This is going to get good.
As everyone is by now aware Amazon (NASDAQ:AMZN) had "blowout" earnings [see transcript], sending the stock up $30, or 15% to $226.85. As one of the "high-flying darlings" of the world today they're a great stock to own right here and now, right?
Not so fast.
Buried in the rah-rah was the fact that the company agreed to collect and remit Texas sales tax, as they have facilities (warehouses) in Texas. Amazon has been quietly reaching these deals of late, and will be collecting and remitting tax in 12 states, making up ~40% of the population, by 2016.
The problem Amazon has is part of the "law of large numbers." Long-standing law says you need "nexus" to be forced to collect and remit sales taxes. "Nexus" is defined as some sort of business presence or connection to the state in question; without it there is no jurisdiction and therefore no ability of the state to impose a legal duty to do something.
Amazon has for years set up subsidiaries and played other games to allow them to locate warehouses around the country while not collecting sales tax. They have to do this to control shipping costs, as shipping is distance-sensitive -- as volume goes up there comes a point where it is far less expensive to put a warehouse in a given place than ship product the extra 500 miles. Amazon's tax-dodging strategy is a dubious practice that has come under attack by various jurisdictions (in my opinion with good cause) as this is not so simple as hiring someone to deliver something (e.g. contracting with UPS) or similar but rather extends to the actual function you perform in the market -- in this case, reselling and delivering taxable goods at retail.
It appears that Amazon management is quietly coming to the conclusion that these games will ultimately fail, either by new legislation or court case, and that it's far better for them to come to an agreement with a fixed start date and known expense than risk a court challenge that could nail them for retroactive assessments, plus penalties and interest. That makes sense.
But if you're an Amazon bull you've got a problem as the company's acceptance of reality expands. The company has an operating margin of 1.79% and a profit margin of 1.31% (incidentally, that internal efficiency is amazing -- best-in-breed, which is why they're still in business. Credit where credit is due when you can manage to run a company on 50 basis points of operating margin or less!)
Now figure out what happens if prices go up net-net to cover the tax. Remember that Amazon's primary draw is that they're cheap -- even with shipping costs. Add an average 6% or so sales tax to the price though and the differential narrows -- a lot -- with the local store. Basic logic says that as Amazon's "as delivered" price rises and the differential with the local store narrows their sales volume will decrease. Remember that the local store always has one advantage -- you can have it right now compared to having it in a few days. Time has value and Amazon has "won" largely on the premise that the money difference is large enough to win over immediacy.
One of Amazon's attempts to broaden the base from retail goods (especially electronics) to services, attempting to blunt potential risk in the physical goods business, has been the Kindle. The "Fire," their color tablet, looked great -- right up until Samsung came out with the 7.2 Tab. The margin destruction that is going to come here will be massive, and it won't be limited to Amazon. Apple (NASDAQ:AAPL) is in big trouble in this regard although you won't hear the Fanbois talking about it and frankly I suspect RIM's (RIMM) tablet is now doomed as I doubt they can make them profitably at the current $199 price point. The problem is that both RIMM and Amazon now are stuck with their $199 price-point, as the Galaxy 7.2 tablet is $249 -- and it both has cameras and expandable storage.
But Amazon, even with the Kindle, still has that nasty low operating margin.
That's the problem with hardware; margin compression eventually comes and it comes hard and fast. Don't discount the Koreans -- they're really, really good at figuring this stuff out, and while it takes them a while once they get calibrated you're in trouble.
Samsung is after both Apple and the upper end Kindles and I predict they will ultimately slaughter both, along with Apple's iPhone. (Incidentally in all the hoopla did anyone notice that Samsung blew past Apple on phone sales?)
So what do we have here? A trailing P/E of 165, a P/E/G ratio of 6.8 (!!!) and a stock price of $226.85 at the close Friday with margin pressure coming from all sides while the company has less operating margin to play with than pretty much anyone else in the game.
Yeah, that'll work out well.
Back in early 2000 I said Amazon was a $2 stock when it was flying high. It bottomed at $4 -- close enough. I don't think there's any chance that the company will die, but a similar swoon -- a monster collapse in the share price that could take them down as much as 90%, is not only in the realm of possibility, I see it as likely. Timing is the problem and as such I will take my cue from the technicals on this, watching to see if we get a fail up at the old high of $246.71 or if we get one of those "last gasp" blow-off moves higher first.
Disclosure: No position today but as noted my bias is certainly to the short side with entries being stalked entirely on a technical basis in the short term. Longer-term I believe the stock trades under $50.