AWS Long-Run and Normalised FCF Margins
Last week we interviewed a Former Finance Manager at Amazon, who was partly responsible for collating country and retail product category financials into one consolidated P&L for Brian Olsavsky, AMZN’s CFO.
Our aim was to deconstruct Amazon’s Retail P&L from the consolidated accounts to better understand its e-commerce unit economics. Members can read the full analysis and how we estimate the gross, contribution, and long-run EBIT margins of AMZN retail.
This week we published our analysis exploring AWS’ potential long run and current normalised FCF margin. We’ve shared a few snippets from our work below but the full write-up is available for members.
Using last week’s estimates of AMZN Retail’s opex lines, we decouple AWS’ operating expenses to estimate a rough gross margin of AWS:
We also explore three major risks for AWS’s long-run margins: losing high-margin software revenue, heavy price competition with Azure / GCP, and EC2/S3 being displaced as a cloud computing platform.
Rapid innovation, typically from open-source projects, puts AMZN’s microservices on top of EC2 and S3 at risk of obsolescence. AWS’ ‘good enough, me-too’ services will always have a market, but losing high-margin revenue to best-in-class ISV’s poses a long-term risk to AWS’s margin.
If AMZN can partner with the best ISV’s and host the database revenue it may lose, the net impact may be negligible. Switching high-margin software revenue for lower-margin EC2 revenue may not be bad if it drives utilisation of the whole network. Just like the retail business is all about putting more parcels through Amazon Logistics, AWS is all about driving more volume through EC2 rails.
What worries us more is that AWS loses significant market share to Azure. MSFT has a long tail of legacy Windows customers and a huge, experienced sales team to win the incremental dollar moving to the cloud.
MSFT also owns Github, the default code hosting platform and leading social network for developers. If MSFT allows developers to simply push code directly from Github to Azure, it will save developers a lot of time and win the low, start-up end of the market from AWS.
Arguably the greatest terminal value risk to AWS is that EC2 and S3 itself is disrupted. Could more effective storage primitives or new ways to run compute on the edge neutralise AWS’ advantage?
We explore these risks further in our analysis.
Putting aside current competitive pressures, we estimate the current normalised FCF margin for AWS excluding SBC and 50% of consolidated principal lease repayments. The chart below shows the difference in the FCF margin in its current high-growth state compared to a normalised run-rate with a 7-year server life.
If we assume $80bn revenue grows at 25% for 2 years, AMZN is currently trading at ~42x normalised AWS FY24 FCF.
This is a fine business. But as we discussed, the longer-term competitive questions for EC2 / S3 and all the services on top remain. It’s our mission to share insight into such risks over the following quarters.
Members can read the full analysis on AWS' long-run and current normalised FCF margins.
Datadog, Open Telemetry, & A History of Observability
Rapid innovation in open-source software is also threatening Datadog and the observability vendors. Open Telemetry is an open-source observability framework allowing customers to receive logs or metric information effectively at a fraction of the price of vendors like DDOG.
OpenTelemetry is a vendor neutral standard developed under the aegis of the Cloud Native Computing Foundation for how you generate and transmit telemetry data. When I talked earlier about distributed tracing, these start-stop timers, and recording all these key-value attribute pairs, OpenTelemetry provides the libraries, the SDKs, that enable you to generate that data and specify the format for that data, so that multiple vendors can ingest it. Even that you can transmit that data so that you can AB test multiple vendors against each other. - Field CTO at Honeycomb and Former SRE at GCP
The legacy vendors have gradually added each devops service using the same API's which leads to extremely high costs for customers.
Datadog was built on the cloud, but Datadog was built as a metrics first product. They were oriented solely around infrastructure metrics collection. Then they pivoted and said, you can have app metrics. The problem for Datadog’s users, but the way that Datadog profits is when you have application metrics that you're inputting with the same APIs that Datadog uses for infrastructure metrics. Datadog will charge their customers per combination of tags, per combination of dimensions and unique values, or cardinality per tag…Datadog charges a per host fee for collecting infrastructure metrics, and then a per host fee for collecting APM and tracing data. - Field CTO at Honeycomb and Former SRE at GCP
We explore how new devops services built atop O-Tel are entering the market to win share from ‘New Datadog Splunk’.
