Amazon: Why The Giant (P/E Ratio) Must Fall

| About:, Inc. (AMZN)

It is said that Warren Buffet popularized the idea of a moat protecting long-term investments. The word moat tends to beget an image of companies as castles in warring medieval principalities. The castles with a moat can sustain the assaults of their enemies more readily than the kingdoms possessing fortified walls alone.

Those invested in Amazon.Com Inc. (NASDAQ:AMZN), point to Amazon's simple, user-friendly interface, their commanding presence in ecommerce, their reputation for strong customer service, and their price leadership as a moat capable of preserving Amazon's castle.

Others in the investment community view Amazon as a marauding giant, slaying hapless retail foes in a sequential fashion. In one tremendous stride, Amazon crosses the hapless victim's puny moat, topples their flimsy fortifications and devours their foe without even a hint of indigestion to mark the companies passing (now is the time to imagine Border's bookstores).


While conducting research for this article, I spoke with a number of my friends. They were unanimous in their opinion that Amazon offers the best ecommerce site. There is no doubt that Amazon has transformed the retail industry, not only in the United States, but throughout the world. They have created a new paradigm, and in doing so have gained the high ground in the battle against their opponents.

Supposedly, a Confederate general, when asked about his success in battle, stated his strategy was to, "git thar fustest with the mostest." If Amazon's intent was to get there first with the most, they succeeded. But if the Confederate general were here today, he might better describe Amazon's strategy as to, "git thar the biggest and the fustest."

Amazon's current dominance in the ecommerce arena is undeniable. But what did it cost Amazon to gain this advantage? What are the obstacles to Amazon moving forward? More importantly, should an investor ally themselves with Amazon, or with those Amazon wars against?


In May of last year, the U.S. Senate passed the Marketplace Fairness Act. Currently stalled in the House, the law, if enacted, would require ecommerce retailers with over $1 million in out-of-state sales to collect tax on those revenues.

Amazon has stated publicly they are proponents of the Marketplace Fairness Act and believe it will serve their business interests. Practically every other internet retailer expresses opposition to the law.

Since Amazon needs to build fulfillment centers throughout the U.S, there are analysts who contend the law will benefit the company. Their line of reasoning views the law as easing Amazon's ability to expand their network of fulfillment centers, thereby aiding in Amazon's continued growth.

Amazon's actions seem to contradict this assumption. Amazon's construction of fulfillment centers appears to be very deliberate in nature. Many states are without fulfillment centers, almost certainly as a means of avoiding increased taxation.

Furthermore, recent sales trends, while not definitive in nature, seem to indicate Amazon's sales suffer when the company is required to collect a state sales tax. In the third quarter of 2012, Amazon began collecting sales tax in California, Texas and Pennsylvania. Sales growth in North America began to drop significantly thereafter: from 36% in the second quarter of 2012, to 35%, 30% and 26% respectively in the following three quarters.


Let me return for a moment to the imagery of the medieval period. My favorite movie is Braveheart, and a consistent theme of the movie is the various Scottish clans tendency to quarrel amongst themselves. Grievances, great and small, act as a centrifugal force to prevent the clansmen from uniting and facing a common threat: Longshanks, bent on the subjugation of the Scots!

And just as Longshanks was able to sway certain Scots to his side in the cinematic thriller, Amazon once had major retailers as allies. A few years ago, Amazon counted Target (NYSE:TGT), Toys "R" Us, Macy's (M) and Gap (NYSE:GPS) as retailers selling products on their site. Today each of those retailers, and many more once affiliated with Amazon, stand as ecommerce competitors. In the year before their departure, Target alone had $1.2 billion in on-line sales through Amazon.

Not only are large retailers leaving Amazon, smaller businesses are also leaving in significant numbers. Those businesses complain of reduced customer service, which if accurate, can be defined as neglect.

In addition to the small businesses voluntarily leaving Amazon, the company is jettisoning others in states that require the collection of a state sales tax. In May of 2013, for example, Minnesota legislators passed a law requiring Amazon affiliates to collect and remit the state's sales tax. Amazon's reaction to the law was to unceremoniously end relationships with vendors in that state (it should be noted other ecommerce companies responded in the same fashion).

