Payments Not Guaranteed To Pay Off For Amazon, No Immediate Threat To PayPal

| About:, Inc. (AMZN)


Amazon is making another push into a crowded industry, hoping to steal market share with their usual strategy of undercutting more established players.

This would seem to bode poorly for currently dominant PayPal, but I believe they are well enough established, especially with larger retailers, to fend off Amazon's charge.

eBay shareholders stand to benefit from the continued strong performance of PayPal, while Amazon shareholders could see just another unprofitable foray into a low margin business.

Yesterday, Amazon (NASDAQ:AMZN) announced further expansion of their mobile payment initiatives, rolling out a credit card reader and associated payment app dubbed Local Register. This takes square aim at the similar service popularized by, fittingly enough, privately held Square. It also targets (no pun intended since Target hasn't rolled out their own payment system, although they do have a thriving credit business) other players in the mobile payments game including eBay's (NASDAQ:EBAY) PayPal and Intuit's (NASDAQ:INTU) GoPayment.

In typical Amazon fashion, they have come in with the lowest prices, offering an introductory 1.75% fee for new customers who sign up by Halloween, and 2.5% thereafter. This undercuts the 2.7% and 2.75% fees charged by PayPal and Square, respectively. Therefore, Amazon is banking on attracting new customers by offering price breaks, with their vice president of local commerce, Matt Swann, saying in the press release that they've "heard some business owners say the only thing that would make them change (point of sale) systems is cost savings."

If Amazon is correct and makes significant inroads into the payments arena, we would certainly expect this to negatively impact the established players, a sentiment echoed by this article. While I often joke that no one can compete profitably with Amazon, not even Amazon themselves, I feel that this is not as big a threat as initially perceived.

For one thing, Amazon is only targeting small businesses at first, and if they try to expand into larger retailers, the very same ones they're often engaged in cutthroat competition with, they might meet with some stiff resistance, especially since their system collects information on each transaction, presumably to try to figure out how to route even more sales through Amazon.

Also, people seem to be underestimating the current leaders in this area, especially PayPal, which has incubated under eBay's watch for over a decade now. They have obviously done a fabulous job expanding the business, such that it now contributes 45% of revenue as of the latest quarter. The even more impressive thing is that, unlike some of Amazon's ventures, eBay managed this growth without sacrificing profitability.

Coming out of the downturn, eBay has managed to grow EPS from 26 cents in 2007 to $2.20 last year, with a peak of $2.50 in 2011. Earnings the next couple years are expected to eclipse this mark, with average analyst estimates just under $3 for this year and $3.40 for next. Meanwhile, the share price has gone nowhere the last two years and is now trading at forward P/E ratios under 18 and 16 based on 2014 and 2015, respectively.

We all know that Amazon has been going in the other direction, from $1.15 in 2007 up to $2.58 in 2010 before turning negative in 2012. Amazon posted a meager EPS of 60 cents last year, but earnings are again predicted to come in negative this year after their most recent disappointing second quarter and even worse guidance for the third quarter, with a possible loss of $800 million predicted on the low end.

While analysts have kept the faith that earnings will rebound to around $2 next year and then presumably accelerate from there, it's worth mentioning that this delayed gratification has been continually put off, with estimates coming down over a dollar for both periods in just the past month.

The mantra of the Amazon bulls is that they're "investing in the future." Well, I've got news for them: so is eBay. They just seem to be going about it in a more focused manner, buying a logistics company in 2011 and growing it into their underrated Enterprise division, which helps manage the online sales and distribution for a number of other retailers, something I covered in more depth in my previous article on eBay. Instead of competing directly with them like Amazon, this further demonstrates eBay's willingness to form profitable partnerships, such as with South American rival MercadoLibre (NASDAQ:MELI) and historic auction house Sotheby's (NYSE:BID).

Amazon has adopted a more scattershot approach, seemingly trying to singlehandedly be all things to all people. While this has paid off in some cases in their quest to be "The Everything Store", such as with AWS becoming a dominant player in cloud storage, not all their initiatives have been home runs and even fewer seem to be profitable.

They have not seemed to make a dent in some of the other high profile markets they've entered, such as streaming video. Despite Amazon investing billions in this area, Netflix (NASDAQ:NFLX) has continued to thrive and has become the dominant player, although they could have avoided this if they had just bought Netflix when they had the chance, like I suggested.

Also, as with their initial push into tablets with the Kindle and then the Fire, this is also likely to be the case with the Fire Phone, whose high price and lukewarm (pardon the oxymoronic pun) reviews make it seem more likely to flop than generate the much anticipated profits the company may have had in mind with the aggressive pricing and consumer targeted features.

Maybe mobile payments will be different, and Amazon will be able to use their vast scale, deep pockets, and secure cloud based technology to become a major player, but I highly doubt this will happen any time soon. The incumbents such as PayPal and Square are too well established to cede too much market share no matter how much money Amazon throws at the problem.

I think investors are overestimating the benefits of this development for Amazon and the effect it will have on competitors. Just for reference, the $3 billion plus gain in market cap Amazon tacked on yesterday on the news is more than half the entire valuation implied for all of Square in their last funding round.

PayPal has a more than 10 year head start and is already benefiting from a well established network effect, so Amazon has a lot of catching up to do. Therefore, so I would look to buy eBay on any weakness related to this perceived threat and avoid Amazon for the time being, at least until they can start to demonstrate more consistent profitability or cash flow.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in EBAY over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.