Amazon Finally Comes For Generative AI

Summary:

• In Amazon.com, Inc.’s latest letter to shareholders, CEO Andy Jassy talks of how embracing (i.e., accepting) change has been at the core of the company’s success in past years.
• Recounting the myriad of challenges faced in 2022, and some that have persisted into 2023, Jassy also reviews how Amazon continues to be bracing (i.e., preparing) for change as well.
• This includes the cloud-computing leader’s first official mention of generative AI in its long-term corporate strategy.

Slowing growth at the Amazon.com, Inc. (NASDAQ:AMZN) profit engine, Amazon Web Services (“AWS”), has been a drag on the stock over the past year. The stock’s latest rally has primarily been a reflection of market optimism over a potential Fed rate cut by the end of the year, which would benefit growth valuations, alongside a broad-based rotation back into big tech havens with strong balance sheets amid shakiness in the financial sector.

Yet, Amazon CEO Andy Jassy’s letter to shareholders earlier this week has unlocked incremental momentum for Amazon shares, as investors regain confidence over AWS’ longer-term prospects. Specifically, Jassy’s specific call-out of AI – especially the generative AI subfield – as a core investment focus at AWS going forward has been well received by markets. The latest development is also consistent with our views that AWS, as the world’s leading public cloud provider, remains the critical backbone to ongoing AI developments, as well as broader secular digitization trends.

Building on our previous coverage on AWS’ prowess in the continued development of generative AI technologies, the company has introduced “Bedrock,” a suite of large language models. Bedrock will be the key marketplace for developers looking to develop and deploy generative AI solutions at an optimized timeline, cost structure, and performance going forward. Pinpointed focus on generative AI investments will also benefit adjacent segments, including its recession-prone consumer-centric retail business, as well as its burgeoning advertising business, by improving user experience.

Amazon stock is currently trading at about 13x forward EBITDA after the recent rally, which is still a discount to the broader Internet peer group of about 18.8x, and not reflective of Amazon’s leading profitability, robust balance sheet, and retail and cloud moat despite transient macro challenges to the consolidated business. We believe the stock remains a durable mega-cap investment at current levels, with the recent implementation of aggressive cost-cuts and restored focus on key growth segments capable of immediate returns being core mitigating factors to impacts of the looming economic downturn.

An Overview of Amazon’s Latest Pledge

In Jassy’s latest letter to shareholders, which almost mimics a lookback on acute challenges faced across every corner of Amazon’s business, he made sure to highlight how embracing change has always been at the core of the company’s success. In short, the letter highlights how Amazon, time and again, has risen on top after every downturn in the past – and promises the same this time around.

Change is always around the corner…when you see it is coming, you have to embrace it. And, the companies that do this well over a long period of time usually succeed. I’m optimistic about our future prospects because I like the way our team is responding to the changes we see in front of us.

Source: 2022 Letter to Shareholders.

In review, Jassy recalls painful decisions made in 2022 (which really accelerated in the second half) that were essential to ensuring its core fundamental focus areas – revenue, operating income, free cash flow and return on invested capital – remain resilient in the face of a looming downturn. These included aggressive workforce downsizing with the elimination of 27,000 roles across the company – one of the worst among the tech industry – alongside permanent closures/cancellations of projects as well as adjustments to existing strategies and programs. Taken together, Amazon looks to preserving margins through a leaner and more efficient set-up amid a challenging economic environment.

And looking ahead, Jassy highlights Amazon’s continued commitment to making its core e-commerce and retail businesses more efficient, capturing greater share of cloud opportunities as the adoption curve steepens, and bolstering ad momentum. To achieve these goals, Amazon will focus on integrating its nascent dabble in grocery and healthcare with its massive footprint in consumer retail, bolstered by new program introductions including Amazon Business and Buy with Prime. The company has also made one of its first comments regarding developments directed at generative AI opportunities in the recent letter to shareholders, reinforcing AWS’ prowess in the field.

Amazon and Generative AI

And to zero-in on Amazon’s foray in generative AI, Jassy’s incorporation of everything that AWS has its hands on pertaining to the budding subfield – ranging from in-house developed chips (e.g., Graviton, Trainium, and Inferentia) to supporting applications (e.g., CodeWhisperer) – in the letter to shareholders brings into focus again the key role that the company plays in enabling continued development and deployment of related technologies. We have also explored in detail the implications of related technologies in our previous coverage on the stock here.

And the latest development, Bedrock, underscores AWS’ ambitions to engage in direct competition for share in the AI subfield against rivals like Google (GOOG / GOOGL) and Microsoft Corporation (MSFT), even in the absence of an Amazon-brand chatbot. Despite having no plans for an Amazon-branded ChatGPT or Bard, Bedrock will put Amazon on the map of pioneers leading the development of generative AI technologies. Launched earlier this week, Bedrock represents a marketplace on AWS that will allow developers access to both Amazon-developed LLMs, including “Titan,” as well as those developed by external companies including “AI21 Labs, [Google-backed] Anthropic and Stability AI”.

