Re-Evaluating Amazon Prime’s Strength

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An analyst from Macquarie recently stated that Amazon (NASDAQ:AMZN) has confirmed it has over 20 million Amazon Prime members globally. [1] The company has been competing with Netflix (NASDAQ:NFLX) for a long time in the online streaming business but has remained mute about its membership base. The revelation suggests that it has become a force to reckon with, and could spell trouble for Netflix in the coming quarters. Amazon has also started taking advantage of its distribution capabilities to expand its streaming business and plans to sell set-top boxes of its own. It can sell the set-top box directly online, or strike partnerships with the pay-TV companies to distribute them. Given these developments, it makes sense to review the importance of Amazon Prime in the context of the company’s value.

Our price estimate for Amazon stands at $324, implying a discount of about 20% to the market.

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Amazon Prime Service Is Bringing Almost $1.7 Billion In Revenues On Annualized Basis

Assuming that the member count is somewhere close to 21 million currently (>20 million), Amazon would be earning close to $1.65 billion in annualized revenues at membership fee of $79 per year. Amazon Prime’s subscription offers free shipping along with access to video content. This implies that streaming content is just acting as one of the key features of the service that attract subscribers.

While the revenues earned from the Prime service account for just 2% of the company’s total sales, the margins are much higher. The primary cost that the company incurs to run this service is content acquisition and licensing cost. We believe that this cost as a percentage of revenue will be lower than that for Netflix, given the latter’s aggressive pursuit of original content and some lavish deals done in recent years. Even if we assume Amazon earns a 30% EBITDA margin (higher than that for Netflix but still lower than that for many media companies) for its Prime service, it implies that Amazon Prime’s EBITDA will amount to close to $500 million, thus accounting for nearly 10% of the company’s total EBITDA. However, the importance of Amazon Prime extends beyond these numbers as shown below.

According to a report, Prime customers tend to buy twice as much as the regular customers and overall accounted for 10% of the purchases in 2012. [2] This proportion could increase going forward as Amazon continues to invest in the streaming content to lure in more buyers. There is lot of incentive for the company to promote this service, which implies that it will be willing to shell out significant amount of money from its pocket to improve the content. This means trouble for Netflix as Amazon’s ambitions could lead to a content bidding war, thus putting pressure on the former’s margins.

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Notes:
  1. Amazon Says It Has 20 Million Prime Members, Business Insider, Jan 7 2014 []
  2. Amazon Has An Estimated 10 Million Members For Its Surprisingly Profitable Prime Club, Business Insider, Mar 12 2013 []