"Does Amazon have the financial heft to compete with Google and Microsoft in an enduring cloud war?"
That question (paraphrased) was posed to Amazon Web Services' head Andy Jassy in a press conference last week at the cloud provider's re:Invent conference. Jassy's answer was predictable. He noted AWS' torrid growth and even said at some point the cloud service may be larger than Amazon's e-commerce business.
"You invest in what you believe are the most important investments long term. We think of (these investments) as planting seeds for very large trees that will be fruitful over times. There aren't many opportunities like this in your lifetime."
Jassy satisfied a crowd of reporters with the answer because most people realize that AWS is probably the best business Amazon has.
But the question lingered at re:Invent. We're not talking major worries about Amazon's financials or ability to compete, but the company's latest quarter did come up quietly in my discussions among partners and customers. Perhaps it's fear, uncertainty and doubt spread by rivals, but suddenly folks seem to know AWS investment is tied to Amazon's balance sheet.
Given that development, I did a tour of the financials via Thomson Reuters data. I looked at free cash flow, which highlights the money available to reinvest; return on invested capital, a ratio showing how efficient a company is using its cash; and the war chest.
My prism revolved around one simple question: Can Amazon fund AWS in a protracted cloud arms race?
Here are the results.
Amazon's ability to invest
In 2013, Amazon had free cash flow of more than $2 billion, a sum on par with 2011 and better than 2012. Free cash flow for Amazon is a fourth quarter affair since its business looks more like a retailer so a year-to-date free cash flow figure for 2014 doesn't make a lot of sense. That commerce focus is why Amazon's fourth quarter outlook was worrisome. Thomson Reuters gave Amazon and earnings quality score of 80 in 2013, down from 87 in 2012 and 91 in 2011. The earnings quality score is based on a net income analysis and the various moving parts. For the third quarter, Amazon had an earnings quality score of 81, up from 75 in the second quarter.
Return on invested capital was 2.2 percent for 2013, up from 1 percent in 2012. In 2011, return on invested capital was 6.8 percent, down from 15.4 percent in 2010. In the third quarter, Amazon's return on invested capital was -2.2 percent.
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Amazon ended the third quarter with $6.88 billion in cash and short-term investments. That war chest is Amazon's smallest since the third quarter of 2012.
Microsoft's ability to invest
In fiscal 2014 — the year ended in June 30 — Microsoft had free cash flow of $26.75 billion. Note that Microsoft is the only one of the big three cloud infrastructure as a service providers that pays a dividend. Microsoft's annual cash flow has ranged from $22.1 billion to $29 billion over the last five years.
Given that Microsoft doesn't rely on one large quarter to make all its money, a quarterly view of free cash flow is helpful.
As for return on invested capital, Microsoft checked in at 19 percent in 2014, down from 22.6 percent in 2013. It's worth noting that Microsoft's returns on invested capital was more than 33 percent in both 2011 and 2010.
Microsoft ended fiscal 2014 with $85.5 billion in cash and short term investments. As of Sept. 30, Microsoft had $88.7 billion in cash and short term investments.
Google's ability to invest
For 2013, Google delivered free cash flow of $11.3 billion, down from $13.35 billion in 2012. The company's free cash flow in the September quarter was $8.44 billion. Like Microsoft's Google's free cash flow can be tracked quarterly. Here's a look.
Google's earnings quality score in the September quarter was 79, up from 67 in June, but well below the 96 in 2010. Return on invested capital was 2.8 percent for the September quarter. On an annual basis, Google's return on invested capital was 14 percent in 2013 and has been trending down. Like Amazon, Google has a bevy of experiments underway — robotic cars, cloud infrastructure, Google Glass etc. Microsoft's experiments usual entail some big acquisition that may or may not pay off — think Nokia.
The search giant ended the third quarter with $62.16 billion in cash and short term investments, up from $58.7 billion in 2013.
It's clear that Amazon has the weakest financial hand of the big three cloud providers and e-commerce just doesn't generate as much cash as search ads and software.
However, Amazon grabbed a lead with AWS and could extend it. It's unknown whether AWS' cash flow can be completely returned to grow the business, but it's safe to say that Jeff Bezos isn't going to scrimp.
So far, Amazon has been able to fund its infrastructure as well as generate returns via AWS and there's no evidence that investment will be pared. Sure, Amazon may have to become pickier about where it places its bets, but the company would be insane not to put its chips on AWS. And if the financials really became a problem, Amazon could float AWS as a quasi-independent company and simply emulate what EMC did with VMware.
Microsoft and Google can clearly make life difficult for Amazon, but both companies have their own cloud distractions. Google has to overcome a beta reputation among large enterprises with its cloud and at times looks like it has corporate attention deficit disorder. Other than trying to annoy Amazon is there really any justification for Google getting into the low-margin delivery service market? Should Google's core ad business slow — and it will — the search giant is going to have to get focused too.
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As for Microsoft, CEO Satya Nadella has the cloud plan, but Nokia is a distraction. Microsoft plays on too many fields too. It's also unclear how well Microsoft can move from licensing to subscriptions without worrying about cannibalization.
The other wild card here is the valuation of focus. Microsoft is focused on the cloud for sure, but Amazon's take on the world is disruptive to enterprise tech. Amazon just doesn't care about margins and has nothing to lose. A look at the AWS Marketplace is instructive: Software companies are actually delivering applications by the hour. AWS willed that model to happen over three years with its e-commerce experience. Meanwhile, as more companies go all-in on AWS, Amazon grabs a recurring revenue stream. AWS is likely to become a cash flow machine at some point if it isn't already.
In the future, it'll be unclear whether AWS is funding Amazon's e-commerce business or vice versa.
Here's when you should worry: When AWS' investment and innovation cadence slows down dramatically and the core e-commerce business really stumbles. Until then, there appears to be enough cash to go around for Amazon to compete in the cloud arms race even if it lacks the war chest of its rivals.