Abrupt End To Tax-Free Internet Shopping Predicted: Significant Impact On Valuations

by: Abe Garver

As an investment banker for the Web-only retail sector and creator of the Web-only Retail Index, Seeking Alpha followers have asked me to keep them abreast of material developments in the effort to end tax-free Internet shopping.

At this time my sources tell me that two Republican senators are preparing to introduce new legislation this week that would allow states to force Amazon.com (NASDAQ:AMZN) and other out-of-state online retailers to collect sales taxes.

Lamar Alexander of Tennessee and Mike Enzi of Wyoming and are currently putting the final touches on their bipartisan bill, which is backed by Wal-Mart Stores (NYSE:WMT), Best Buy (NYSE:BBY), Home Depot (NYSE:HD), and other companies that are currently required to collect sales taxes.

As I reported previously in Valuations Of Web-Only Retailers Could Drop 25% Sen. Dick Durbin has been championing a related effort dubbed Main Street Fairness Act for several months.

The justification for the measure is the claim that Amazon.com, Overstock.com (NASDAQ:OSTK), Blue Nile (NASDAQ:NILE), and other online retailers such as those in the Web-only Retail Index (below) that don't collect taxes are unreasonably depriving states of revenue, and that they enjoy an unfair competitive advantage over local retailers that must collect taxes.

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Alliance for Main Street Fairness Spokesperson Danny Diaz put it this way, “The objective is to level the playing field between brick-and-mortar and Internet retailers. Today, a gross disparity exists in the marketplace that allows online-only retailers to sell their products at a perceived yet artificial price advantage as they are passing on the sales tax liability to unknowing consumers, while brick-and-mortar businesses are required by law to collect and remit the tax."

On the other hand, a 1992 Supreme Court decision says that, in general, retailers currently can't be forced to collect sales tax on out-of-state shipments unless they have offices in those states. And with more than 7,500 taxing jurisdictions, each with its own rules and ability to conduct audits, compliance with each is not a trivial task.

NetChoice.org's Executive Director Steve DelBianco says, "The SST Cost of Collection study found that a small business spends 17 cents for every tax dollar it collects for states. Even if SST software works as promised, that only helps with 2 cents of the 17 cents in costs per dollar collected.” That leaves small businesses with a 15% cost burden on every dollar they collect.

In response, The Federal Tax Authority’s CEO, R. David L. Campbell says, “Today's technology actually makes collecting sales tax online easy -- certainly no more difficult than calculating shipping costs, which every online retailer already does. There is reimbursement available if retailers incur any cost in adapting their systems to collect sales tax, but there's really no reason for collecting sales tax to cost anything at all -- free sales tax management services (like TaxCloud) are available to manage every aspect of online sales tax collection, at absolutely no cost.”

Another recent development is that beginning February 1, 2012 merchants who sell through Amazon.com or through an Amazon-hosted e-commerce sites can now opt to pay the company to collect applicable sales tax on their sales transactions for a fee for the service equal to 2.9% of what it collects in sales tax and any related transaction-based charges.

Amazon will remit those funds to the merchants and merchants are responsible for documenting and paying all taxes to the appropriate state and local tax authorities.

As a Seeking Alpha contributor my purpose is to share actionable investment commentary. Based on my judgment as a banker in the sector I believe an abrupt end to tax-free Internet shopping would have a significant impact on valuations and investors should be on alert.

How would an abrupt end to tax-free Internet shopping impact Internet retailers?

  1. Near Term Revenue Dip - Revenue in the sector is expected to fall between 10.0% and 13.0% in the short run based on detailed data from one retailer and three earlier studies.
  2. High Ticket Items Hit Hardest - Revenue may decline more than 13% for Internet Retailers with high average ticket orders where the online tax savings have been substantial, and more than offset by freight costs and delivery time (e.g. top-tier consumer electronics and jewelry).
  3. Collection Cost is Real - The cost of collecting tax (as a % of collected tax) will range between 13.5% for small retailers to 1.5% for large retailers.
  4. Consolidation of Healthy Channel Players - Large strategics will likely accelerate their acquisition of smaller retailers whose margins are impacted the most by the cost of collecting state and local tax.
  5. Thin and Getting Thinner - Many smaller internet retailers will find it almost impossible to compete if the new rules take place due to the already thin operating margins becoming almost non-existent.
  6. Valuations Falling - Depending on a host of factors (e.g. magnitude of revenue declines and increased collection costs), we expect valuations of Internet retailers to fall by as much as 25%.
  7. No Dance Partners – Even those that can marginally compete are likely to find that large e-tailers no longer find them as attractive due to the new competitive burden placed upon them. Those smaller e-tailers that were at one time hoping to exit at a premium may be disappointed in their ability to even find buyers for the business.

Web-only Retail Index companies include Amazon (AMZN), eBay ( EBAY), O.co (also known as Overstock.com) (OSTK), United Online (UNTD), Vistaprint (VPRT), 1-800-Flowers.com (FLWS), Nutrisystem (NTRI), Blue Nile (NILE), U.S. Auto Parts (PRTS), Vitacost (VITC), PedMed Express (PETS), Coastal Contacts (CSOAF.PK), Bluefly (BFLY) and Stamps.com (STMP).

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

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