It effectively boils down to the earlier question I asked, should we be approaching observability clean slate, or should we be trying to build observability as a multi-product strategy? Or as an evolution of one of the existing pillars that someone is doing well. In the case of providers like Aspecto or Honeycomb or Lightstep, there is no notion of buying two separate products, and you’re paying to store the data twice; it's all one product. The vision is, if you can store the data once and materialize it in a time series plot, like metrics, or if you can visualize it in a trace waterfall graph, you shouldn't have to get charged twice for that. - Field CTO at Honeycomb and Former SRE at GCP
There is no doubt DDOG’s agents embedded in customers’ code base is sticky, the question is how much of the incremental dollar can DDOG win as Open Telemtry gathers popularity? At 10x revenue, it better be a huge percentage!
I think their infrastructure and application metrics are sticky, and it's hard to remove them once they're there. However, again, this is a growing market, which is not necessarily a problem. For the reason we discussed, of people not wanting to rewrite your code, you're never going to rip out something like Datadog that has wormed its way into your infrastructure. I think it's about those net new use cases built from OpenTelemetry from the start. Those built to send data to Honeycomb or Lightstep from the start. I think that's what we see; that growth of these Datadog custom metrics, that they charge you an arm and leg for, that slows or stops, and then maybe starts to reverse as people start ripping them out. - Field CTO at Honeycomb and Former SRE at GCP
ASOS Marketplace: Third-Party Brand Perspective
An interview with a Current Third-Party Brand Supplier to ASOS provides worrying insight into how the company’s 3P business is performing:
They are my biggest third-party partner and they are absolutely killing my third-party business at the moment. They are not taking any deliveries. I think we released some last week. I think part of their problem is that they phased all of our stock back. We do pre-orders with them; they book stock with us and we book that with our supplier. It comes in at the same time as my stock comes in for my own channels. What we are finding with ASOS is that they have phased all the stock back so they are not taking it in. When I was there, one of the things I was adamant about is that I needed stock so that when the third-party brand went live with it, I was live with it as well. I want to be first to market. Now, they are at least three months behind me. I have stockpiles now that they won’t even take in from me for another three months. They’ve even phased some stock until next season. - Current 3P Vendor to ASOS
HCA Healthcare: Staffing & Emergency Dept Operations
A Former HCA Healthcare COO on why it earns industry leading EBITDA margins:
They run incredibly efficient hospitals, everything is analyzed and thoughtfully funded, they don't throw money around. It's that culture and efficiency and trying to control productivity, because in a hospital, roughly 50% of your expense is labor. They're also very intentional around the markets they're in, versus 20 years ago. 50% of the company is in Texas and Florida, and Austin, San Antonio and Dallas are high growth areas, so those markets will continue to grow over the next 10 years. They're intelligent around the markets which make sense for them and trying to live in those suburbs and the downtown areas. It's harder to be admitted to the hospital because, with the technology and advancement in surgeries, so much is going to the outpatient side. - Former COO at HCA
Maravai LifeSciencies: Trilink Biotech
Maravai LifeSciences is a biotechnology company whose subsidiary TriLink Biotechnologies has developed a mRNA capping technology called CleanCap. This interview with a Scientist at Moderna evaluates Maravai's IP, the trade-offs in the use of CleanCap and reasons why biotech companies will license CleanCap instead of developing it internally.
I’m going to say, the additional ecosystem wide product portfolio, offered by Maravai, with some potential license, or maybe no license at all, would speed up the R&D and especially the commercialization process development for a new mRNA product. Companies would have maybe only used one or two years instead of the three years, to be able to get the same level as Moderna, to be able to get it done." - Principal Scientist at Moderna
Licensing CleanCap has two distinct advantages for customers: regulators are more familiar with the technology and it saves years of R&D to optimize RNA per liter output.
Fentimans, Fever Tree, & US Premium Mixer Distribution
An interview with a Former US Sales Director at Fentimans, a premium mixer that competes with Fever Tree, shares how Fever's scale in distribution means it can leverage smaller brands new product development ideas effectively:
Fentimans had 25 flavor types in the market, whereas Fever-Tree had half that. All Fever-Tree need to do is watch the market, see what trends are happening and if Fentimans introduced a successful product, they would break into the market with that flavor. - Former Fentimans US Sales Director