U.S. Internet – Multiple growth opportunities ahead May 27, 2019 897

Amazon – Re-acceleration of growth driven by new product categories, AWS and advertising

There has been a lot of concerns on the slowdown of growth for AMZN’s retail revenue. We see constant currency online stores revenue growth slowing by 300bps to 12% YoY in Q1 2019. In our view, the decline in growth may be attributed to slower Prime subscriber growth, high penetration rate for existing product categories and lacklustre growth of international businesses (negative operating margins since 2015, 19% YoY growth of revenue). We think that AMZN still has great growth potential despite its enormous scale. We think there are 3 key drivers for AMZN’s growth in 2019: 1. Grocery and pharmacy markets represent an expansion of US$900 of total addressable market (TAM) respectively for AMZN. 2. AWS remains the dominant cloud service provider with 32% market share. AWS would continue to experience robust growth as 80% of the workload has yet to be migrated to cloud. Worldwide public cloud market to grow at 17.3% CAGR to reach US$206bn in 2019. 3. Advertising (ad) remains a huge opportunity. We estimate that AMZN will gain a revenue of US$3bn from search ads with a market share of 8.8% in 2019.


Facebook – Social commerce will be the next story   

Facebook (FB) remains the largest social media platforms with 2.3bn monthly active users (MAUs). Although total ad revenue growth for core FB is set to ebb, revenue and ARPU growth for the core markets, North America and Europe, remain strong as they grew 27.7% and 17.6% YoY respectively in Q1 2019. In our view, the shift towards family-oriented content for News Feed on FB app will improve the machine-learning algorithm for FB, which would increase its strength of engagement. Instagram Stories remain the largest growth story as advertisers embrace the new video ads. Advertisers for Stories grew to 3mn in Q1 2019 as compared to 2mn in the last quarter. We think that Instagram Checkout will be a long-term growth story which may add US$5bn of revenue for FB in 2021 in our bull scenario.


Google – Ads growth supported by Cloud and Maps

Q1 results spooked investors as it is the first time revenue growth for GOOGL was sub-20% since Q1 2016. We believe such fears are exaggerated. We think GOOGL’s deceleration of revenue growth is temporary and will not change its long-term trajectory. The slowdown may be due to the timing of product changes to GOOGL search and Youtube in response to GDPR and privacy concerns in its core markets (North America and Europe). We are encouraged by the new ad formats and shopping function to drive engagement and enhance digital experience. In our view, GOOGL may capture US$127bn digital ad revenue in 2019 given that it accounts for 31% market share of the worldwide digital ad spending. We think Google Maps remain an untapped opportunity with 154mn MAU and more than 1bn users worldwide. Cloud will likely emerge as the best story among its other bets as 80% of workloads have yet to be migrated to cloud, and the TAM of GOOGL hybrid cloud to reach US$92bn by 2021.



The expansion into new product categories such as groceries and pharmacy will be instrumental in driving AMZN’s retail business growth. AMZN already captures 52% of the total U.S. e-commerce market share in 2018. By category, AMZN has more than half of the online market share in 7 of 17 categories, especially in books (90%), toys (70%) and baby products (65%). We think that the venture into groceries and pharmacy is key to the reacceleration of revenue growth for AMZN. The total retail sales for groceries is USUS$680bn in 2018 (Figure 2). Assuming the current trend of 3% annual growth for grocery spending continues, the TAM is close to USUS$700bn, or 12% of the core retail TAM in 2019. As for pharmacies, it represents a US$200bn market opportunity in 2019.


