My fellow Seeking Alpha contributor Anthony Ruben and I have been having a respectful colloquy about the best way to interpret the recent data from Amazon (NASDAQ:AMZN) and AT&T (NYSE:T). While we have differing opinions about DirecTV Now, I did want to look at the problem from another angle. Regardless of what recent numbers say or don't say about AT&T, what do they say about Amazon?
AT&T's Loss Is Amazon's Gain
If there was one bullish sentiment I came away from Mr. Ruben's article with, it pertained not to AT&T, whom the jury is still out on, but Amazon. Amazon and Apple (NASDAQ:AAPL) devices are being offered by AT&T for free with an upfront commitment to one to three months DirecTV Now service. This has doubtless been a contributing factor to their sales totals. The source of our disagreement is how large a factor.
Mr. Ruben believes it is a major factor, at least for Amazon. Mr. Ruben points especially to Amazon's Fire Stick, which already sold out through December 27th a week before Christmas on Amazon's own website. In his own words, Mr. Ruben says that
"The Fire Stick is not a new "must-have" product, nor an obscure product. The catalyst for the stock-out situation is surprising demand and the source of that demand is DTN."
He therefore sees Amazon's success as evidence of AT&T's success, because otherwise why would Amazon be out of something like the Fire Stick?
Questioning The Premise
I have to say, I see Amazon's success as having much less to do with AT&T. I could say the same thing about Apple, as well, but Apple TV sales form such a small part of its revenues that higher sales are just not that likely to move the needle very much, so what's causing them is sort of moot. Amazon is another story.
It's not another story because its hardware sales will make it rich, although I have to point out that the hardware sales we are seeing are nothing new. Amazon has been on a hardware tear for over a year now. But like Apple, it is unlikely such hardware sales will move its revenue needle very far. While in Apple's case it's because its profitable Apple TV is dwarfed by its monstrously profitable iPhone, in Amazon's case it's more that it has cut prices and margins on its Fire products to the point that there is little revenue and no profit in them.
But Amazon does not sell hardware to profit off of hardware.
Hardware on Fire
Amazon's formula of "basic but good" devices sold at great prices has proven an unqualified hit with customers. It is leading or a strong challenger in the tablet, streaming box, streaming stick, wireless speaker and home assistant fields. It is really not so surprising that Fire Sticks were sold out in the heart of the holidays, and its a little hasty to draw such an easy connection to DirecTV Now. One of Amazon's Fire HD8 tablet variants was also on back order past Christmas. A second had a delivery estimate of 3-6 months. And Fire tablets are not being subsidized by AT&T at all, even though they too could play the DirecTV Now app, presumably.
Nor does Amazon's hardware success end there. Even devices that have nothing to do with DirecTV Now at all are flying off the shelves. The Echo Dot was sold out until the same date as the Fire Stick. The full-sized Echo is sold out until January 25th. Amazon devices are simply very popular, so I disagree with Mr. Ruben that it's inconceivable that Amazon simply ran out, for reasons having nothing to do with AT&T.
Assuming Amazon hardware is selling itself, with any helping hand from AT&T being relatively small, the question still remains how large the benefit to shareholders will be. Amazon sells its hardware either at or below cost. Its purpose in selling Kindles, Fires and Echoes, everyone agrees, is to recoup their investment down the road. As Amazon CEO Jeff Bezos himself put it, "we don't …. make money when people buy our devices. We … make money when people use our devices."
Priming The Pump
Most analysts have interpreted this to be a reference to all the digital content Amazon can sell users through the hardware devices they buy. And certainly when you add up TV shows, movies, music, apps, games, books, and all the rest, it adds up to a pretty penny.
And of course Amazon also makes it as easy as possible to buy physical goods from their store through their devices. Fire devices let customers order from Amazon without ever going near their computer, and even when they're not home. Echoes aren't quite as portable, but they do allow customers to place an order through Alexa without even using their hands, and without stopping whatever else they were doing when they realized they needed to buy something.
