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Introduction
Amazon (NASDAQ:AMZN) is attempting to dominate a new market: the smart home market. The definition of a smart home is a home equipped with lighting, heating, and electronic devices that can be controlled remotely by phone or computer. Simply, it is a home that future homeowners and generations will likely live in, and I believe Amazon will be one of the dominant players in this market.
Amazon is known for its e-commerce and cloud services, however, not a lot of investors see Amazon as a player in the smart-home market. After the acquisition of iRobot (IRBT), I strongly believe that Amazon will be a dominant player in this new and fast-growing market. iRobot brings vast household robotics to Amazon’s existing ecosystem of hardware products all connected by an AI assistant, Alexa.
Smart-Home Market
The size and the growth of the smart-home market is expected to be enormous. It is expected to reach a potential market size of $380 billion by 2028 growing at a CAGR of about 21%. Even with the magnitude of Amazon’s market size, profitability, and market capitalization, the potential smart-home services can bring is meaningful.
Amazon’s Position
Amazon already has a suite of products in the smart-home market connecting everything from doorbells, surveillance products, speakers, TVs, lightbulbs, thermometers, and monitors all controlled by Alexa.
Starting with doorbells and surveillance products, Amazon owns Ring. A company that specializes in making smart doorbells and home surveillance products. It allows the homeowners to see when the doorbell was rung, who rang the doorbell, and more while providing an integrated service of security alarms and cameras throughout the house. All of these features can be controlled on an app or through Amazon’s AI assistant Alexa. Further, Alexa can control smart monitors, light bulbs, TVs, thermometers, and speakers. Even products that are not made by Amazon connect to Alexa increasing the value proposition of owning an AI Assistant.
To further strengthen Amazon’s position in the market, the company has announced the acquisition of iRobot, a leader in automatic household cleaning robots. iRobot offers a completely automatic cleaning experience. Its product Roomba not only vacuums the house, it empties the dust and charges on its own. Further, iRobot offers an automatic mopping robot called Bravo. The integration of iRobot into Amazon’s existing smart-home ecosystem will bolster the company’s presence in the market.
Through these vast services, Amazon will be able to sell multiple Alexa devices in a household with an opportunity to cross-sell significant portions of the hardware it wholly owns including Ring. Therefore, Amazon’s presence in the smart-home market is expected to be strengthened upon the acquisition of iRobot. After all, a consumer will likely stick to Amazon’s ecosystem of products once it purchases Alexa.
Future Potential
Beyond the current market opportunity, I believe Amazon can monetize on this trend with the company’s scale through the expansion of available smart home hardware while creating more private label brands in the market.
The potential of smart-home appliances does not end with Ring, iRobot, thermometers, lightbulbs, speakers, monitors, and TVs. Other items such as curtains, smart gardens, refrigerators, washing machines, dryers, etc can be a suite of products that can be interconnected in the Amazon’s ecosystem. Most of these products exist in the market today, but it lacks the convenience and connectivity platform Amazon provides, which can only be achieved with scale. No consumer will want five different apps for five different products. Single Alexa-controlled hardware will provide more convenience and value. Thus, Amazon can leverage its scale and ecosystem to its advantage.
The expansion of the smart-home market will not only bring strong top-line growth but also margin expansion potential for Amazon as well. Amazon will be able to sell multiple Alexas in a single household as it is needed in all rooms for maximum convenience. Further, Amazon can expand upon the hardware market through its private label brands for cross-selling potential beyond the e-commerce platform. As such, I believe the potential Amazon has in the market creates a strong underlying trend.
Risk To Thesis
Amazon is already one of the biggest conglomerates in the world. As such, the company’s planned acquisition of iRobot raised antitrust regulatory concerns. The Federal Trade Commission has announced that they will investigate the matter due to the concern that Amazon will be able to hoard even more users’ private data through the acquisition of iRobot. Amazon already operates multiple smart hardware services that collect personal data including Alexa and Ring creating a hurdle in the potential acquisition of iRobot.
Amazon Beyond Smart-Home Market
Slowing consumer spending poses risk to Amazon’s core business today; thus, despite a bright smart-home market opportunity, I believe Amazon today is a hold. The smart-home market is a factor that may play out in coming years but will not affect the company’s near-term stock price.
In a record inflation setting, consumer sentiment and spending have been pressured. According to the St. Louis Federal Reserve, consumer sentiment is at its recent lows with an index score of 51.5 in July of 2022, which is even lower than the lowest point during the 2008 subprime mortgage crisis. Further, with the high inflation environment, consumer income growth slowed bringing U.S. consumer spending growth to a halt. These data show the waning confidence consumers have in the market, which will likely lead to more conservative spending significantly damaging Amazon’s e-commerce business.
Although cloud growth remains robust, the risk in Amazon’s e-commerce business offsets the positive catalyst from AWS. In 2022Q2, Amazon’s operating profit declined to $3.3 billion from $7.7 billion in 2021Q2. The reason behind this came from Amazon’s e-commerce business where the North American market’s operating loss came in at $627 million from an operating income of $3.1 billion a year ago. Further, the international market saw an operating loss of about $1.7 billion compared to the operating profit of about $362 million a year ago. As such, about $5.5 billion decline in operating profit from the e-commerce business cast a heavy toll on Amazon. With a likelihood of a continued challenging environment due to rising rates and inflation, the current problem is expected to last and more than offset the $1.6 billion year-over-year gain from the cloud business.
Valuation
It is hard to derive an opinion on Amazon’s valuation today using a traditional price-to-earnings ratio or forward price-to-earnings ratio because Amazon’s forward p/e is at about 2750 with a market capitalization of about $1.3 trillion. This is a result of Amazon’s e-commerce business, which is seeing a sharp slowdown compared to 2021 and a “pre-tax valuation loss [from Rivian (RIVN) investment] of $3.9 billion in 2022Q2.” Further, in 2022Q1, Amazon had a “pre-tax valuation loss of $7.6 billion.” As such, looking at Amazon disregarding the losses from Rivian, the company’s expected 2023 forward p/e is 55. Considering the continued strength of AWS and with a short-term expected hurdle in Amazon.com, the e-commerce business, I believe the 2023 forward p/e of 55 is slightly expensive. Amazon has massive opportunities in the long term, but it is hard to ignore short-term macroeconomic hurdles.
Summary
Amazon is working to dominate the smart home market with the acquisition of iRobot, and the company will likely succeed in leveraging its scale and ecosystem. However, even when considering the future potential of the smart home market, the near-term outlook for Amazon is not too bright. Due to high inflation and a hawkish Federal Reserve, consumers have been growing less confident in the market ultimately leading to lower spending, which has resulted in a slowing e-commerce business more than offsetting AWS gains. Further, Amazon’s rather pricey valuation in times of strong negative short-term macroeconomic hurdles is hard to ignore. Therefore, for Amazon shareholders, Amazon is a hold.
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