Amazon: Free Smartphone Won't Happen

Sep. 9.13 | About:, Inc. (AMZN)

Last week, there were several news stories suggesting that Amazon (NASDAQ:AMZN) is seriously thinking about building a smartphone and giving it away to people in hopes of making money on content. This week, the company denied the rumors that it was going to give away phones for free. After all, even Amazon is not that crazy.

Amazon is not always known for making business decisions that are highly profitable. So far, Amazon's priority has been gaining market share, increasing revenues at double-digit rates, killing or significantly hurting the competition and making a name for itself (almost like winning the so called popularity contest). Indeed, Amazon has been gaining a lot of market share from both online and mortar-and-brick stores for the last decade and the company's customer satisfaction rates are impressively high.

Since Amazon doesn't always go for ideas that promise strong profit margins, many people bought into the story that the company was open to the idea of building a smartphone and giving it away to people. Yet, even Amazon wasn't that crazy after all. It takes a lot of investment, time, effort and other resources in order to build a smartphone and there is really no feasible way to give it away and make any meaningful money on content.

First, the largest American mobile carriers already have subsidies for virtually all smartphones that they sell. AT&T (NYSE:T) and Verizon (NYSE:VZ) subsidize every phone in their inventory as long as the buyer agrees to sign a contract, which usually lasts 2 years. During this time, these companies recover all their investment and make some profit as they sell expensive data packages. If Amazon were to give away its phones for free, it would have to sell data packages, which it doesn't have the infrastructure to do. After all, Amazon is not a mobile network carrier and the company would have to invest billions of dollars to become one. The kind of content Amazon would be able to sell to smartphone users (music, e-books, movies) would not be very profitable for the company. Amazon didn't give away its tablets for free, but even those were not that profitable for the company, even after the content income is factored in.

Second, those who buy Amazon's content would still have to get a phone service and they could just buy their phone where they buy their service. It is very rare for people in the western countries (where Amazon's target audience would be) to buy their phones and related services at separate locations. Most people buy their phones and carrier services from the same location in order to get a better deal. If someone got a free smartphone from a hardware provider and went to AT&T to get mobile service, he or she would have to pay so much for the data and other fees that the free smartphone wouldn't really save that person any money.

Third, Amazon doesn't have the capacity to build a smartphone. The company would have to hire a bunch of engineers, designers and manufacturers, and it would have to license a lot of patents from companies like Motorola (NASDAQ:GOOG) and Nokia (NYSE:NOK) to build a feasible phone. Even after it hires people and invests into licensing patents, there is no guarantee that it would be able to build a smartphone that is good enough to compete with the existing smartphones, such as Apple's iPhone, Samsung's Galaxy series and Nokia's (soon to be Microsoft's) Lumia series.

Fourth, even if the whole thing became feasible and Amazon was able to make high quality and comparable-to-competition phones for cheap enough prices, it would still serve people who are not likely to spend a lot of money. Those who are able to spend money on content such as music, movies and e-books tend to get an iPhone. This is also an area where Android struggles because it is having trouble attracting people who are able to and willing to spend money on content. Android usually attracts people who are budget conscious and looking to get free content if possible.

Amazon is a very expensive investment and the company is priced for perfection. At this point, the investors still treat the company as if it's a start-up, and to be fair, the company is growing its revenues at double-digit rates. On the other hand, the company is not profitable at all and it hopes to be profitable someday in the future when its expensive investments in the last few years pay off. Currently, most analysts and investors price Amazon based on its revenues rather than its earnings so that its current valuation makes more sense. Currently the company trades for about 2 times its annual revenues.

I am not saying that Amazon will fail or it will never make a profit. I am not saying Amazon is a bad investment either. I'm just saying that much of Amazon's future success is already priced in. Being aware of this simple fact would help a lot of the company's present and potential investors when making a buying or selling decision.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.