Citi Research analyst Mark May recently issued a report saying Amazon.com, Inc. (Nasdaq: AMZN) should split up into two companies: Amazon Web Services (AWS) and everything else. Would a split-up or spinoff make sense for…
Citi Research analyst Mark May recently issued a report saying Amazon.com, Inc. (Nasdaq: AMZN) should split up into two companies: Amazon Web Services (AWS) and everything else. Would a split-up or spinoff make sense for AMZN stock?
There isn’t an objectively correct answer, but right now, one answer does look superior. Granted, there are good arguments to be had both for and against breaking the e-commerce giant into two pieces.
This isn’t a purely theoretical conversation, either — the issues leading May to suggest the move in the first place are vital to how Amazon got where it is today and where AMZN stock goes in the future.
So, here’s a look at the advantages and disadvantages of splitting the $1 trillion Seattle, Washington-based e-tailer in two.
The Argument for Splitting AMZN
While May officially provided eight reasons for Amazon to split up, the thrust of his argument can be summed up in three general points.
Pro No. 1: A split decreases the risk of regulatory scrutiny. The note’s primary argument is that if Amazon splits itself in two, the company could dramatically reduce its chances of facing regulatory scrutiny from an overzealous Trump White House.
President Donald Trump, who frequently rails against the media and The Washington Post in particular (AMZN CEO Jeff Bezos owns the iconic paper), has tweeted multiple times about how he believes Amazon takes advantage of the U.S. taxpayer by getting the U.S. Postal Service to ship packages below cost, which is untrue.
Aside from that, in 2018 Amazon became the second company ever to reach a $1 trillion valuation, and others have called it monopolistic due to its profound sway in e-commerce, which has driven many brick-and-mortar retailers out of business.
Pro No. 2: A spin-off boosts valuation. One of the classic arguments for a spin-off (which is essentially what this AMZN “split-up” would look like), is that it would unlock value for shareholders. Wall Street more accurately values each distinct business.
“Generally, fully operational and profitable components of a company are worth more outside it than inside it,” says Rob Enderle, technology analyst of the Enderle Group. “In addition, there isn’t much synergy between AWS and the rest of Amazon, so separation wouldn’t be that difficult.”
While it might be true that it’s easier to value a stand-alone AWS and a stand-alone e-commerce business, each with different growth rates, potential and margins, it’s not like AMZN stock isn’t already flying high, boasting a 154 price-earnings ratio and more than 90 percent gains in the last year.
Pro No. 3: A spin-off aligns stock-based compensation and reduces conflicts of interest. May also points out that splitting Amazon stock into the cloud computing leader AWS and the e-commerce leader Amazon.com would allow employees for each division to be more properly compensated with stock options.
“A split into two companies may allow both the e-commerce and AWS businesses to create an incentives structure that puts customer experience first,” says Tim de Paris, chief technology officer at Decibel, a digital intelligence company.
For example, the way things are today, if AWS underperforms in a given period, but Amazon’s retail division excels, AMZN stock as a whole could still take a severe hit. But if the two divisions became distinct companies, employees at each could have incentives more directly tied to performance.
As for conflicts of interest: AWS is so dominant as a cloud platform that some of Amazon’s fiercest competitors, Netflix ( NFLX) for example, actually use AWS servers to run their own websites.
The Argument Against Splitting AMZN
Con No. 1: AWS subsidizes Amazon’s low pricing and innovation. While May was able to furnish eight reasons the AMZN split makes sense, several of the reasons were forced or redundant, and none of the eight was vitally important or didn’t have other, less costly solutions.
However, there is a material reason to keep Amazon as-is.
AMZN shareholders should want a dominant Amazon. That’s not a crazy assumption.
The plain fact of the matter is that Amazon actually functions better as a combined entity — the fast-growing, high-margin AWS provides vital funds for the rest of the company that allow Amazon to innovate, take risks, and invest in other things — like the low-margin retail business, overnight shipping, logistics, warehousing, Alexa development, Prime Music and Video and much more.
In the first six months of 2018, AWS accounted for 11 percent of Amazon’s sales, but 62 percent of the combined company’s operating profit. In previous years, this was even more unbalanced: as recently as the first half of 2017, for instance, Amazon was unprofitable without AWS.
Con No. 2: A split may not achieve Amazon’s goals. Part of May’s rationale is the typical argument that Wall Street rolls out and dusts off when advocating for a breakup: The sum of the parts will be greater than the whole.
It’s not clear that’s true here.
“If given the option, many investors would prefer to back the fast-growing cloud computing space, which could leave the low-margin retail business at risk of stagnation with limited cash for further investment,” de Paris says.
It’s also not clear that, if unlocking hidden value is part of May’s rationale, that such a goal couldn’t be achieved by copying what Google did when it reorganized itself into a holding company, Alphabet ( GOOG, GOOGL). Alphabet started breaking out its financials, reporting the profit and loss for both Google’s search business and its other zany, money-losing “moonshots.”
While Amazon already reports some headline AWS stats, further information like guidance for both divisions, breaking out exact Prime subscription revenue, Alexa penetration and so on would help investors better value the company.
Furthermore, the market itself did not seem to appreciate Mark May’s unsolicited operational advice: AMZN stock fell 3.2 percent the day of the report, its single worst trading day since April.
Con No. 3: If it’s not broke, don’t fix it. Last and certainly not least is this fact: Amazon is thriving as is.
“Separation would mean changes, and one of the big rules in business is that if something is working well, leave it the hell alone or you might break it,” Enderle says.
A split “would introduce new variables, increase costs and introduce inefficiencies that didn’t exist,” Enderle says.
A less disruptive move, like the Google-Alphabet reorganization, could accomplish some of May’s goals — most notably unlocking value (if there is more to unlock) and retaining executive talent — without these risks.
Plus, on the topic of management, one thing is indisputable: Amazon founder and CEO Jeff Bezos knows how to run his company and create shareholder value. Investors should want Bezos at the helm of everything instead of diluting his role or demanding he make a Sophie’s choice between his creations.
Another hard-to-see risk that might pop up is the loss of value that could come from leveraging the Amazon brand with every product, service and interaction with consumers it can.
“Brands are smart to leverage their instincts and infrastructure to continue their evolution,” says Brian O’Neill, chief technology officer at Monetate. Amazon has done this “not only with AWS infrastructure, but also via advances in voice search and in-home devices.”
Should Amazon Split Up?
There are sound reasons on both sides of the argument.
In the end, arguably the most compelling reason to split up — and the most meaningful end goal that can’t be achieved in another way — is to avoid government regulation.
On the other hand, Amazon shareholders should want to do what’s best for the stock, and the more powerful Amazon is, the better.