WMT - Why Amazon's AI Investments Make It A Buy For Forward-Thinking Investors

2023-11-09 10:34:07 ET

Summary

• Amazon is rapidly building a generative AI platform to compete with major cloud rivals and maintain its edge in e-commerce and advertising.
• The company faces competition from companies in the e-commerce and advertising space, many of whom are utilizing AI.
• Amazon's partnership with Anthropic, a company known for its safe and trustworthy use of AI, could help AWS catch up to Microsoft and Google in the generative AI market.

Several Seeking Alpha analysts have already discussed why Amazon.com, Inc. ( AMZN ) stock has risen since it released third-quarter earnings . Unless an investor has been asleep at the wheel, they should be well aware of Amazon's rapidly growing advertising segment, its rebounding e-commerce segment, the stabilization of its cloud unit Amazon Web Services ("AWS"), and the company's free cash flow exploding higher.

Chief Executive Officer Andy Jassy also extensively discussed on its earnings call that AWS is rapidly building a generative artificial intelligence, or AI, platform to match its major cloud rivals. Although you might be aware of the need for the company to build a generative AI platform to match Microsoft Corporation ( MSFT ) and Alphabet Inc. ( GOOGL , GOOG ) in the cloud, few have discussed generative AI's importance in the company maintaining its edge in its e-commerce, advertising, and its other businesses. This article will discuss Amazon's recent partnership with Anthropic, its positioning on the competitive battlefield of generative AI, and why its effort in developing this innovative technology is a reason to buy the stock long term.

Its partnership with Anthropic

OpenAI is on the receiving end of waves of recognition from various analysts this year. Fast Company rated OpenAI as its top innovative company in AI, and it also headed this year's list of CNBC Disruptor 50 Companies . OpenAI produced the fastest-growing app in history when it released ChatGPT in November 2022. As I noted in this article, Microsoft is building and optimizing its entire AI platform on OpenAI technology and started adding OpenAI's LLMs to its products in early February 2023. The first products Microsoft inserted generative AI into were the browser Edge and the search engine Bing. Google released a competing AI chatbot named Bard based on the AI model PaLM 2 on March 21. Its chatbot and LLM have advanced significantly. Like Microsoft, Google has started infusing its generative AI model throughout its products and services, seriously threatening Amazon's ambitions in many areas, including cloud computing, advertising, and e-commerce.

In a technology landscape where you can measure a lead in months, you might consider Amazon's mid-April 2023 entry into the generative AI market as late. Some might even wonder if Amazon has any hope of catching up to the perceived generative AI market leaders, Microsoft and Google. However, Amazon made a move recently that potentially gave it a chance to catch up when it made a deal with Anthropic.

If one company could build an LLM that would have enough credibility with large customers to compete against OpenAI's LLM, GPT-4 , and Google's LLM, PaLM 2 , I would place my bet on Anthropic. Two siblings, Daniela Amodei and Dario Amodei, founded the company in 2021. According to this Fortune article , Dario Amodei quit OpenAI and started Anthropic to build a " safer and more reliable " AI model. Considering that the E.U. has already passed the AI safety act that it plans to implement before June 2024 , and the U.S. President issued an executive order on "Safe, Secure, and Trustworthy Artificial Intelligence," there is a path for Anthropic to differentiate from competitors with its reputation for safely using AI. This article's review of Anthropic's chatbot Claude AI states, "While it is still too early to say with any certainty, Claude does seem less likely to give wrong answers and is less susceptible to jailbreaking," and later in the article entertained the idea of whether Claude AI was a "ChatGPT killer in the making."

So, when Amazon announced a $4 billion investment in Anthropic for a minority stake at the end of September, observers should not have been astonished about its interest in a company that could potentially provide a solid counterpunch to OpenAI technology. This investment comes with an agreement that AWS will become Anthropic's primary cloud provider for workloads.

AWS will also collaborate in designing Amazon's future AI chips and include expanded support for AI Claude. Anthropic's press release announcing the deal stated:

Based on significant AWS customer demand for Claude , we're also expanding our support of Amazon Bedrock. This will include secure model customization and fine-tuning on the service to enable enterprises to optimize Claude's performance with their expert knowledge, while limiting the potential for harmful outcomes.

Source: Anthropic.

Amazon Bedrock is a cloud-based service that allows developers or companies to use pre-trained machine-learning models without building or maintaining computing infrastructure. These pre-trained models can be AI models that Amazon makes, like Titan , or models from third-party companies like AI21 Labs, Cohere, Stability.ai, or Anthropic. Its collaboration with Anthropic could help Amazon catch up to the Microsoft-OpenAI partnership and Google in the cloud. Amazon's partnership with Anthropic is still early, and management has yet to disclose all the ways it will use Anthropic's AI models.

