"Your margin is my opportunity" — Jeff Bezos
In Cases in Finance BBA321 we analyze Prof. Damodaran's valuation of Amazon [AMZN] with Free Cash Flow to the Firm [1]. As he does in most valuations in his latest book, he projects reinvestment by means of the sales-to-capital ratio [see]. His line on Amazon can be summarized in a couple of sentences: the internet giant is deliberately chasing revenue in order to become dominant in as many areas as possible; at that point, its market power would eventually enable it to drastically improve margins and profits. It doesn't hurt if, along the way, new business opportunities (with higher margins) pop up. This last point is not emphasized enough in Prof. Damodaran's narrative. The reason for that apparent 'neglect' is obvious: it was written in 2014, before the explosion of Amazon Web Services.
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I was reminded of this as I read Richard Waters' informative piece on Amazon and Microsoft's alliance to link their voice-activated digital assistants [2]. Everybody in the AI space wants to be the platform company par excellence. While this happened with PCs and smartphones, Mr. Waters thinks that in the field of AI "it will be difficult for any single platform company to dominate. That explains the alliance between Amazon and Microsoft. They have more to gain from joining forces against mutual enemies Google and Apple. Their decision to connect highlights a shared weakness: their failure to crack the smartphone market". Note that platform companies command significant premia in PE terms: 18x vs. only 13x for large-cap hardware vendors, according to Morgan Stanley. From an Amazon press release:
SEATTLE--(BUSINESS WIRE)--Aug. 30, 2017-- Amazon (NASDAQ:AMZN) and Microsoft (NASDAQ: MSFT) announced today that Alexa will be able to talk to Cortana, and Cortana will be able to talk to Alexa. You will be able to turn to your Echo device and say, "Alexa, open Cortana," or turn to your Windows 10 device and say, "Cortana, open Alexa."Alexa customers will be able to access Cortana's unique features like booking a meeting or accessing work calendars, reminding you to pick up flowers on your way home, or reading your work email – all using just your voice. Similarly, Cortana customers can ask Alexa to control their smart home devices, shop on Amazon.com, interact with many of the more than 20,000 skills built by third-party developers.
[1] Aswath Damodaran. Narrative and Numbers. The Value of Stories in Business. New York: Columbia Business School, 2017.
[2] Richard Waters: "Microsoft and Amazon steal AI march as they look past smartphones", Financial Times, 1 September 2017.
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