Innovation in in-store shopping will push growth for grocery, which is crucial to reacceleration and ad. AMZN announced in March that it is going to open new grocery-store business separate from Whole Foods Market (WFM) in major U.S. cities. In our view, a major differentiation point that AMZN has against its grocery competitors is its rich database and advanced technology. We would expect AMZN to transform the physical grocery shopping experience, similar to how they have innovated the digital shopping experience through fulfilment networks and cloud capabilities. We think there are 2 benefits for the continued push for grocery:


  1. By expanding into new product categories such as grocery, AMZN will be able to reaccelerate subscriber (sub) growth for Prime. AMZN has seen slower growth in Prime sub-base as the number of AMZN Prime members in the U.S. reaches 101mn (more than 50% penetration rate) as of December 2018 (Figure 3). In our view, the recent introduction of 1-Day Prime, exclusive WFM benefits and deals for Prime customers, pickup and delivery options for new grocery stores are ways of AMZN to entice customers to switch to Prime. This will help in the reacceleration of revenue growth as Prime members spent twice as much as non-Prime members (Figure 4).
  2. AMZN Go, WFM and the new grocery stores will provide valuable household purchase data to AMZN. As the average American does grocery shops 1.6x a week, the data will enhance the machine-learning algorithms of AMZN to drive higher sales for grocery stores. Also, the Prime members’ purchase data from physical stores could be linked with their online purchases to improve online and in-store sales for advertisers.


AMZN Web Services (AWS) will secure its foothold in Cloud and sustain growth by expanding its product offerings. We continue to see robust AWS revenue growth (41% YoY in Q1 2019) as companies migrate their workload onto the cloud (Figure 5). We believe that AWS will continue to expand its services to cater to the hybrid cloud environment of companies. In the latest AWS re:Invent conference, AWS announced 20 new service launches focusing on machine learning, database offering and hybrid cloud to differentiate against competitors. One of the most notable offerings introduced is AWS Outposts, which allows AWS services to be run on on-premise facilities. It could run on either VMwareCloud on AWS Outposts or through AWS native variant. In our view, it brings AWS’s offering up to speed to compete directly with Microsoft Azure Stack, which is a similar hybrid cloud service offering.


We think cloud remains an enormous opportunity as 80% of the workload has yet to be migrated to the cloud. Based on research by Gartner, the worldwide public cloud service market is projected to grow 17.3% in 2019 to US$206bn (Figure 6). AWS remains the dominant cloud service provider with 32% market share, followed by Azure at 16%. AWS would be able to offer more competitive price points against its competitors, given its larger scale of operation. Importantly, the market has moved beyond cost to look at hybrid offerings that provide deep domain expertise and bridges legacy systems with new cloud service platforms. This explains AWS’ move to enhance its platform to reduce price sensitivity.


Ad has been the largest growth story for AMZN since 2018. Revenue growth for ad has been more than 100% from Q1 2018 to Q4 2018 (Figure 7). Although constant-currency ad revenue growth has slowed 61 percentage points to 36% YoY for Q1 2019, we believe the story is not yet over. We think AMZN is well positioned due to its scale and data from the in-market customers. One differentiation point of AMZN is its availability of actual purchase data. Unlike FB or GOOGL, AMZN can collect data of what customers bought, what they add to shopping carts and their entire journey through completion of purchase. With its new WFM business, AMZN can also make correlations between online and offline shopping behaviours to create innovative ad (ad) campaigns to drive omnichannel sales for advertisers. According to AdBadger, the conversion rate for AMZN search ads is 9.7% as compared to 3.17% for GOOGL search ads. Merkle also noted that AMZN advertisers saw sales attributed to both Sponsored Products and Sponsored Brands more than double YoY in 2018, as spending grew 19% and 77% for those formats respectively. Therefore, AMZN ad will likely gain a greater share of trade promotion budgets due to its higher ROI compared to GOOGL ad.


In terms of the market opportunity for AMZN, we think most of AMZN’s ad revenue comes from search ads instead of display ads. Although AMZN is aiming to provide more display ads through the introduction of AMZN Live and Fire TV, we think it is still in the infant stages and may require larger investments before it can compete with Instagram, FB Video and Youtube. According to Statista DMO, worldwide search ad will grow at a CAGR of 6.5% to reach US$141bn by 2023. U.S. search ad will reach US$39bn in 2019. Assuming that AMZN will be able to reach 8.8% market share of the digital ad space in 2019 (Figure 13), it would translate to a US$3bn revenue gained from ad.


