnessed the extent to which Alexa will revolutionize our lives. Moreover, the market is not properly valuing AWS as it will look in 2030. Therefore, I'm dubbing Amazon the winner, especially as they head into an earnings report for a Q4 that was likely historic for the company.

 

 

Now the question I'm sure many of you are asking: "How can these companies reach multi-trillion dollar valuations? Surely, regulators will begin to scrutinize them to a greater extent if, for example, Amazon sports a $4 trillion something valuation by 2030." Well, you're in luck as I plan to address that in one of my coming pieces regarding what a mass break up of tech might look like, based on historical precedent for anti-trust legislation in the U.S.

 

Thanks for reading, and happy investing in 2020!