This wildly expensive tech stock is a massive buy

Twitch: a smart move by Amazon

Amazon is spending $1bn to be ‘down with the kids’.

The internet retail giant is buying a video-gaming business called Twitch. The move should help Amazon “strengthen its position with younger audiences”, it reckons.

A billion dollars seems a high price to pay for a bit of street cred. And as an Amazon shareholder, you might think I’d be worried about this.

But I actually think Amazon’s latest move is very smart.

50 million users spend hours each month on the Twitch site, and there are several ways Amazon could make money from this young and fast-growing audience.

What on earth is Twitch?

Before I go any further, let me explain how Twitch works. It’s basically a YouTube for video gaming. So when you’re playing a game, you can broadcast what you’re doing, and viewers can watch you play and hear your comments as you play. Viewers can also participate in games and watch previously played games in the archive.

(If the idea of watching other people play games seems odd to you – just remember the crowds around the expert arcade game players or pinball machines of your youth – this is the same thing for the digital era.)

According to Business Insider, the site now has 55 million monthly users, and 58% of those users spend at least 20 hours a week on the site. What’s more, internet infrastructure company Deep Field says that during the web’s ‘primetime’ hours in the US, Twitch is the fourth-largest source of network traffic, behind only Netflix, Google and Apple.

A big attraction for Amazon is that Twitch could help Amazon sell its Fire TV set-top box. For a $40 supplement in the US, the Fire box already comes with a games controller, and Amazon has also invested in a games studio. Buying Twitch should boost Amazon’s attempts to appeal to gamers.

And as Wired magazine points out, while Amazon is a long way behind Google and Apple when it comes to phones and tablets, the battle for the TV is still wide open. Twitch could help Amazon win that battle.

Twitch should also help Amazon engage with younger customers. As Ian Maude of Enders Analysis told the Evening Standard, “The obvious thing [about the deal] is the connection with games and retail. The deeper connection is probably around strengthening its position with younger audiences.”

On top of all that, there’s an advertising angle here. Amazon isn’t a big player in advertising, but it wants to change that. Amazon has launched a new ad platform called Amazon Sponsored Links which may become a rival to Google Adwords.

Adwords offers ads around search queries. Amazon hopes to offer a similar service when users search for items to buy on various retail sites, including Amazon itself. I suspect that Amazon’s data on its customer’s purchases is a potential goldmine here.

That said, I’m not suggesting that Amazon’s ad business will ever be as large as Google’s. Amazon won’t get close. But there is potential for growth here, and Twitch can help deliver that growth. Think about it. Twitch has millions of youngsters spending 20 hours a week on its site – surely those viewers are an attractive target for advertisers?

Amazon is a buy

So as an Amazon (Nasdaq: AMZN) shareholder, I’m very pleased by the latest developments. I’m hanging onto my shares, and if you don’t own any yourself, I think you should seriously consider buying some.

The shares look very expensive on conventional share price metrics, there’s no denying it. But as I said in June, I believe there will come a time when we realise that the current share price – around $340 – wasn’t so crazy after all.

Amazon doesn’t make much profit right now, but it’s investing to create shareholder value in the long term. Some of that investment is into new businesses such as Amazon Web Services, which has been a big success. Another chunk of that investment is in keeping prices as low as possible.

Keeping prices low is an investment for the future, because it drives rivals out of business, and it also brings more and more customers into the Amazon universe, who then get used to using the site on a regular basis.

And I can speak from experience in saying that once you’ve used Amazon for a while, it’s very hard to break the link. Back in 2012, I was so irritated by Amazon’s low tax payments in the UK that I vowed to boycott the site.

But that boycott only lasted six months as I just couldn’t resist the lure of low prices on a brilliantly designed website backed by excellent logistics.

Still not convinced?

Well, look at these ‘back of an envelope’ calculations. Last year, Amazon generated $75bn in revenue. I think that number could easily double over the next three or four years to $150bn.

If Amazon was able to push up prices so that it had a 4% margin, its profits would be somewhere in the region of $6bn a year. Amazon’s current market cap is $150bn, so that would put the company on a price/earnings ratio of 25.

Now, I admit that Amazon probably won’t have a 4% margin in four years’ time. The company will probably still be building new businesses and investing in price. But the point is, Amazon could probably obtain a 4% margin if it wanted to.

If instead, the company decides to carry on investing for the long term and building shareholder value, that’s fine by me. I’m very happy to hold.

• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.

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