We noted that AMZN has made significant enhancements to its ad campaigns for Sponsored Products and Sponsored Brands since 2018. Brian Olsavsky, the CFO of AMZN, highlighted during the Q1 2019 results that AMZN is currently focused on “adding more functionality, adding more products and adding reporting for businesses and advertisers”. In our view, AMZN has yet to fully develop its ad tools and leverage on its data mine. We think AMZN ad growth may reaccelerate as they flesh out their ad campaigns and tools.



FB to refocus on core markets which remain strong despite a deceleration in revenue growth. Although we see a deceleration of revenue (26% YoY for Q1 2019), the core markets (North America and Europe) surprised to the upside. ARPU for North America and Europe increased 27.7% and 17.6% YoY respectively although MAU YoY growth remains relatively flat at 0.5% and 1.4% respectively (Figure 8 and 9). We believe it remains an uphill challenge for FB to push for further growth in Asia as the difference in ARPU between Asia and the core regions remain stark (Figure 10). Although the fastest growing user base is in Asia (13.4% YoY growth), ARPU for Asia still stands at US$USD2.78 as compared to US$USD30.12 in North America. Based on eMarketer, social media ad spending for North America and Europe will remain the highest among the regions. As ARPU and MAU growth wanes for all regions, it is difficult for the user base in Asia or Rest of World to converge with that in core markets. Therefore, it is likely that FB could refocus their efforts on core markets instead of being fixated in expansion into other markets.


FB would be able to maintain its share of digital ad spend with an overhaul of the FB app. FB has also been battered by a slew of criticisms regarding privacy issues for the past 2 years. A survey done by Creative Strategies found that 32% of the respondents plan on using FB much less in future (Figure 11). FB announced an overhaul for their mobile app during the recent F8 keynote to address such privacy concerns. FB is changing its News Feed to emphasise on events and groups instead of public feed. Along with the “Clear History” tool, the new focus on private content is FB’s response to address ongoing concerns about privacy and content moderation. Although FB guided that the change in focus will be a headwind for ad revenue in the short term, we believe there are 2 reasons why the platform will be redesigned effectively to mitigate any impact:


  1. Ad-targeting will likely be improved as it is based on groups and events that users join/express interest to join. This will ensure ads are more relevant to users and potentially drive higher ROI for advertisers and marketers. The higher ROI for advertisers will translate into a higher share of ad spending on the FB platform. The ROI of FB and GOOGL remain the highest among digital ad platforms (Figure 12).


  1. FB announced that they are testing to combine News Feed and Stories into a single “Stories feed” that can be swiped though like Instagram Stories. This is aligned with users’ changing preferences for video content instead of inanimated pictures and texts. We also see the addition of advanced video capabilities for other social media apps such as Instagram, Twitter, Snapchat and Pinterest. As social video ad spending in the U.S. is estimated to grow at 44% through 2021, we think FB is well positioned to maintain its market dominance for social video ads. According to eMarketer’s forecast, FB’s market share will remain relatively unchanged at 22.1% vs 21.8% last year, while GOOGL will drop slightly from 38.2% to 37.2%. Their closest competitor, AMZN, remains far from the lead with 8.8% market share (Figure 13).


Instagram Stories ads continue to have strong adoption rates. Although FB mentioned that Stories command lower ad prices than a traditional news feed, we are bullish about its high growth opportunity. The number of advertisers using Stories Ads increased from 2mn in Q4 2018 to 3mn in Q1 2019. During the Q1 2019 results, FB asserted that impression growth continues to be primarily driven by ads on Instagram Stories, and the YoY decline in average price per ad reflects an ongoing mix shift towards Stories Ads.


Social commerce will increase monetisation opportunities for Instagram. FB announced that they are adding an Instagram Checkout function which allows users to make direct purchases on the app. Instagram will charge retailers a selling fee when the item is checked out. We believe that the new Checkout function is targeted towards small-medium businesses (SMBs), but will also catch the attention of large brands. SMBs, especially direct-to-consumer (DTC) firms that only have a digital storefront, have limited ad budgets to bid with large brands for GOOGL search, Youtube or AMZN. Since Instagram has the highest MAU apart from FB and Youtube (Figure 14), it remains a primary platform for SMBs to maximise their reach and awareness. The new Checkout function will also allow SMBs to save cost on developing and maintaining their mobile apps and websites.


