Heads in the Cloud, Analysts Say Amazon Web Services Gives Stock 28% Upside

 | Jun 07, 2016 | 12:51 PM EDT
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Amazon's (AMZN) market leadership in the cloud services sector is even more valuable than analysts at Oppenheimer had previously estimated, leading the firm to up its price target on the company to $930 from $780. The upgraded target represents a potential 28% upside from the stock's previous closing price of $725.54.

Based on the firm's industry checks, Oppenheimer came to the conclusion that the efficiency inherent in the shared computer costs will "not only drive higher than previously expected returns for cloud providers, but will drive overall computer costs down."

Part of the reason Oppenheimer puts such an emphasis on Amazon Web Services (AWS) cloud computing business is its high-margin nature, according to Growth Seeker portfolio co-manager Chris Versace. While accounting for only 9% of sales in the first quarter, it accounted for 43% of Amazon's total profit.

Amazon, part of TheStreet's Growth Seeker portfolio, was one of the early adopters of cloud-based Software-as-a-Service (SaaS) solutions, and its Amazon Web Services platform has garnered a 31% market share as a result, according to data from Synergy ResearchMicrosoft's (MSFT) Azure platform has a 9% market share, with IBM (IBM) placing third at 7%.

Add in the fact that cloud applications will account for 90% of world mobile data traffic by 2019, with mobile cloud traffic expected to increase 11-fold from 2014 over that period, according to a Cisco report published in February, and the reason for Oppenheimer's bullish stance becomes apparent.

"Amazon is one of the few large-cap companies benefiting from the secular shift to e-commerce. The company continues to gain share of U.S. e-commerce with its deep product selection, low-cost express delivery through its Prime program, and breakthrough success of Kindle and other emerging media content," analyst Jason Helfstein wrote. "Furthermore, AMZN's Web Services segment is now the global leader in cloud computing, and has significant value, in our view. Overall, we project annual free cash flow per share growth of about 60% over the next two years."

The firm also pointed to several other catalysts that could help increase Amazon's profitability in the coming years, including the expansion of new cloud service software and products, the expansion of Prime Now and Prime Fresh services, expansion of original video and new content services, and strong quarterly earnings.

As the company expands its cloud storage capabilities, those margins will only get better. "We believe AWS' competitive advantages in procuring, designing and architecting data centers and compute/storage resources are driving even higher profitability and lower capital intensity than previously expected," the firm said.

This is due to the fact that cloud service providers are able to design their data centers to be twice as efficient in terms of space requirements. "For example, we believe that an additional 100,000 square feet of incremental data center capacity for AWS would cost about $376 million but generate over a 20% return," Helfstein wrote.

The bottom line is that Amazon's dominance in the online retail sector isn't the only front where its business is thriving. Cloud services remain a high-margin sector that the company is dominating over more established tech companies. That hidden value means the stock could increase in value by nearly 30%, according to Oppenheimer's estimates. 

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