Generative AI in Amazon's other businesses

Amazon's developing generative AI is important for more than just its AWS business. The company must create robust generative AI tools to compete in the long term in many other businesses. For instance, Andy Jassy said the following about how the company plans to use the technology in its e-commerce business:

In our stores business, we're using generative AI to help people better discover products they want to more easily access the information needed to make decisions. We use generative AI models to forecast inventory we need in our various locations and to derive optimal last mile transportation routes for drivers to employ. We're also making it much easier for our third-party sellers to create new product pages by entering much less information and letting the models do the rest.

Source: Amazon Third Quarter Earnings Call.

Another area in which Amazon will soon introduce a generative AI tool is advertising. Management learned through surveys that ad creation is a considerable pain point for marketers. Some smaller advertisers may not have competent graphics or creative design teams and need help in ad creative design. According to an Amazon blog :

Creative production has always been a barrier for advertisers who may not have access to the resources to create copy, imagery, or video. In fact, a March 2023 Amazon survey found that among advertisers who were unable to build successful campaigns, nearly 75% cited building ad creative and choosing a creative format as their biggest challenge.

Source: Amazon.

Amazon announced on October 25 at Unboxed 2023 , an annual advertising event, that it has started beta testing an unnamed, generative AI image generation tool. Andy Jassy further stated, "All brands need to do is upload a product photo and description to quickly create unique lifestyle images that will help customers discover products they love."

Last but not least, Amazon wants to protect its first-mover advantage in smart speakers. With its built-in voice assistant Alexa, Echo surprised people with its popularity when the company first introduced it in 2014. Echo spawned a few copycats from Google Home device to Apple HomePod. The danger for Amazon is that Google, Apple, or some other high-tech competitor like Microsoft will build a competing AI far smarter than Alexa using generative AI and displace Amazon in the smart speaker market. Andy Jassy addressed that threat on its third quarter earnings call when he said:

In Alexa, we built a much more expansive LLM [Large Language Model] and previewed the early version of this. Apart from being a more intelligent version of herself, Alexa's new conversational AI capabilities include the ability to make multiple requests at once as well as more natural and conversational requests without having to use specific phrases. We continue to be convinced that the vision of being the world's best personal assistant is a compelling and viable one and that Alexa has a good chance to be one of the long-term winners in this arena.

Source: Amazon Third Quarter 2023 Earnings Call.

Like Meta Platforms, Google, and Microsoft, Amazon plans to infuse generative AI throughout its business. Expect to see more announcements from management about how it's implementing generative AI in areas outside of AWS. CEO Jassy said in his third-quarter prepared remarks, "Every one of our businesses is building generative AI applications to change what's possible for customers, and we have a lot more to come."

Beware of the risks

Amazon building a generative AI platform involves more than competition against Microsoft and Google in the cloud. Both competitors also battle on different levels with Amazon's e-commerce and emerging advertising businesses and could use generative AI to gain an edge. The company also competes with Walmart Inc. ( WMT ), Shopify Inc. ( SHOP ), The Trade Desk, Inc. ( TTD ), Meta Platforms, Inc. ( META ), Roku, Inc. ( ROKU ), and more in the increasingly intersecting businesses of e-commerce and advertising. If you read the recent conference calls or press releases of many of the above companies, you will see discussions of how they are using the newest AI techniques to improve their services.

For instance, Shopify has already started promoting generative AI tools to its merchant customers. Shopify intends to distribute a ChatGPT-like tool, Sidekick , driven by an AI model it has dubbed "Magic' to a small number of merchants right before its official release in the near future. According to this article , "Shopify is leading the race in terms of making AI more accessible to e-commerce merchants."

While the above comment might be hyperbole, Amazon can't afford its competitors to get a leg up on it in generative AI. Shopify has presented a serious threat to Amazon in the past and could very well be a thorn in its side in the future. Although Shopify is David to Amazon's Goliath, Shopify is sizeable enough to present a credible threat. Using the figures from Market Pulse ; Amazon has a 42% market share in the U.S. if you add its third-party marketplace and first-party retailer market share together. In comparison, Market Pulse has Shopify at a 10% market share. As I write this article, Amazon has yet to announce a product comparable to Shopify's Sidekick.

Walmart is another challenger in e-commerce, with around 7% of the market, according to Market Pulse. Still, out of all the companies, it might present the greatest threat to Amazon's e-commerce ambitions in North America. While the first thought to mind when thinking of Walmart may be as a retailer, some need to remember that it has a robust technology division that is up to date with the latest AI technology. Walmart plans to use generative AI for everything from helping customers search for products on its website to combining it with Augmented Reality for a new shopping experience.

