Amazon’s and Google’s stocks could be a ‘win-win’ even if both companies face government-ordered breakups

Amazon’s stock
AMZN,
+0.05%
was flat Wednesday as investors shrugged .

Alphabet Inc.’s stock
GOOGL,
+1.34%

GOOG,
+1.29%
rose 2% on Wednesday, as its main subsidiary, Google, celebrated its 25th birthday.

What the companies have in common is their long-term success — Amazon in online retailing and Google in internet search. Then again, both have been successful branching out. For Amazon, one gem is Amazon Web Services, which competes in the cloud-services business with Microsoft Corp.’s
MSFT,
+0.33%
Azure platform and Google Cloud Platform. Alphabet has had great success with YouTube, and more recently YouTube TV, which, according to the company, has “over 5 million subscribers and trialers.”

With both companies dominant in their core businesses, and the prospect of a breakup of Amazon on the table, it isn’t much of a stretch to imagine Alphabet potentially being broken up, too. The Justice Department sued Google in January for “monopolizing digital advertising technologies,” and in its complaint asked that Google be required to divest several units, “with any additional structural relief as needed to cure any anticompetitive harm.”

On Tuesday, the FTC and states accused Amazon of using “a set of interlocking anticompetitive and unfair strategies to illegally maintain its monopoly power.” The behavior has enabled Amazon “to stop rivals and sellers from lowering prices, degrade quality for shoppers, overcharge sellers, stifle innovation, and prevent rivals from fairly competing against Amazon,” according to the complaint.

FTC Chair Lina Kahn said in a press release that the lawsuit “seeks to hold Amazon to account for these monopolistic practices and restore the lost promise of free and fair competition.” That is where things may seem a bit vague, but, in the 172-page complaint, the plaintiffs ask for “any preliminary or permanent equitable relief, including but not limited to structural relief, necessary to redress and prevent recurrence of Amazon’s violations of the law, as alleged herein.”

And that could spell profits, eventually, for Amazon’s shareholders. “Structural relief” could include a breakup of the company, which would allow investors to put a price on Amazon Web Services, which happened to be running at a 24.23% operating margin (operating income/sales) during the second quarter. In fact, the unit’s operating income of $5.365 billion made up 70% of Amazon’s total operating income. AWS’s quarterly net sales of $22.14 billion made up 26.8% of Amazon’s total net sales of $82.546 billion.

Amazon’s quarterly net sales were up 10.9% from the year-earlier quarter, while AWS saw an 12.2% sales increase.

So one might argue that AWS has been “trapped” within Amazon. Amazon’s stock has always traded very high relative to earnings because the company has been content to plow its cash flow into continual expansion. AWS on its own could be valued in a more traditional manner.

D.A. Davidson analyst Tom Forte made the case that a breakup of Amazon would be good for its shareholders. In a scenario under which Amazon is split into three units — direct retail, third-party retail and AWS — the stock would be worth up to $193 a share, by Forte’s calculation, on a sum-of-the-parts basis. The stock closed at $125.98 on Tuesday.

The Google trial began on Sept. 12 in U.S. District Court in Washington, D.C.

Read: If the government breaks up Google, would it be worth more?

JPMorgan analyst Doug Anmuth wrote in a report on Sept. 8 that many professional investors see the Google trial as a “win-win” for Google. Either Google wins the case, preserving its current status, or it loses, “which could enable the company to recoup tens of billions of dollars in [traffic-acquisition cost] payouts with perhaps only negligible impact to overall search volume, market share, and
revenue,” he wrote.

Brad Klapmeyer, a managing director and senior portfolio manager at Ivy Investments (a unit of Macquarie Asset Management), said he and colleagues had “gone through iterations of what it would mean” to break up Amazon and Alphabet, and that “there would be higher value of the pieces in the aggregate.” Shares of both companies are among the top 10 holdings of the Delaware Ivy Large Cap Growth Fund IYGIX WLGAX, which Klapmeyer co-manages.

But he doesn’t expect the companies to be split up, even though he said during an interview that it was “not terribly surprising” that the companies would “be attacked, from a government perspective, on the strengths of their businesses.”

Klapmeyer said: “Sum-of-the-parts math is always a dangerous way to value a company,” since there can be benefits to keeping a company together. AWS is an example, he said, being developed initially to support Amazon’s retail business, to help with “knowing the customers well, [and] aggregating the data,” before it expanded to offer cloud services to other companies.

“These are synergistic businesses,” he said.

So what about the two stocks? Here’s a quick comparison of valuations and total returns, with those of S&P 500 sectors and full indexes through Tuesday:

Click on the ticker symbols for more about each company and index.

Click here for Tomi Kilgore’s detailed guide to the wealth of information available for free on the MarketWatch quote page.

Amazon and Alphabet are considered tech stocks, but Amazon is actually in the S&P 500 Consumer Discretionary sector, while Alphabet is in the Communication Services sector. So those sectors are shown, along with the IT sector.

Amazon has had the worst five-year performance of any stock, sector or index on the table. Then again, it has been the best 10-year performer. And 10 years ago, you might have reasonably thought the company’s best years of growth were behind it.

Amazon always trades at a high forward price/earnings ratio, as the company has never emphasized the bottom line while funding most of its continuing expansion through current cash flow. But on a forward price-to-sales basis, the company trades even lower than the S&P 500
SPX.

Alphabet’s price-to-sales ratio is high, but it’s lower than that of the IT sector. Its forward P/E valuation is high when compared with that of the S&P 500, but it might seem more reasonable when compared with that of the Nasdaq-100 and when considering the following estimates for earnings and sales growth:

This table shows expected compound annual growth rates, or CAGR, for sales and earnings per share through 2025, based on consensus estimates among analysts polled by FactSet.

Amazon is expected to continue growing sales a good clip, and both companies are expected to put up good numbers relative to the sectors and indexes.

Among 53 analysts polled by FactSet, 50 rate Amazon a buy or the equivalent. The consensus share-price target is $172.60. This 12-month target is 37% higher than Amazon’s closing price on Wednesday.

For Alphabet, 45 of 55 analysts rate the stock a buy, with a consensus price target of $150.18 — 15% higher than Wednesday’s closing price.

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