Minnesota has approximately 5,200 affiliates affected by the law. A drop of water in the sea that constitutes Amazon's clients. But Amazon has severed associations with affiliates in other states to avoid the remission of taxes, and it is logical to believe they will feel compelled to do the same in more states in the future.

In preparing for this article, I was left with the impression that Amazon is a ruthless competitor. Retailers complained of Amazon mining their data sources and siphoning sales from their product lines. There is a belief that once Amazon identifies a product as commercially successful, they will contact a retailers' suppliers and undersell their own clients.

In March of 2013, a class action lawsuit was filed against Amazon. The suit claims Amazon routinely withheld funds from third-party vendors for longer than 90 days. Amazon's Participation Agreement gives the company the authority, without the vendors' consent, to withhold payments for up to 90 days if Amazon believes seller behavior could cause problems with customers.

If the plaintiffs' allegations are true, this does not bode well for Amazon's continued relations with third party vendors -- vendors that provide 40% of Amazon's products and contribute up to 12% of Amazon's revenues. It could also substantially and immediately impact Amazon's bottom line. According to the suit, Amazon's third-party vendors racked up an average of $160 million in daily sales. By routinely withholding those funds, Amazon is able to reap "many tens of millions of dollars annually."

If the above listed allegations and grievances are true, one has to wonder, how many retailers and vendors can Amazon sabotage, neglect and otherwise alienate without harming their own business?

OPAQUE: Not transparent: hard to understand or explain

There are those who complain of Amazon's lack of transparency when dealing with investors. In a Barron's article, It's Time for Amazon to Open Its Black Box, the author, Alexander Eule, cites his and analysts' attempts to determine the value of Kindle tablets and the digital media sales associated with the device. His conclusion: nobody really knows. Analysts continue to tout Amazon as an enterprise worth paying $400 a share for while unable to thoroughly analyze the company.

Paulo Santos, my esteemed colleague with SeekingAlpha, (OK, he is light years ahead of me, but I can dream can't I?) has spoken of alleged accounting shenanigans perpetrated by Amazon. I will admit I'm out of my league when grappling with some of the arcane aspects of the accounting discipline, so I will refer you to this article.

This begs the question, why does Amazon feel compelled to cloak their figures? And how can analysts issue buy ratings for a company they can't analyze? More importantly, why would an investor risk hard earned money in a stock that one is unable to truly understand?


Amazon is the retail industries' Longshanks. There is no reason to believe Wal-Mart (NYSE:WMT), Target and Best Buy (NYSE:BBY) have any love for each other. But every brick and mortar retailer views Amazon as a threat to their continued existence. Consequently, they are in a never ending state of war with Amazon.

But traditional retail establishments aren't Amazon's only foes. As Amazon marches into ever more distant realms, they tend to threaten other established businesses.

Take Cloud services, for example. Amazon is the acknowledged leader in that arena, but they are running into a formidable opponent in Microsoft (NASDAQ:MSFT). So while Amazon is fighting on the ecommerce front against the likes of Wal-Mart and Target, they are also engaged in a second offensive against Microsoft and others. I (literally) have my money on Microsoft. In my estimation, an article by another SeekingAlpha contributor, Pim Keulen, makes a cogent argument that Microsoft could win on this front.

Here are some of the more salient points made by Mr. Keulen: In the most recent quarter, Microsoft improved revenues in their cloud services division by 105%, year over year. Microsoft has long established relationships with a broad range of corporate clients. Microsoft also has over $80 billion available for investment in new ventures.

It is often wise for companies to diversify into other fields. My problem with Amazon's multiple initiatives are they have limited resources and razor thin margins. Microsoft is an able adversary, and history is not kind to those who wage wars on multiple fronts. Could Amazon be spreading their forces too thin?


Did you know a Google is the largest number with a name? I learned that long before Google (NASDAQ:GOOG) was a company, but I wasn't sure my memory served me well, so I Googled Google.

Google (the company) has launched an offensive against Amazon. Referring once again to Mr. Santos, he points to Google's foray into ecommerce and notes they are gaining market share at much faster pace than Amazon. Google's efforts prompted Amazon to remove its listings from Google shopping (one less venue for Amazon's products). Now it appears Google is committed to the fight.

