Vertical Integration Is Why Amazon Will Be Worth So Much More

Apr. 9.12 | About: Amazon.com, Inc. (AMZN)

The stock I most wish I had purchased during the crash of 2008 is that of Amazon (AMZN). In this post I'll explain where I believe the company is headed, and how I believe this is a far superior strategy to competing Internet firms. At its current price I don't believe the stock is sufficiently undervalued for my taste (not to say that it is overvalued, just simply not undervalued, which is what I look for), but if there is another market crash, Amazon will certainly be a stock I buy.

Let's start with a mere observation of price. At its current price just above $194, Amazon is over 4.5X its price from the start of December 2008.

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Amazon's stock has clearly significantly outperformed the market at large, and with a P/E ratio of over 141, it's clear that investors are expecting much more out of Amazon in the years to come. The reason I think the stock is valued so highly, and why I believe this valuation is justified, boils down to two words: vertical integration.

Vertical integration simply means Amazon will own every step of the Internet experience. Via AWS, Amazon is a major force in cloud hosting, meaning it stores and delivers pages for many of the web's largest companies -- from new social media companies like Foursquare and Zynga (ZNGA) to established organizations like NASA and IBM. And with its line of Kindle computers, the company now has true vertical integration: an increasing number of queries on the Internet go from Amazon servers to customers on Amazon computers. Amazon touches on the advantages of this in its video on Amazon Silk, the web browser that is a part of the Kindle Fire tablet.

There are two main benefits this type of vertical integration brings: speed and personalization. Because the Silk browser on Kindle Fire is designed to communicate with Amazon Web Services, the end result will be a faster experience for end users -- and on mobile devices, which is where Internet usage is really growing, speed is of paramount importance. This gives Amazon a huge advantage that other computer manufacturers will have difficulty matching; yes, Google (GOOG) and Microsoft (MSFT) also have their own cloud hosting offerings and have operating systems and browsers, but neither has the customer base on both ends (cloud hosting and tablet computers) that Amazon currently has. Apple (AAPL) may have the hardware, but it lacks a meaningful presence in cloud computing -- a major weakness from a competitive standpoint that I believe will be exposed in due time.

Personalization is the other major benefit that vertical integration brings; it will allow Amazon to thoroughly track all user behavior. Privacy advocates will find this appalling, though its marketing power should not be underestimated: access to this type of data will let Amazon deliver web pages faster (because it will be able to predict what web page you will click to next based on mass usage patterns) and will enable the creation of an immensely powerful advertising network. And of course, given that Amazon is an e-commerce titan, access to this type of data will enable the company to take its recommendations engine to the next level, so that it can deeply understand its customers and help them discover the products and services that they are most inclined to value.

Currently, Amazon's market capitalization is just over $88 billion. Google and Microsoft are over $200 billion, and Apple is closing in on $600 billion. From this perspective, I think Amazon can easily double. Sure, the company may have razor thin margins, but it is, in my opinion, better designed for scale than any other company in the world. And with the power of vertical integration and the leadership of Jeff Bezos (recently declared the best CEO in America by Forbes), a valuation north of $200 billion seems very feasible.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.