Thursday, 27 October 2011
Amazon: Overcooked, just right or raw?
Amazon's stock price took a beating Wednesday with its stock tanking 13% in a single day of trading after announcing less than stellar earnings and also some Q4 projections that could see the retailer even post a loss for the first time since 2001. So are the Wall St boys right or are they over-reacting? First, let's look at the flip side of the equation. Until recently, Amazon had actually, under some measures, been more richly valued even than Apple. If you compare PE ratios (price / earnings) you'll notice that up until Wednesday the stock traded at 119 times earnings. Compare that with Apple that trades around 14 times earnings and you have to question whether Wall St. was ever getting it right in terms of this stock. Second, I think you also have to think about what kind of company's Wall St. likes - nice smooth, predictable companies with smooth cash flows that reward investors. This is often times anathema to company's being able to make aggressive investments for future growth. Particularly in technology where product cycles and consumer preference often change quickly, companies have to be able to react quickly or face being left out of the market (Nokia, Microsoft, HP?). This isn't necessarily what investors like to hear. I mean would you prefer to get a higher dividend check or see a company increase capital expenditures? That really depends on your investment horizon for starters. So the truth is that Amazon is placing a big bet on the future. They're betting that a big part of their business will be the distribution and retail of digital content. This includes books, music, movies and apps. This really shouldn't have been a surprise to Wall St particularly given the launch of their Android App store and their focus on distributing music over the Web. In addition, the company has a history of making significant investments for the future. For many years Amazon actually lost money as it was growing its brand, distribution footprint and acquiring new customers. The good news today is that Amazon is a household name in many parts of the world and has an enormous user base of consumers who buy everything from MP3's to video games and now apps. They've also established themselves as a very good manufacturer and retailer of hardware with their line of Kindle products. Wall St.'s view on the Kindle Fire to me seems short sighted. Although they say each device causes a $10 loss, it's unclear what their assumptions are behind Amazon's ability to make money off content sales on this device. We know Kindle users purchase content since they primarily use it to buy books. With the Kindle Fire it's save to make a couple of assumptions: - They will acquire even more content since the device is even more powerful and also able to run more than simply books but also better suited to movies, music and apps - They have an established form of payment already integrated given that they will likely need an Amazon account (credit card included) to use the device So if you assume a consumer purchases at least one song or app per week at .99$ at a 30% revenue share to Amazon then that already earns Amazon an extra $14.25 a year which wipes out the loss on the device. Throw in Amazon's ability to cross sell other products, scale their buying power of components for the Kindle to bring down the cost and also the sale of higher value digital goods the picture becomes even better. So what's the problem? Simply put Amazon was overvalued. A number of investors made the comparison to Apple. This really isn't fair. Apple is a device manufacturer selling premium products at premium prices. Amazon is a retailer. It's a bit like comparing Apple to Walmart. Walmart business is about scale and selling millions of items at low margins. Fundamentally, Amazon is in the same business although they have their cloud services business and Kindle business which have better economics. The question becomes whether they can leverage their consumer relationships into something that provides better margins. So over-reaction? yes. However, overvalued also yes. let's see what Jeff Bezos comes up with next. Mad Mork