Spend some time on Seeking Alpha researching Amazon (NASDAQ:AMZN), and it may seem clear that the bias is clearly negative against the stock. The problem is that, for the negative bias to be worth listening to, it should be more focused on the business side of Amazon and not the valuation of its stock price. You find far fewer people making the argument that Amazon offers terrible products or service. The opposite appears to be true. Those same people that are so bearish on the company from a market valuation standpoint might be ordering something from Amazon in between their next negative rant about its valuation.
Sound advice would be to stop trying to value Amazon because it is not possible. The company is reinventing retail and along the way has managed to enter into a multitude of other business segments that more than complement its core retailing operation. Online retailing is still in its infancy, and Amazon is the undisputed king of the hill. Recent projections call for a 10% CAGR for online retail sales out until 2017 when those sales in the U.S. will reach ~$370B annually.
Shorting Amazon on a belief the company is overpriced from a price to earnings standpoint is a mistake. The stock market is overflowing with companies with outrageous price to earnings multiples. Most of these companies probably do not deserve their multiple, but if one company does, why not put your money on the one ranked as the most trusted brand in America?
There has been some buzz recently that Google (NASDAQ:GOOG) is targeting Amazon and moving in on its turf so to speak with some of its new offerings. For numerous reasons explained below, this is entirely wrong and if anything, Google should be the one looking over its shoulder at Amazon.
If Amazon Is Overvalued, Why Does Google Want To Emulate Its Business Model
There is no question that Google is a highly profitable company from just about any way you choose to measure profitability. Its core search business, as reported for 2012, generated a gross margin of over 65%. This compares to Amazon whose gross margin for 2012 was in the low 20% range. This would also be significantly lower if you just accounted for the core retail operation.
This begs the question then of just how scared Google is of its growth runway for the search business. It seems there is at least some fear if it is willing to play in Amazon's low margin businesses. To argue that the market should see Google as threatening Amazon is akin to arguing that Apple (NASDAQ:AAPL) would rather sell an iPhone for $100 instead of $500. If Google is going to try to make a play at Amazon's business, then Google investors should dump their shares. When you chase revenue growth at the expense of a lower return on invested capital or shrinking operating margins, this should be a large warning sign.
The key point of this entire article is that investors have already accepted that Amazon is a low margin business. The company is reinvesting the cash it generates into the business today to lay the foundation for future growth. The market has spoken and rewarded that strategy. Google, on the other hand, is a high margin business that has essentially had minimal competition in its core search business. Is the market ready to accept Google as a cutthroat retailer embarking on operating margin dilutive adventures?
Specifically, arguments are made that Google is making moves with the effect of undercutting Amazon and its already low prices. Examples range from the introduction of the $199 Tablet, cloud services that might be 50% cheaper than Amazon and its AWS service, and saving the best for last the Google Shopping Express service meant to compete with Amazon Prime.
Google did not have a choice when it came to introducing a tablet to the market. The company was essentially last to the party behind Apple and Amazon. The introduction of the $199 Nexus tablet last year was unquestionably a reaction to the $199 Kindle Amazon introduced in 2011. It made logical sense for Amazon to develop a piece of hardware such as the Kindle. Its reason for existing being the unabashed goal of making it easier to buy from Amazon and utilize the company's Prime video service. With Google, you have to question what it gets from developing a profitless piece of hardware. Aside from the Kindle, all Android tablets and most iPad users already utilize Google search. So the Nexus theoretically does not generate incremental search revenue unless you assume that the Nexus buyer would have been a Kindle buyer instead. It may generate a little revenue selling e-books or movies. It is probably so immaterial the accountants have to remember to include those amounts in the financials. All Google did with the Nexus was create an alternative to the Kindle to try and prevent its adoption, which would reduce its future search revenues. This was a defensive and not an offensive move at all.
The AWS cloud hosting service provided by Amazon is clearly a successful and high margin business that provides a lift to its overall profitability. There are plenty of other articles that can provide lengthy analysis about the future of this business. The crux of the argument here is that it just does not seem to make sense for Google to enter this business unless it is a defensive move. First off, Amazon has the first mover advantage, at least when compared to Google, and has built a massive customer base. If the rumors are true that Google is undercutting Amazon in pricing by 50%, it is because that is the only way it can reach a critical enough mass to support a cloud offering. Again in entering this business it will significantly erode its overall company operating margin. It is hard to believe that Google could find a way to have a cheaper cost structure than Amazon when comparing the two cloud offerings. You can bank on the fact that Amazon will refuse to lose customers to Google over price. Will the market allow Google to sacrifice operating profitability in a price war with Amazon to chase top line growth?
Apparently Google has some world changing service it will be rolling out in the future to solve a problem that Amazon could not solve. Google is going to introduce Google Shopping Express which, wait for it, will offer expedited delivery. Amazon clearly has failed to provide that with its Prime service and guaranteed 2 day delivery. This soon will turn into 1 day delivery in the near future with fulfillment center expansion. The rumor is that the service will provide same day delivery from certain retailers. It would be at an annual fee possibly $10 to $15 less than the $79 charged for Amazon Prime. A couple of items jump out that are pretty laughable.
First of all this trial version is in San Francisco, which is where brilliant ideas are trialed. That is until someone realizes the Bay Area is not representative of the rest of North America. Second, it is hard to understand how a service like this genuinely could be cost efficient. It would take significantly critical mass within an urban area for this to have a chance of succeeding. You are not talking about procuring goods from a shelf in an Amazon distribution center and putting them on a truck at the end of the day headed straight to the airport. You are talking about potentially dozens or maybe hundreds of retailers with orders coming in throughout the day. Then somehow you have to pick these items off shelves, load them into a truck, and transport them over who knows how large of a geographical area all in one day. This is a pipe dream that will not happen. To argue that if this did happen, Amazon would have to lower its Prime price to match what Google charges is humorous. For $79 at Amazon, you get the equivalent of free 2 day shipping all year. Amazon will also go ahead and throw in its more and more competitive version by the day of Netflix for free. The Google brain trust must have been riding in their driverless car, wearing their all knowing glasses, and listening to their talking shoes when they came up with this idea.
The key takeaways are twofold. First, do not short Amazon just because everyone screams that it is overvalued. The company is pioneering how consumers purchase things and is at the heart of the retail revolution. Whether it is or is not overvalued will not be answered in the near term. You short this company at your own risk.
The second takeaway is that Google is not a threat to Amazon. The reality is Google has much more to fear from Amazon than vice versa. Amazon is encroaching on the high margin search business where Google lives. Amazon is already the landing page for 33% of all online shopping compared to 13% for search engines like Google. Both companies have established brands and core sources of revenue today. One company is moving into higher margin businesses, and one company is looking for future growth in lower margin businesses. Which would you rather invest in for the long run?