New Internet Tax Grab Will Burden Companies and Your Portfolio

by: Investment Underground

Like vampires, desperate government officials are searching for any way to suck capital out of the private sector to fund their largesse. The newest plan swirling around policy circles is a tax on internet sales. The word's "fairness" and "responsibility" keep getting thrown around. It seems no doubt some kind of blanket internet VAT tax is just around the corner.

This should upset you for three reasons: The costs of these new taxes and administrative expenses will be passed along to you, the consumer. Online retailers will see revenue and profitability decline, as consumers opt to put off purchases in the face of higher prices. And thirdly, rather than get their fiscal houses in order by pushing through necessary austerity measures and pension reform, state lawmakers are villainizing anyone but themselves for this mess.

Tax king California, dealt the first blow to online retailers yesterday. The online tax bill, ABX1-28, passed the legislature and will head to Jerry Brown's desk soon. We hope Amazon (NASDAQ:AMZN) makes an example of California and Assembly Speaker Perez by cutting ties with its affiliates in the state. Only time will tell. Regardless, should the worst case scenario come to pass, the following companies will be hurt.

Amazon: AMZN is an online retailer that operates both in North America and internationally. AMZN also offers programs that enable sellers to sell their products on its Web sites, and their own branded Web sites. While AMZN has come to dominate the online retail industry over the past few years, it is starting to face increased competition from brick-and-mortar retailers struggling to maintain internet sales revenue from the increasingly lucrative online shopper. AMZN’s operating margin of 3.66% is already among the lowest in the industry, and given AMZN’s inability to provide the kinds of in-store service alternatives for customers that brick-and-mortar stores offer, AMZN could be poised to decline even further in 2011. AMZN is currently trading at a 60+ P/E multiple, a 20% premium to our fair value estimate. We think Amazon has become a poster-child for a tax levy. Texas papers reported that the Texas legislature attempted to cram a tax increase on its citizens while Amazon appeals the Texas comptroller's demand that Amazon pay $250M in back taxes on sales in the state. So far, Texas Gov. Rick Perry vetoed the legislature's measure. Nonetheless, if all states adopted tax measures, Amazon would be hit hardest. Sales would decline only marginally due to higher transaction costs, but we think customers are loyal and find shopping on Amazon to be a habit. Tax expense would increase, however, reducing Amazon's bottom line by 4-6%. This would have a significant, negative impact on earnings going forward.

Apple (NASDAQ:AAPL): AAPL designs consumer electronic devices, including Mac computers and laptops, the iPad, the iPhone and the iPod. AAPL also has an online store that sells and rents music, TV shows, movies, games and apps. It is called iTunes, and it happens to be the largest music distributor in the world. AAPL is currently trading at a price of $315.

Here are the numbers that separate AAPL from almost every competitor in the same industry: AAPL, in the last three years, has grown earnings per share by 56.8%, the industry average for the same time period is a shocking -0.2%. In the same period, AAPL has grown its revenue by 39.5%, while the industry average is only 6.7%. This industry domination is insane since, only half a decade ago, AAPL was just considered a niche computer company that had a stock price of roughly 55 dollars. AAPL has a current price to earnings of 15, and a future price to earnings ratio 11.

With dominate numbers compared with the industry average it looks like AAPL still has room to grow if it can continue to take advantage of its ingenious marketing and slick products. Apple would take a hit if legislatures pass internet sales tax measures. Much of Apple's growth has come from online sales of the iPad, iTunes service, and the iPhone. New taxes would dampen Apple's income growth because of higher consumer prices, as it is unlikely that Apple executives would make the decision to raise prices to make the difference. (NASDAQ:OSTK): As the company name suggests, this online retailer specializes in selling overstocked goods through the website and Should internet taxes become the norm, Overstock could be particularly hurt given its web-only presence. Shares have been weak as of late, trending downward from highs in October. The stock trades on a P/E multiple of 35. At the time of writing, shares trade at $14.36.

Overstock is leveraged to the online sales revolution and, with an operation smaller than that of Amazon, would be disproportionately impacted. Overstock has already been burdened by California's new internet tax. In response, it moved operations out of California, Hawaii, Rhode Island, and North Carolina, which have been unfriendly toward the company's presence there.

Travelzoo (NASDAQ:TZOO): Currently, shares trade at a 15% premium to our fair value estimate. Insiders have also been selling TZOO stock between $59 and $73 per share, suggesting upside could be limited. TZOO shares trade with a P/S multiple of 9.4. Projected EPS growth is aggressive, but not explosive enough to merit the current P/S multiple. That being said, the company has no outstanding debt. Travelzoo is a global Internet media company.With more than 22 million subscribers in North America, Europe, and Asia Pacific and 24 offices worldwide, Travelzoo publishes deals from more than 2,000 travel and entertainment companies. Travelzoo’s deal experts review offers to find the best deals and confirm their true value.

Travelzoo already sees the heavy burden that airlines face as one of the internet's up-and-coming travel deal makers. Airlines already face a 35%-40% tax burden as a component of ticket cost. It is consumers who ultimately pay that burden, which is especially apparent considering razor-thin margins at most major airlines. Travelzoo may escape further tax liability depending on how new taxes are structured because the product it sells is a service. Most legislatures are considering taxes on retail goods for sale.

Expedia, Inc. (NASDAQ:EXPE): Expedia is an online travel company. Some of its many sites include, and The current stock price is $27. Expedia’s trailing P/E is $18, and the forward P/E is 12.97. The dividend yield is currently 1%.

Expedia also has a front-row seat to the incredible tax burden that airlines face. We think Expedia has a good shot at escaping increased tax liability, since its unit already pays "room and meals" (or equivalent tax) in most states where it applies.

Mixed department store retailers like Macy's (NYSE:M) and JC Penney (NYSE:JCP), while less exposed than pure-play online retailers, will still face considerable headwinds as they attempt to grow their businesses online. The additional burden of online sales taxes should not create such an obstacle that it warrants a reduction in cash flows, given that these retailers have operations in all 50 states. Most legislatures are crafting tax bills to exempt retailers with a presence in their state already, in order to not duplicate taxes on retail sales.

Big box retailers like Best Buy (NYSE:BBY), Sears (NASDAQ:SHLD), Wal-Mart (NYSE:WMT), Home Depot (NYSE:HD) and Lowe's Stores (NYSE:LOW) are betting on sales from their revamped online stores to improve sales. In the face of increased taxes, the burden should be less cumbersome since all of these companies have a store in all 50 states.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.