DIS - Amazon's Streaming Step Is A Big Warning For Competition

2023-09-25 10:03:27 ET

Summary

• Amazon has announced that it will include advertisements for Prime Video from early 2024 and members looking for ad-free option will have to pay an extra $2.99 per month.
• This initiative will help the company report faster growth in its subscription and advertisement segments, both of which are at close to $40 billion annualized revenue rate.
• Amazon’s Prime membership has a significantly lower churn rate compared to other streaming players which should help the company improve monetization.
• Even at a modest 15% YoY revenue growth rate, Amazon’s subscription segment should reach a revenue of $100 billion by 2030 making it a key growth driver.
• Despite the recent bull run, Amazon’s PS ratio of 2.5 is less than the pre-pandemic historical average which gives the stock good upside potential.

Amazon ( AMZN ) has recently announced that it will launch limited ads for Prime Video in early 2024. Members looking for an ad-free option will have to pay an extra $2.99 per month. Most of the streaming players including Netflix ( NFLX ) and Disney ( DIS ) have also hiked their subscription plans . This initiative by Amazon should help the company increase its subscription revenue and improve its advertising revenue growth rate. There has also been some progress in AWS and we could see improvement in its growth trajectory as the macroeconomic situation improves and new AI tools are launched.

We should see a significant uptick in the churn rate of other streaming services as the customers start to feel the pinch due to recent price hikes. It is highly likely that the average number of streaming services used by customers will decrease as they try to limit the expense of different memberships. Amazon is in a strong position due to the high renewal rate of its Prime membership. The company spent $16.6 billion on video streaming in 2022, up from $13 billion in 2021. Amazon's ad-supported streaming initiative should help further increase the streaming budget. We could see Amazon crowd out other streaming players with higher churn rates over the next few years. This initiative by Amazon is a major warning to the competition and we should see significant changes in the streaming industry.

The growth in subscription business and video streaming improves the bullish case for the stock. Even at a modest 15% YoY revenue growth rate, the subscription segment should hit $100 billion in annualized revenue by 2030. This will improve the long-term moat for the products and services offered by the company. Currently, the stock is trading at a PS ratio of less than 2.5 which is lower than the historical average of the past 10 years. There is a strong upside potential for Amazon as the revenue share of subscription and advertising segment increases in the next few years.

Solving two problems at one time

The recent ad-supported Prime Video streaming initiative should help Amazon improve the growth trajectory of subscription and advertising segment. Amazon has a Prime member base of over 200 million . Even if 50% of these members opt for the ad-free option of paying an extra $2.99 per month, it would add close to $4 billion in annual revenue for the subscription segment. This is more than 10% of the current revenue rate of the subscription segment. We could also see future price hikes in Prime Video which will improve the growth trajectory for the subscription business.

The annualized revenue rate of subscription services and advertising segment is close to $40 billion each. Over the last few quarters, the subscription segment has reported an average YoY revenue growth rate of 15% while the advertising segment has reported revenue growth rate of 25%.

Figure 1: Revenue and YoY growth rate of subscription and advertising segment in last few quarters. Source: Amazon Filings

If Amazon can deliver an average growth rate of 15% in subscription business, the annualized revenue rate could reach $100 billion by 2030. This should also help the company invest a higher amount in the streaming service and gain an edge over the competition.

Crowding out the competition

In 2022, Amazon spent $16.6 billion on its streaming service. The total subscription revenue in 2022 was $35 billion. Hence, Amazon spent more than 45% of its subscription revenue on its streaming platform. As mentioned above, we could see the annualized subscription revenue rate of Amazon reach $100 billion by 2030. If the company spends 40% of this on streaming, the streaming budget can reach $40 billion by the end of the decade. This would likely be the highest streaming budget among all the players in this industry.

At the same time, Amazon’s Prime membership has a very loyal base and the renewal rate is over 95% for long-term members. A small price hike is unlikely to cause an increase in churn rate for Prime membership.

Figure 2: Retention rate of Prime membership. Source: Statista

On the other hand, the churn rate of other streaming players is very high. According to Antenna , the monthly churn rate of some streaming players like Apple TV+ ( AAPL ) is more than the annual churn of long-term Prime members.

Figure 3: Monthly churn rate of top streaming players. Source: Antenna

Many users binge-watch popular shows on their streaming service and then cancel their membership. This leads to a higher churn rate. It also forces the streaming service to invest heavily in order to produce more original programming to retain customers. The recent price hikes will increase this trend as the customers will be more careful about the streaming service they keep for the long term.

Amazon has a massive advantage due to the ecosystem of Prime membership. This allows the company to add new services and it does not have to spend heavily on customer acquisition.

Increase in advertising revenue

Many members would opt for the free ad-supported streaming option on Prime Video. This should improve the advertising growth rate for Amazon. Over the past few years, Amazon has been able to break the duopoly of Meta ( META ) and Google ( GOOG ) in digital advertising. Amazon has an annualized revenue rate of $40 billion in the advertising segment with an average YoY revenue rate of 25%. It has a very good ad-targeting system due to its ecommerce platform. Most of the customers using Amazon have a very high intention to buy compared to other platforms like Meta, Google, or TikTok. This allows advertisers to gain a good return on investment for their ad placements.

It is likely that Amazon could build a very strong advertising platform on Prime Video. It should be noted that other major platforms like YouTube also receive a bulk of their revenue from advertising instead of the paid ad-free subscription option. For the past few quarters, Amazon has reported YoY revenue growth in advertising segment between 20% to 30%. The Prime Video ads should be a long-term tailwind for the total advertising growth, and we should see an uptick in the growth trajectory over the next few quarters.

Impact on stock price

In the recent quarter, Amazon reported a revenue base of $134 billion. The cumulative quarterly revenue of subscription and advertising segment was $20 billion. Hence, the revenue share of these two segments was 15%. The YoY revenue growth of both these segments is higher than other segments. This should lead to further increase in the revenue share of these two segments. We could see the revenue share of advertising and subscription business increase to over 25% by 2030 which should positively impact the valuation multiple of the stock.

Amazon is currently trading at less than 2.5 times its PS ratio. This is significantly lower than the 10-year average.

Figure 4: PS ratio of Amazon in the last few years. Source: Ycharts

Amazon’s overall revenue growth has slowed down and it is likely that future growth rate will be modest due to the large revenue base. However, we could see strong YoY revenue growth in key segments like subscription and advertising. Even AWS should see some acceleration in growth as macroeconomic conditions improve and new AI tools are launched by the cloud service.

Investor Takeaway

Amazon is going to launch ads on Prime Video and members who wish to have an ad-free option will have to pay an additional $2.99 per month. This is a good initiative from Amazon as all other streaming players are also increasing their prices. The company should see an uptick in the subscription and advertising revenue. This initiative is unlikely to cause an increase in churn rate for Prime membership as the overall ecosystem is quite strong.

Even at a modest 15% YoY revenue growth, the subscription segment could see its annualized revenue rate reach $100 billion by 2030. A higher subscription revenue will allow Amazon to increase investment in streaming, and it can also crowd out other competitors which have a higher churn rate and lower streaming budget. This initiative is a big positive for the stock. Amazon stock is trading at a reasonable level compared to its historical average, and we could see good upside potential if the new initiatives are successful.

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