This is all very true, but I still read Amazon's new hardware focus a little differently. As I have said before, hardware at Amazon doesn't really exist to sell digital goods or physical goods directly. Instead, it exists to sell Prime subscriptions.
The True Value Of Amazon's Hardware
Almost every hardware device Amazon sells has this one thing in common: while it could be used without a Prime subscription in a halting, disjointed way, it is infinitely more valuable and enjoyable with one. Prime members get free video content to watch on their Fire sticks, free music to listen to on their Echo devices, free photo storage for their phones and tablets, etc.
Prime subscriptions fundamentally alter the behavior of Amazon customers, even more so than owning an Amazon device does. When someone has already paid $99 for an annual subscription, it motivates them to get the most value out of it. Which of course means ordering more from Amazon, to get as many freely shipped goods as possible. The low estimates have Prime membership doubling consumer purchases of Amazon physical goods. The actual number may well be higher. Consumer Intelligence has it at 2.4 times non-Prime members.
Putting a number on this is a little harder, with Amazon being so secretive. We are pretty sure that Prime members became more than half of Amazon's total shoppers on a daily basis sometime in 2015. They became more than half of the total customer base sometime this year. We think. Their average orders tend to be smaller, since they don't have an order minimum, but they also shop more frequently.
Prime membership is also somewhat more attractive in North America and Europe than Asia, where shipping times aren't as fast. They are more than three times as likely to order over $800 in merchandise per year. Prime membership estimates also vary. Consumer Intelligence has it at 63 million now, a 19 million increase from last year. That surge in Prime memberships followed a surge in hardware sales, though of course we can't say for certain the two are connected. Like I said, secretive company.
Hacking The Fire Tablet Numbers
There are a few things we do know. We know Amazon's TTM revenue figure, $128 billion. We know that North American revenue last quarter came to 57.6% of the total. From Consumer Intelligence we know that the total size of the US customer base is calculated to be 126 million. Canada skews the numbers a little, but probably not much. If half the customer base is spending 2.4 times what the other half is, then Prime members accounted for (an extrapolated) 70% of total sales in N.A. Non-Prime members accounted for 30%.
Spreading Prime spending evenly over Prime members, of the $51.6 billion Prime members in North America spent, $15.6 billion of it was spent by new Prime members. The equivalent number of non-Prime members would have only spent $6.5 billion. So adding 19 million Prime members netted Amazon $9.1 billion in additional revenue. Given that IDC put Amazon's 2015 Fire sales at around 9 million tablets, that would mean each one sold generated potentially as much as $500 in subsequent revenue if each produced a Prime subscription.
We won't have final sales figures for tablets until February if IDC keeps to its usual schedule. And we may never get final Echo sales figures. But Amazon did say that Cyber Monday Fire sales this year were at least double what they were last year in every category. Those sales, in turn, were over double what they were in 2014. Doubling those sales last year was enough to boost Prime membership 19 million and revenues $9.1 billion.
Of course, as Fire sales and Prime penetration increases chances grow that further sales go to those who already have a Fire device and a Prime account. But on the other hand, while sales last year only grew in the fourth quarter, after Fire's product line was refreshed, this year Amazon has made Fire sales throughout the year. Amazon's Prime Day sales, which are only open to Prime members, were up 60% over last year as the rolls swelled, even though Amazon's total sales are only growing half that. That's still very impressive, though, of course.
I expect that the increase in device sales portends an increase in Prime membership and and sales to them, by at least the same amount as last year, and perhaps even twice as much. That is a growth of almost 20-40 million Prime memberships and $9-$18 billion in sales, over and above whatever organic growth Amazon's other initiatives produce.
My opinion of Amazon has risen after reading Mr. Ruben's article. It seems Amazon's hardware business is still growing so fast they can't keep up, and that will in time lead to higher sales of physical goods. I recommend going long Amazon, which has dipped 10% off its highs.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.