Sell-side reaction to AMZN's earnings

| About: Amazon.com, Inc. (AMZN)

American Technology Research analyst Mark Mahaney sent a note to clients outlining his reaction to Amazon's (ticker: AMZN) first quarter results. Key excerpts:

AMZN posted an In-Line & In-Line Quarter -- $1,902MM revenue and $141MM pro forma (NYSE:PF) operating income came in-line with the Street at $1,896MM and $126MM, respectively. May seem like a PF operating income beat, but there was a positive revenue surprise from possibly unsustainable, high-margin advertising revenue. Slightly increased revenue and operating income guidance came in-line with consensus.

Fundamentals weakened. FX-adjusted Y/Y revenue decelerated from 26% in December to 22% in March. And International revenue was strikingly weak – growing only 24% Y/Y excluding FX versus 32% in December. PF margins declined 20 bps Y/Y to 7.4%, with 6.5% incremental margins. And PF North American margins declined 130 bps Y/Y to 7.6%. The margin trend was not as bad as we had expected, but a margin decline IS a margin decline. The Bull goal is double-digit operating margins, and they're currently going the wrong way. The company's guidance implies further decline in June.

We'll reiterate our Hold rating. We're just ever so slightly more negative/less positive. We expected fundamentals to weaken, but we weren't expecting international revenue growth to slow down so much. Also, TTM FCF growth decelerated to 21% Y/Y, while TTM EBITDA/FCF conversion dropped to 70%. What keeps us around the hoop on this stock is that unit growth remained at 26% Y/Y (same as December), third party mix increased to 27% of units, e-commerce growth remains strong, and AMZN trades at a material discount to EBAY, GOOG, and YHOO on an FCF and EBITDA multiple basis.

We're adjusting our estimates – 2005 PF operating income remains unchanged -- $559MM goes to $569MM. And PF EPS goes from $1.14 (untaxed) to $0.79 (35% taxed)/$1.21 (untaxed) due to below-the-line items. Price Target remains $34 – 20X 2006 FCF of $1.68 or 17X EBITDA of $1.97. We expect shares to remain under pressure through at least Q2.

AMZN three month chart below.
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