• Titan: Titan is the Amazon-developed LLM that can be further customized and trained by developers to enable “text summarization, generation, classification, open-ended Q&A, information extraction, embeddings and search” applications.
• Jurassic-2: Jurassic-2 is the latest foundation LLM developed by AI21 Labs. Jurassic-2 comes in 5 variants – Large (lowest number of parameters), Grande, Grande Instruct, Jumbo, and Jumbo Instruct (greatest number of parameters) – and enables optimized “production costs and speed without needing to sacrifice quality”. Jurassic-2 can be further trained to enable application in multi-language summarizing and paraphrasing, among other language tasks.
• Claude: Claude is the ChatGPT-equivalent chatbot developed by Google-backed Anthropic. In addition to conversational service applications, Claude itself is a foundation LLM that can be further trained for application in “summarizing, searching, answering questions, and coding”.
• Stable Diffusion: Similar to OpenAI’s “Dall-E,” Stable Diffusion is a “text-to-image model” that can allow developers to generate art in a matter of seconds.

The compilation of foundation models made available through Bedrock will compete directly against rival equivalents, including Microsoft’s “Azure OpenAI Service.” Bedrock will also complement AWS’ existing open-sourced hub for ML models, “Amazon SageMaker,” and enable streamlined development, testing and deployment of generative AI applications at scale under AWS “without having to manage any infrastructure.”

Implications for AWS

The latest addition of Bedrock continues to underscore the comprehensive suite of AWS solutions in supporting budding opportunities in generative AI. Specifically, the new suite of foundation models for the development of generative AI applications continues to complement AWS’ ongoing optimization strategy.

Starting back in the middle of the third quarter of 2022, we saw our year-over-year growth rates slow as enterprises of all sizes evaluated ways to optimize their cloud spending in response to the tough macroeconomic conditions. As expected, these optimization efforts continued into the fourth quarter…Our customers are looking for ways to save money, and we spend a lot of our time trying to help them do so…

Source: Amazon 4Q22 Earnings Call Transcript.

With an aim to provide cost-effective solutions without compromising on performance for customers, foundation models offered within Bedrock bode favorably with demand for optimization across the enterprise cloud spending segment. Specifically, cloud optimization – which refers to enhancing “applications, performance, and business needs in the cloud while eliminating costs and inefficiencies” – is taking precedence in the next stage of cloud migration. And this has encouraged an increase in demand for a multi-cloud strategy, thus weighing on AWS’ growth over the past year given the sheer size of its market share already (almost all enterprise IT infrastructures that have migrated to cloud are linked to AWS one way or another). Currently, almost 90% of corporations that are in the process of cloud migration have indicated that they use “multiple public cloud providers” to reap benefits spanning “risk mitigation, reliability/redundancy”, multi-function availability, and most importantly, cost-efficiencies.

With 90% of global corporate technology spend still haven’t yet migrated to the cloud, AWS remains “early in its adoption curve” and looks to significant opportunities on the horizon still. Yet, growing demands for cloud spend optimization, and inadvertently, a multi-cloud strategy is stalling the cloud computing leader’s growth as corroborated by deceleration observed in recent quarters. Yet, growing momentum in generative AI, alongside renewed focus on its comprehensive suite of supporting solutions with the latest introduction of Bedrock, could potentially be the lifeline AWS needed for demand reacceleration.

With a comprehensive suite of cloud computing solutions to generative AI-specific offerings like the Bedrock LLM marketplace and specialized chips to support related workloads, AWS effectively demonstrates reinforced confidence in its sustained trajectory of growth over the longer-term. The segment’s high margin nature – thanks to massive scale – also remains a critical advantage for enabling continued R&D needed to enable optimized benefits for customers. This includes the development of specialized chips for supporting complex generative AI workloads at enhanced cost efficiency and performance, which makes another advantage that differentiates AWS from rival hyperscalers. Specifically, being able to effectively address cloud spend optimization calls from the enterprise cloud spending segment continues to make a differentiated advantage at AWS, allowing it to reinforce market share gains in the expanding cloud TAM, while also helping it overcome pressure from an increasingly multi-cloud strategy-driven demand environment.

The Bottom Line

If Jassy’s letter is to reassure investors that acute business challenges in 2022 and deceleration in key operating segments during recent quarters will not become a mainstay for much longer, then I’m convinced. Despite warnings of a near-term slowdown in its profit engine, AWS, alongside expectations for margin contraction in the near-term as it works through growing demands for optimization and other transient macro challenges, the hyperscaler continues to demonstrate capabilities in ensuring sustained market leadership over the longer-term. This is corroborated by the recent introduction of Bedrock, which builds on ongoing momentum in generative AI and aims at clawing back attention to AWS’ critical role in enabling the development and deployment of related technologies going forward.

And as Amazon continues to scale the deployment of related technologies, alongside other adjacent investments– including “Buy with Prime,” “Amazon Business,” grocery, and healthcare – there remains better days ahead, ensuring a sustained trajectory of incremental value creation over the longer-term. The stock currently trades below both its internet peer group average and historical average, while the underlying business continues to exhibit a sustained trajectory of further growth reacceleration over the longer-term.

While we remain mindful of near-term macro challenges facing Amazon.com, Inc.’s recession-prone business – with the weakening consumer a risk to its retail front and tightening IT budgets a risk to its consumption-based pricing model for AWS – AMZN stock’s longer-term outlook continues to be bolstered by a moat in two core secular digitization trends that remains largely intact. And with an anticipated back-end-loaded year bolstered by continued scale of newly deployed offerings alongside recently implemented cost-cutting efforts that will aid margin preservation, we remain confident in Amazon’s long-term valuation prospects from current levels.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of AMZN either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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