Why I'm Short Amazon: Waiting for State Governments to Wise Up

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Includes: AMZN, RTH
by: Hedgephone

Amazon (NASDAQ:AMZN) is a richly valued stock, trading at nearly 70X trailing earnings and 47X forward earnings, according to Reuters. Could the recent decision by the State of Texas to levy a $269MM backed taxes assessment against AMZN kill the stock price over the next two months? My guess is only if and when the overall market sells off.

However, the real risk is if states wise up and realize that AMZN is in fact not paying taxes when the mom and pop in-state competitors must pay the taxes -- an unfair competitive advantage to the big guys.

In essence, the argument for the levy of online state taxes is that bad enforcement of state sales tax and Anti-Trust laws are crushing small business at home -- the small in-state businesses cannot compete with Amazon. I am sure that if Texas wins this legal case, the legal loophole that allows AMZN to "consolidate" the retailing business will close, and Wall Street would then have to cover their shorts in the Retail Holders Trust (NYSEARCA:RTH), creating havoc. This little known tax assessment disclosure is gearing up to be a monumental showdown: Wall Street vs. Main Street, Online vs. Brick and Mortar, State Government vs. Federal Government -- you name it.. Wall Street has never embraced the long online vs. short brick and mortar trade more than it has today -- in effect, online retail consolidates all of the regulatory and taxation power at the Federal level and removes the money and power from the state level.

All told, the argument against Amazon is a fairly straight forward one: AMZN sells the same commodity type good to a state-of-Texas resident that any in-state brick and mortar competitor sells, yet the in-state brick and mortar business must pay a tax while AMZN pays nothing... Basically, there is a tax subsidy for AMZN to crush local retailers. The only real beneficiaries are the Wall Street shareholders who own AMZN stock and the CEO -- after all, it's not like AMZN needs to employ lots of people... that's not what automation is all about. The lobby behind the web companies is very liberal, which is likely why it took a Republican state like Texas to strike first.

Well, it appears as though Texas is fed up and committed to this fight; its residents are not going to watch their state go bankrupt because local businesses must pay taxes go bust partially directly because AMZN has lower prices. Texas knows that if they don't act, AMZN will sell everything and the states will have no tax dollars left to collect. Most of the cost savings provided by Amazon come from customers not having to pay the state tax -- an uncompetitive tax shelter. In one sense, Amazon can be seen as the good guy because customers don't have to spend as much for the same product that they do at a local store.

Don't get me wrong, at heart I am all about saving money and I am generally against more taxes. Opinions aside, the argument from a competition or Anti-Trust standpoint could direct the attention of struggling state government officials toward AMZN for backed taxes because it's not equitable for local businesses to be punished in favor of a company that employs a very tiny group of incredibly wealthy people located in Seattle.

I find this debacle to be highly fascinating. If AMZN loses this battle against Texas, a flood of claims may come from state governments who will surely claim they are suffering in direct proportion to the growth of AMZN over the long term. For, in essence, out of every dollar of revenue that AMZN pulls in online, 5-7% of that number is from simply not paying state sales tax while AMZN only earns a 3.8% return on their sales. Meredith Whitney says a state government financial crisis is the next big event on the horizon. Could AMZN's margins contract from here?

I recently spoke with an unnamed, high ranking State of California employee who told me off the record that California could soon declare bankruptcy... If they are willing to legalize pot to generate sales taxes, I would not put it past them to enforce state sales tax on Amazon.com and similar out of state internet "Duty Free" retailers.

In any event, investors chasing AMZN after a 300% gain in only a year and half should consider the headline risk that could be coming to the company and also realize that 7% of the sales on the web could soon be paying for better roads and schools in your home state. Could a change in tax status cause AMZN to become materially less profitable in the future?

Amazon's operating margin is a little over 5% -- a margin that is actually likely less than the state sales tax that customers don't have to pay because they bypass state sales taxes when using Amazon.

At a 70X multiple, investors could be risking far too much on a company that may only exist to its current degree because of a soon to be closed tax loophole. Or, might AMZN have big time connections at the federal level to kill this move? If campaign funding has any bearing on the issue, investors should note that Google.com (NASDAQ:GOOG) is one of the largest contributors to the Obama campaign.

No matter what, the fight ahead will be interesting and industry shaking going forward.

Disclosure: Author is short AMZN