Amazon Solidifying Network Effect

 Amazon.com (AMZN) solidified its case as one of the most disruptive companies in the consumer space, with the first quarter featuring a number of initiatives that should solidify the network effect and intangible asset sources underpinning our wide moat rating. 

We're upbeat about recent enhancements to the Prime membership program--including this week's exclusive content deal with HBO and the rollout of Prime Pantry--as well as an expanding stable of complementary devices like Fire TV and Dash that provide consumers less incentive to go outside the Amazon ecosystem for purchases. Additionally, management noted Prime trials and conversions are "growing nicely" since the $20 increase in annual memberships was put in place, lending additional credence to the pricing power inherent in this program. 

Despite price cuts across its core offerings and intensifying competition in the infrastructure-as-a-service category, we were also impressed by Amazon Web Services' momentum, evidenced by the 60% increase in other North American revenue. Taken together, first-quarter results support our five-year top-line growth forecast in the midteens.

We acknowledge that Amazon's margin expansion is less visible than its growth trajectory given new investments on the horizon, including international fulfillment capacity and content deals, a broader domestic Amazon Fresh rollout, smartphones, and new delivery capacity and technologies. These investments likely played a role in management's second-quarter CSOI (operating income excluding stock-based compensation and amortization of intangibles) outlook between $0 and $400 million, which fell short of market expectations. 

However, with gross margins increasing 225 basis points to 28.8% and North American segment operating margin coming in at 4.7%, we remain comfortable with our five-year operating margin forecast of 5%. There is no change to our fair value estimate, and we believe the current stock price offers investors a compelling entry point.

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