Google has several advantages over many of its rivals. Google's shopping search can tell when an item is in stock in nearby stores, and their Wallet service can process the customer's payment. And like Microsoft, Google has very deep pockets: $54.4 billion in cash.


Wal-Mart. There's another corporation with deep pockets. In 2011, Wal-Mart suddenly decided to get serious about competing in the ecommerce field. Their previous efforts could be described as lackluster at best, but with a mere $300 million investment, Kosmix suddenly became a part of the gargantuan retailer.

Kosmix's field of expertise lay in a complicated mix of algorithms that aimed to divine what a user really wanted once a query was initiated. Kosmix was a key acquisition, but the company came with tremendous assets: Venky Harinarayan and Anand Rajaraman.

Venky and Anand, as they are apparently known in Silicon Valley, are the former brains behind, are you ready for this… Amazon's original website. The best of friends, their reengineering of Wal-Mart's search engine reportedly increased the number of visitors who chose to turn into buyers by roughly 15%.

An app born from the efforts of Venky, Anand and their cyber warriors was christened Shopycat. Shopycat monitors your Facebook (NASDAQ:FB) friends' comments, status updates and other information and recommends an appropriate gift.

The efforts of WalmartLabs, the ecommerce division of the retailer, produced other fruits. Gleaning information from social network chatter informs Wal-Mart buyers of consumer trends.

Venky and Anand left Wal-Mart after a year, apparently on amicable terms.

And that's where the King steps in. Where would a story that begins with moats be without a King… Jeremy King.

Jeremy King is in a position that most of us can only dream of. He's the kind of guy that has employers begging for his services at a price tag he more or less dictates.

Another Silicon Valley engineer, Mr. King was heavily recruited by Wal-Mart. Like Venky and Anand, Jeremy King was renowned for his work. King was formerly responsible for building key parts of eBay's (NASDAQ:EBAY) infrastructure.

Since Mr. King is… well, Mr. King, he wasn't really interested in Wal-Mart's overtures. Finally, becoming a bit annoyed by all of the attention, King told some Wal-Mart acolyte that enough was enough. If Wal-Mart was serious, sniffed King, maybe they should have the CEO ring him up.

Before you could say Venky Harinarayan and Anand Rajaraman five times, really, really fast, someone had arranged a videoconference between King and Wal-Mart's CEO, Mike Duke. King is now the head of WalmartLabs. (Mr. King now refers to Mr. Duke as "Mike.")

If Venky, Anand and King's hiring don't convince you Wal-Mart is serious about competing in the ecommerce field, maybe this will.

Wal-Mart's' ecommerce revenue increased 30% in 2013. Wal-Mart now has over five million items listed on their site, up from two million products listed early last year (Amazon boasts 230 million products). And Wal-Mart is adding merchants to their site, at least half a dozen of which are listed on the Top 500 guide of online retailers.

With their recent acquisition of a controlling interest in Chinese e-tailer Yihaodian (YIHAOZ), Wal-Mart gained a market share (albeit small) nearly half the size of Amazon's presence in China.

Wal-Mart's capex for Global ecommerce are exploding. Wal-Mart's investments in technology increased by 70% from fiscal year 2009 through 2014. And technology outlays are expected to increase 12% next year.

Wal-Mart projects online sales will reach $13 billion in 2014, another 30% increase. Due to the construction of new fulfillment centers, Wal-Mart can deliver orders to customers 15% faster than a year ago.

While Amazon's cost of delivery has a major negative impact on their profitability, the cost of delivery for Wal-Mart dropped by 10% last year.

Amazon's losses on deliveries have prompted the company to consider raising the price of Amazon Prime by as much as $40 a year. Amazon touts Prime as a "free" shipping program providing delivery of products within two days. Meanwhile, Wal-Mart just trotted out a new program that offers free shipping on 98% of Wal-Mart's products, provided the orders exceed $50. Unlike Amazon Prime, however, the items are shipped in six to nine days.

