Shares of Amazon (AMZN) have been on a tear this year, up more than 30% thus far, and for those wondering if the shares remain my top pick for 2018 the answer is yes.
As we learned last week in Jeff Bezos's annual shareholder letter, Amazon has 100 million Prime members -- equivalent to 1 member out of every 3.3 people in the U.S. alone -- and
garnered for the eighth consecutive year the top slot in the American Customer Satisfaction Index. As he discussed the achievements across Amazon's various business lines, Bezos gave credit to the 560,000 Amazon employees and the "2 million sellers, hundreds of thousands of authors, millions of AWS developers, and hundreds of millions of divinely discontent customers around."
Amazon has positioned itself for the tailwind that is the accelerating shift toward a digital lifestyle. At nearly every turn it has looked to remove friction for its customers, be they consumers, enterprise or other institutions. According to data from Statista, e-commerce sales accounted for 9.1% of total U.S. retail sales in 4Q 2017, up sharply from 4.6% in 4Q 2010. The combination of Amazon's Prime service, which in my view was the beginning of the end for the mall and brick & mortar retail, paired with a still expanding array of products and services has led Amazon to take consumer wallet share as its disrupts existing business models and industries. As Bezos pointed out, one of Amazons' not so subtle strategies is to tap into consumer discontent.
What many don't realize, however, is the secret weapon that is Amazon Web Services (AWS). The company's cloud business accounted for 10% of its 2017 revenue but virtually all of
its operating profit for the year. On the one hand, it has allowed Amazon to invest in its other initiatives while more often than not beating EPS expectations over the last several quarters. On the other, it means investors need to pay close attention to AWS and its ability to continue to grow, thwart competition and maintain if not further expand its operating margins.
This brings us to the one of the larger known opportunities for AWS -- in March, the Department of Defense announced it would select one cloud vendor for a multibillion-dollar cloud services contract to support its 3.4 million users, 4 million devices and some 1,700 data centers. Likely competitors for this include Microsoft (MSFT) , IBM (IBM) Alphabet (GOOGL) , Oracle (ORCL) and yes, AWS.
This raises the question of market share and here's the answer. According to data from research firm Gartner, AWS has 44% percent of the public cloud market, followed by Microsoft's Azure with 7% percent, China's Alibaba Group (BABA) with 3% and both Google and Rackspace at just over 2%. Outside those top 5, the remaining 41% of the 2017 $22 billion infrastructure as a service public cloud market was spread across a number of competitors.
For those wondering, AWS has already cracked the government cloud market with the $600 million contract it received from the CIA back in 2013, beating IBM out in the process. What makes all of this interesting is that in February, the U.S. Department of Defense awarded a $950 million cloud contract to REAN Cloud LLC, an Amazon Web Services LLC consulting partner and reseller.
While the Pentagon is not slated to make any formal announcement as to the winner of the contract until September, there is pushback on the decision to go with one vendor. is understandable as even companies like Apple (AAPL) are loath to be tied to just one supplier. In this case, there is the obvious risk that just one cloud vendor for the entire Pentagon would more than likely make that vendor the world's largest target for hackers and other digital malcontents. But there are other business reasons for the Pentagon to consider multiple vendors including competitive pricing and innovation as well as limiting complacency.
As an investor, would I like to see Amazon win the Pentagon contract? Absolutely. But given the increasing frequency of cyber-attacks and a bloating government budget, the smarter business decision looks to be having at least a few cloud vendors. As American author Nancy Pearcey summed up rather nicely, "Competition is a good thing, it forces us to do our best." And let's remember, any slice of the Pentagon contract is a win for all of these potential cloud suppliers.
Our price target on Amazon shares remains $1,750, and a win, whole or partial of the Pentagon contract would lead to a reassessment of that target.
This commentary was originally sent to subscribers of Trifecta Stocks on April 23. Click here to learn more about this portfolio, trading ideas and market commentary product.
-- Chris Versace and Bob Lang are co-portfolio managers of Trifecta Stocks.