Seeking Alpha
Contrarian, deep value, special situations, growth at reasonable price
Profile| Send Message|
( followers)  

Amazon has been a smashing success story for many years now. I immensely admire Jeff Bezos. I am confident to say that he is currently one of the best CEOs in the US. I was initially going to write an article praising Amazon and explaining why I think that, despite the headwinds, fierce competition and its hefty stock valuation, Amazon's business model of customer focus and sales loss-leadership as a marketing expense to gain new customers and maximize average customer value, is very sound and can keep generating market share gains.

However, after doing deeper research and building a SWOT analysis of Amazon (NASDAQ:AMZN), I simply don't see how even such an exceptional leader and marketer as Jeff Bezos is, can keep bending the reality for much longer than beyond the end of 2013. The sales growth is likely to slow. This fact will cause investors to reevaluate their view of Amazon as a growth story.

The risks present in Amazon's SWOT analysis are simply overwhelming. It is not the presence of these risks, but the speed at which these adverse trends are accelerating, which make me change my point of view on Amazon from an avid buy-side investor and to recommend a sell of Amazon stock now. The time horizon of below 1 year is when I expect this short position to be profitable, if initiated now. Here is why.

1. Tax advantage is swiftly disappearing

One of the few strong competitive advantages of Amazon was that Amazon operated practically in a tax haven. This edge has been disappearing at an alarming rate in 2012 and 2013. The current trend around the world, not just in the US, is for states and federal governments to tighten any tax loopholes. Crack down on tax havens, increase the amount of tax collected not by increasing the tax rates or creating new taxes, but by maximizing the collection rate from the existing taxes by closing as many loopholes as possible. This trend is evident in many countries in Europe, where I live. And it is evident in the US from the attempts to introduce individual state internet sales taxes by many US states, as well as from the initiative to regulate internet taxes on the federal level.

Amazon has no proactive, offensive, strategy how to mitigate this enormous risk or even turn it into its advantage. The only steps Amazon is taking, and can be taking, are defensive. It is trying to negotiate with individual states, to postpone the effective date of the start of the internet tax collection in exchange for a promise to build distribution centers and create jobs in those states. (source).

2. Commoditization of all Amazon product lines

Virtually all industries Amazon has entered are turning into commodity businesses much faster than before. Including the AWS services. The space is crowded with mighty competitors gushing with cash, hungry to deploy this cash to earn a better return on it. Just look at the example of BlackBerry (NASDAQ:BBRY) or Apple (NASDAQ:AAPL) in the mobile phones arena, or the tablets war. Even breakthrough innovation is arbitraged substantially faster than in the past. One of the largest competitive advantage of Amazon, its innovativeness, is losing its value. The situation is similar to Apple (AAPL). What is entirely different from Apple, is the profitability, the margins.

(click to enlarge)

Amazon quarterly profit margins. Source: Ycharts.

3. Innovation losing part of its value as a competitive edge

Investors didn't expect Amazon to make profits because their strategy is to be the innovator, the leader in every field they enter, and grow the market share at virtually any cost. This is a brilliant strategy, and I greatly admire Jeff Bezos for being such a formidable innovator. However, the world has changed. Innovation is discounted extremely fast, if you have no long-term competitive advantage, a way to protect your innovation from being copied by the multitude of competitors, waiting with ample cash to throw at any new competitor's idea. Amazon has no such long-term competitive advantage.

4. Cash position of Amazon and its competitors

Amazon started issuing debt to finance its investments, by issuing $3 billion in bonds late last year. Although the interest rate is extremely low, and it can be viewed as a smart way to finance business operations, Amazon will still need to pay some interest. The debt issuance is also shifting Amazon from the group of growth companies that are not financed by debt, to a different bucket. Amazon's debt to equity ratio is very low yet. So this debt by no means threatens Amazon's financial position now, but the trend is there. To engage in fierce battles with competitors to maintain the 'king of the hill' position, Amazon requires, and will require, to invest ever more. Resources for these inevitable investments have nowhere to come from than from debt issuance, when margins are not sufficient to finance all investments. Of course, Amazon could issue new shares and dilute the value of existing shares in the process. However, not only the specific dilution, but the mere fact that Amazon was willing to dilute existing shares, would probably send Amazon's stock price south.

If Amazon tried to finance its expansion by increasing margins, this would again be at the expense of something vitally important to the company, and that is the sales growth rate.

Amazon's cash. Source: Google finance

On the contrary, its major competitors in various businesses, especially Apple and Google (NASDAQ:GOOG), not so much Wal-Mart (NYSE:WMT), virtually don't know what to do with their cash. They have enough money to defend their market shares or even grow them by lowering their margins even further. On the contrary, Amazon has zero cash to defend its position, unless it issues even more debt. Amazon will most likely be hurt from the permanent cost cutting and price matching activities of its competitors.

5. Rising costs of gasoline

Gasoline prices profoundly influence the total shipping costs of Amazon. Their current level of 8.5% of sales is high. If the price of gasoline keeps rising, this could put further pressure on the already thin margins. On the contrary, lower gas prices can be the main factor that could actually help Amazon cope better with its deteriorating financial position. However, lower gas prices will benefit its competitors as well. So gasoline is not Amazon's ticket from the competitive hell.

6. Relatively high valuations of the broad market and negative seasonality

The broad market has been rising rapidly in the past 4 months. However, a short-term pullback is possible, coupled with seasonal trends of usual weaker performance of the markets during the summer months. This presents an additional advantage of selling Amazon or even shorting it at the height of a four-year bullish cycle. This doesn't imply that the bullish trend will not continue, but rather gives us relatively more advantageous entry point into any short in the current market. Shorting Amazon in the past four years practically meant going against the main trend. If this bullish market trend stalls or reverses, the Amazon short position will get a positive lift.

Conclusion

I am a huge fan and an ardent admirer of Jeff Bezos and the Amazon business model. Amazon is a fantastic enterprise. However, it is priced for perfection. And it will face extremely strong headwinds in 2013. If there ever was a good time to realize profits from your long Amazon positions, it is now. My expectation also is that short positions initiated in Amazon now will pay off handsomely within one year. Which of course doesn't mean that Amazon's price can't go higher from here. And it by no means mean that Amazon's business will not keep thriving as I believe it will. What it means that its price will get readjusted lower with more realistic expectations.

And what is your opinion? Will Amazon's stock keep rising?

Source: Amazon Falling From Tax Haven To Debt Hell - Prepare To Sell