Amazon's (AMZN) third-quarter update made a convincing case that the network effect underpinning our wide moat is strengthening, with revenue trends before Whole Foods accelerating across most revenue categories and indicating greater engagement among Prime members, third-party sellers, and AWS users. We believe investors should focus on three themes: 1) the shift from Prime acquisition to engagement via new products and services in the U.S.; 2) the jump in Prime international and the lifetime value potential; 3) and continued monetization of AWS.

Unpacking each of these trends, we believe that 2017 will go down as a pivotal year for Amazon Prime memberships, where the company's focus in North America shifted from Prime enrollment to engagement and many international markets seeing a Prime recruitment ramp similar to the U.S. in 2012-13. This is evident in the 59% increase in subscription services (versus 53% currency-neutral growth last quarter), with Prime Day helping to drive U.S. members into new services and a record day for Prime trials globally. Not surprising, this recruitment/engagement is also helping to drive third-party seller activity, where revenue growth remained robust at 40%. AWS posted health currency-neutral revenue growth of 42% and segment margins of 25.5%, which we attribute to adoption of mission critical services and AWS Marketplace contract term changes.

For 2017, we now forecast top-line growth of 30% but also a modest reduction in operating margins to 2.2% (versus 3.1% a year ago), which is consistent with management's fourth quarter guidance for revenue between $56 billion-$60.5 billion and operating income between $300 million-$1.65 billion. Over the next five years, we now expect average annual revenue growth of 24% (up from 22% due to new category expansion like apparel, home furnishings, and pharma) and operating margins of 6%. As such, we're planning a modest increase to our $1,200 fair estimate and view shares as undervalued.

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