Wal-Mart holds several advantages over Amazon. One enormous advantage Wal-Mart enjoys is the proximity of their stores to the average consumer. Two-thirds of the U.S population resides within five miles of a Wal-Mart store, and 96% of Americans live within 20 miles of a Wal-Mart. While Amazon has 40 fulfillment centers in the U.S, Wal-Mart, with 4.600 stores, potentially has 4,600 fulfillment centers. With that in mind, Wal-Mart is currently conducting an experiment with 35 stores as fulfillment centers.

A recent marketing study indicates 9% of U.S consumers consider same day delivery as the most important aspect of their online shopping experience. Once again, with 4,600 locations near most of the nations' consumers, who is better prepared to exploit that market?

Wal-Mart also offers a pay with cash service. With this option, those not holding a credit or debit card can purchase online and make payment at a local Wal-Mart store.

Perhaps you believe Wal-Mart can't overtake Amazon. If so, consider this:

In 1982, Sears was the largest retailer. Nine years later, their revenues were approximately half those of Wal-Mart.

Toys "R" Us was once the number one retailer of toys. Wal-Mart claimed that title in 1990.

Wal-Mart did not open its first store in California or Pennsylvania until 1990.

Shortly thereafter, Wal-Mart entered the retail grocery business in earnest. They are now the largest grocer in the U.S.


A study of the market is considered a soft science. I would argue it is both a science and an art. The price of a stock can be affected by weather, political events, scientific discoveries, natural catastrophes, social changes, presidential elections, changing consumer trends… the list can go on and on.

Consequently, I am generally loathe to make predictions concerning the movement of a stock's price.

I do know this. There are allegations with some merit that Amazon is deliberately opaque concerning the information they provide to investors. I shy away from investing in any company that is less than forthcoming with the public. I see it as a snare set to catch the unsuspecting investor.

While analysts sing Amazon's praises, they are unable to determine the companies' worth. The earnings estimates for Amazon in the latest quarter ranged from $1.88 per share to a penny. It is difficult under the best of circumstances to forecast a companies' future growth. How can an analyst or an investor forecast Amazon's future worth when the corporation is not forthcoming with the facts? (Must I remind you that analysts once considered Enron a company worthy of investment?)

Amazon is locked in a struggle with the entire retail industry. A decade ago, Amazon was practically the only ecommerce retailer of note. Now every major retailer is fighting for a share of that market. And everyone in the retail industry believes the battle is for their very existence.

Amazon has chosen to lock horns with Microsoft, Google and Wal-Mart. Those three companies combined are sitting on a stack of cash roughly equal to 86% of Amazon's market cap.

While Amazon possesses certain advantages over their competition, their foes also enjoy distinct advantages in their struggle against Amazon.

Amazon's margins are razor thin. In four of the last eight quarters, Amazon posted a loss.

Amazon posted disappointing fourth quarter results, sending the stock into a nosedive on the last day of January.

It is quite possible we are in the midst of a market correction, which will place greater downward pressure on the stock.

Even if Amazon's stock price survives the disappointment of this latest quarter, I cannot believe it has a future worthy of a P/E multiple exceeding 600. Amazon's profits are too thin. The company's hurdles are too high. Amazon's competitors are too adroit.

I do not contend that Amazon will be a failed enterprise. But I can find no justification for a P/E ratio exceeding 600. (For an outstanding perspective on the value of Amazon, read the recent Seeking Alpha article from contributor, Asymmetrical Investing.)

The P/E of Amazon must fall to a fraction of its current level.

On 02/04/14, I sent the following request for information to Amazon's Investor Relations office:

I am writing an article for Seeking Alpha regarding your company, In the article, I address claims by others that you made accounting changes in your 2013 3rd Quarter report (regarding valuation of e-books) that mislead investors as to your true profits in that quarter. I also address the recent class action suit filed in the U.S District Court in Seattle by law firm Terrell, Marshall, Daudt & Willie, as well as the perception that deliberately provides opaque Quarterly and Annual reports. I am providing three of the many articles I have hyperlinked to my Seeking Alpha contribution in an effort to better inform you as to the perspective of the authors I am citing. I would be more than happy to include any information contrary to the above cited sources in my upcoming article; after all, there are always two sides to every story.

I provided Amazon with links to the appropriate articles as well as my email address and phone number. Amazon has yet to contact me.

Disclosure: I am long MSFT, WMT. 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.

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