Google and Meta are digital advertising leaders and arguably have more gravitas in AI than Amazon. After all, Google had hired futurist Ray Kurzweil and the "Godfather of AI," Geoffrey Hinton (who has since left the company). Around the same time, Meta employed New York University professor Yann LeCun, generally considered one of the pioneers of deep learning. Google invented the Transformer technology that underlies ChatGPT, Bard, and most of the new chatbots. Without Google's Transformer technology, there would likely be no ChatGPT. Meta Platforms is responsible for some of the latest image-generating technology and has recently built among the fastest AI supercomputers in the world. Both companies are racing to add generative AI to advertising. For instance, Meta Platform rolled out a few generative AI tools on October 4, 2023, to assist marketers in ad creation. Google announced similar generative AI features to its Performance Max advertising tool on November 7, 2023.

Amazon also has many other smaller, niche competitors in different areas of the digital advertising market that could prove a thorn in its side over the long term. For example, The Trade Desk, Inc. ((TTD)) and Roku, Inc. ((ROKU)) compete on the demand side of digital advertising. The Trade Desk runs a demand-side platform across all digital formats, and Roku's streaming platform competes directly with Amazon Prime Video. While neither The Trade Desk nor Roku has explicitly stated that they use generative AI, there is likely heavy experimentation in this new AI technology by both companies. No one should be surprised if either company introduces an innovative, generative AI advertising tool in the future.

Additionally, Amazon will soon begin advertising on its streaming platform, Prime Video, bringing it into even greater competition for advertising dollars with Roku and streaming apps from companies like Netflix, Inc. ( NFLX ), The Walt Disney Company ( DIS ), Apple Inc. (AAPL), and Alphabet's YouTube. Since some companies mentioned above have big plans for generative AI, Amazon can't play around and must bring its A-game to developing generative AI for video or quickly fall behind.

One last competitive threat investors should consider is NVIDIA Corporation ( NVDA ). It may not compete in advertising or e-commerce. Still, it is a formidable competitor to AWS' AI platform. According to NVIDIA's website :

Now, the world's most advanced AI platform-NVIDIA AI-brings cutting-edge advancements to every organization. With innovation at every layer-the AI supercomputer, AI platform software, and AI models and services-the possibilities are infinite.

Source: NVIDIA.

Aside from competition, Amazon's most significant long-term risk is litigation from government regulators. For instance, on September 23, 2023, The U.S. Federal Trade Commission ("FTC") and 17 state attorneys sued the company . The suit alleges that Amazon is a monopoly and has secretly engaged in price-gouging consumers in its e-commerce unit. According to the news release on the FTC website, "The FTC, along with its state partners, are seeking a permanent injunction in federal court that would prohibit Amazon from engaging in its unlawful conduct and pry loose Amazon's monopolistic control to restore competition."

The courts breaking Amazon up is not necessarily the worst that could happen. After all, some argue that the company is worth more if courts split it into a retail operation, a marketplace platform, and a cloud-computing business. What would be terrible for investors is if court cases distract management and they take their eye off the ball and fall behind in a critical technology transition, similar to how Microsoft got distracted by their antitrust lawsuit in 2001. Bill Gates claims he missed the mobile revolution because of that court battle.

Last, investors should be aware that some analysts predict generative AI adoption will stall in 2024 due to AI regulation and the technology being too costly . Suppose the market for generative AI tools does slow in 2024; AWS' growth could be less than the company expects, and investors could ding the stock. Additionally, generative AI is still a new technology with many issues , including the potential to disseminate inaccurate information, misuse by malicious actors, violation of data privacy rules, copyright risks, etc. There is a potential for Amazon to build a generative AI tool that causes widespread harm, resulting in lawsuits and loss of reputation.

Valuation

The chart below shows Amazon's price-to-sales is well below its median ratio on a five- and ten-year basis. You can calculate a company's price target by multiplying its revenue per share for the trailing twelve months by its price-to-sales (P/S) ratio. Suppose you value the company at its ten-year median; multiplying the company's revenue per share for the trailing twelve months at the end of the third quarter of $53.32 by its ten-year median of 3.112 gives a price target for the stock of $165.93, up 16.78% from November 8 closing price of $142.08. Using the five-year median P/S ratio of 3.556, the price target is $189.60, up 33.44% from $142.08.

Although Seeking Alpha quants gives Amazon an overall valuation of D-, Wall Street analysts rate the stock as a strong buy and award it with an average one-year price target of $172.34, at least 22% upside.

I believe Amazon sells at a reasonable valuation for growth investors to consider buying at current prices.

Consider buying the stock

At this stage of AI development, the more data there is for an AI model to learn, the more accurate its predictions or answers will be. Therefore, companies with large data repositories will likely benefit from the AI era the most. Amazon may have one of the most extensive data sets on products and services consumers purchase and should be among the largest beneficiaries of AI in advertising and the retail industry. The company's massive datasets and proficiency in building AI infrastructure make it a great bet to be one of the more dominant retailers and advertising platforms over the long term. Consider adding this winner to your portfolio today if you are a growth investor. I rate Amazon stock a buy.

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