The e-commerce function will also make sense for large brands who are looking to diversify their ad strategies. This is especially relevant if they already have a large following on Instagram. There is little cost in adding shopping items to allow direct purchases on the app. Furthermore, it allows large brands to increase their reach to Millennials who spend more time browsing social media than other demographic groups.


Based on our estimates, eCommerce on Instagram will add US$3bn (2.9%) to FB’s North America ad revenue base case by 2021. A bull case with more commercial volume and growth of MAU may yield as much as USDUS$5.3bn revenue.


Although we are encouraged by the new shopping opportunity on Instagram, it may take a long time before e-commerce on Instagram becomes a full-fledged functionality. The checkout function is currently still in its beta stages with only 23 brands available. In addition, direct engagement capabilities are necessary for shopping apps. With the launch of Whatsapp Business, we think FB is likely to embed such chat functionality to enhance pre- and post-sales experience for customers. FB has to deploy significant resources to ramp up the capabilities of the payment system and the integration of chat capabilities. Therefore, we think the monetisation of Instagram Stories will still be the key driver for FB in 2019.



The deceleration of revenue growth in Q1 is likely due to temporary factors. Q1 results surprised to the downside as revenue growth slid to 16.7% YoY. This is the first time that topline growth for GOOGL was sub-20% since Q1 2016 (Figure 15). The CFO pointed to forex fluctuations and timing of product changes as reasons for the drop-off in revenue growth. We believe that it could be due to self-inflicted product changes for GOOGL search and Youtube as a response to GDPR and increasing privacy concerns in North America/Europe. Revenue growth YoY has declined across North America/Europe, while we still see sustained growth in APAC (Figure 16). This may imply that the algorithm changes are more substantial for GOOGL’s core regions. The timing of the algorithm changes may have a lumpy impact on engagement rate and click growth rate, especially for Youtube.  


On the positive side, there was strong growth for GOOGL Other Revenues and Other Bets, with expenses well-controlled. There was strong growth for GOOGL Other Revenues, which increased 25.1% YoY in Q1 2019. Other bets also see a 13.1% YoY growth as compared to -62.3% in the previous quarter. Traffic acquisition costs (TAC) growth has also been on a declining trend for the past 5 quarters, GOOGL Network only up 2.7% YoY and Distribution Partners stabilising at 16.6% (Figure 17).


We believe that the pullback does not signal maturation in growth for ad. 1. Based on eMarketer, digital ad spending will reach US$333bn by end 2019.  GOOGL dwarfs all other digital ad sellers as it remains the largest digital ad seller, accounting for 37% of worldwide ad spending in 2018. In terms of search engine ads, GOOGL accounts for 90% of the global market share for desktop search (Figure 18) and 62% for mobile search (Figure 19). This means that GOOGL has the potential to capture US$127bn digital ad revenue in 2019. 2. The new Discovery and Gallery Ads, along with the redesigned GOOGL Shopping, represents GOOGL’s continuous ads innovation in improving return on investment (ROI) for agencies and firms 3. Continued monetisation of GOOGL Maps will be a key growth driver with updated local campaigns.


New ad formats will help GOOGL stay ahead in the digital ad business. During the recent GOOGL Marketing Live 2019, GOOGL announced two new forms of ads, Discovery and Gallery, and the revamp of GOOGL Shopping.


  1. The intent-based Discovery Ads offers content in the form of clickable images and text ads under the search box in GOOGL mobile app, in Gmail under Social and Promotions, and the Youtube home feed. The ads displayed on the new format will be based on the “power of intent”. GOOGL determines the intent of consumers by using machine learning to segment consumers based on past site visits, GOOGL Apps downloads and map searches.
  2. Similar to FB’s Carousel Ads, Gallery Ads are carousels that appear on search results. They are based on search queries entered by the consumer instead of based on intent data.
  3. GOOGL is offering a direct payment function on its GOOGL Shopping. Advertisers can choose from different options for consumers to purchase their listed product – 1. On the spot 2. Nearest physical store 3. Online through GOOGL. In addition, the cart option will be made available across Search, Shopping, Images and Youtube.


One of the key themes we noted from the conference is “machine learning”. The Discovery Ads, along with the complementary Bumper Machine[1], are a key differentiation from its competitors as it leverages on GOOGL’s machine learning technologies. The Gallery Ads and the new universal cart are likely a response to its key competitor, FB which launched its new Checkout function in March. We believe the new ad formats will help to bring GOOGL Ads up to speed with competitors such as AMZN, FB and Pinterest.


GOOGL Maps remains a large under-tapped opportunity. With the ongoing trend towards multi-channel marketing, advertisers are looking not only to drive online business but also to direct foot traffic to their brick-and-mortar stores. We believe GOOGL Maps remains well-positioned to provide local ad to businesses who wish to drive retail sales. It remains the most popular mapping app in the U.S. (Figure 20), with the number of monthly unique users for GOOGL Maps reached 154mn as of April 2018. GOOGL Maps remain unique in the market and offers a strong differentiation point over its competitors such as FB, AMZN, Pinterest and Twitter. We are encouraged by the new ad inventories for local campaigns announced during the conference and we see it as a key growth driver for GOOGL ad revenue.


Cloud will be the best bet for GOOGL. We think that GOOGL Cloud remains the largest and most probable source of growth out of all other optionalities such as Stadia, Waymo and Wing. During the GOOGL Cloud Next keynote, Thomas Kurian, the CEO of GOOGL Cloud emphasised on GOOGL’s commitment to catch up with its competitors AMZN and Microsoft by massively expanding its technological investments, technical expertise, sales force and infrastructure. This stands in contrast to Ruth’s comments during the Q1 2019 earnings call when she mentioned that headcount and capex growth is likely to moderate in 2019. During the keynote, GOOGL highlighted its US$13bn data centre and office spending this year. Although GOOGL reiterated that headcount growth would moderate in 2019, Cloud will most likely be the largest area of headcount and capex expansion. In relation to our previous report on Cloud, we continue to believe that the slowdown in capex growth for hyperscales is due to excess memory purchases in 1H 2018 and will likely pick up in 2H 2019.


GOOGL also announced the new Anthos (formerly named Cloud Services Platform) which allows customers to deploy and run their apps on any Cloud platform, including on-premise. We see a similar trend across all other hyperscale providers who understand that most companies are adopting a hybrid/multi-cloud strategy. We think this is GOOGL’s response to bring its cloud services up to speed with other hyperscale cloud offerings which provide cloud capabilities to customers’ on-premise (AWS Outpost, Azure Stack and IBM’s Cloud Integration Platform).


We think there is still great opportunity as the management noted that 80% of workloads remain on-premise and 88% of companies are expected to adopt a multi-cloud strategy. The size of the hybrid cloud market will grow at 23% CAGR to US$92bn by 2021 (Figure 21). GOOGL’s aggressive investments in technical expertise and infrastructure will help to sustain growth momentum for Cloud. Although GOOGL Cloud remains distant from AWS and Azure in the short-term, we believe that it is possible to become a third hyperscale powerhouse given its aggressive expansion in headcount and infrastructure. GOOGL’s capex was the largest among the three internet giants (US$4.38bn vs AMZN US$3.8bn vs GOOGL US$6.1bn).



We are encouraged by the tech giants’ commitment to aggressively invest in new technologies to drive innovation. They continue to show great strength in their engagement, cloud offerings and ability to disrupt industries by leveraging on their leading technologies. Based on our analysis, we think valuations for AMZN, FB and GOOGL are reasonable given their strong revenue growth and earnings power (Figure 22-24). With the three firms valued at lower than the historical average, we initiate a BUY rating for AMZN, FB and GOOGL. We are OVERWEIGHT on the internet sector.

[1] Bumper Machine is a tool that made use of machine learning to help video advertisers create six-second bumper ads from existing video ads that run 90-seconds or less.

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About the author

Profile photo of Edmund Xue

Edmund Xue
Research Analyst
Phillip Securities Research Pte Ltd

Edmund covers the US Market Strategy. He was previously a risk transformation consultant in the Big Four.

He graduated with a Bachelor of Accountancy (Honours) with a major in Finance from the National University of Singapore.

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