An Attractive Entry for an Amazon Short

Before the open this morning, Citigroup analyst Mark Mahaney upped his rating on Amazon (AMZN) to “Buy” from “Hold” and raised his price target on the stock to $119 from $95 (AMZN closed Monday at $92.64). He cites consolidation in the stock since July and a toning down of expectations for long term operating margins.

His ratings increase has given Amazon some pop today in an otherwise down tape and, in my opinion, provides an attractive entry for a short position.

If you’re like me and believe we are heading for a recession and global slowdown, or even if you just want to hedge your position and have some exposure to the downside in an expensive stock, Amazon is an attractive short.

It is, after all, a retailer. Amazon makes most of its money selling books, DVDs and CDs (64% of total revenue for the last 4 quarters) and a good chunk from electronics and other general merchandise (33.4%). In other words, it is completely dependent upon consumer spending, and mostly US consumer spending (55% of total revenue for the last 4 quarters).

US consumer spending is poised to slowdown as the air comes out of the housing market and if the rest of the world is affected by a US slowdown, international consumer spending at Amazon should slow down as well.

So Amazon’s business momentum, which it must be admitted is phenomenal, is poised to slow in the face of these macro headwinds.

Further, valuation has gotten a little rich. Amazon trades for 41-42 times trailing 4 quarters free cash flow and 31-32 times forward free cash flow estimates. That’s not awful expensive for a company growing as fast as Amazon - but it is expensive.

Analysts are mixed on Amazon with 11 buys, 12 holds and 3 sells. There is a sizable short contingent as Amazon is one of the most heavily shorted stocks on the Nasdaq and 7.6% of its outstanding shares are sold short.

Disclosure: Author's fund is short Amazon (AMZN)

Comments

[WilliamOrfly]

A reduction in consumer spending does not necessarily precipitate a reduction in sales or profits for Amazon. Motivated by smaller personal discretionary budgets, and rising transportation costs, consumers might spend less time trolling shopping malls and more time at home surfing the web for good deals.

[Lupus]

I'd be careful shorting Amazon as the notion that Amazon is completely dependent on consumer spending is a thing from the past. Amazon is increasingly opening up its own business model to others who can 'hire' their technology, payment system, warehouses etc. for their own e-commerce efforts. This might not add so much in turnover, but it does add a lot to profits. Hence, Amazon deserves more than a pure retailer stock valuation. It might not be as expensive as you think...

[jpc]

one also needs to give weight for AMZ's data storage business.

[Shorter]

Let's not forget Amazon's financial arm. It is after all what gave it a boost toward the end of last year.

[fgjsfd;g]

I got destroyed shorting AMZN in 2007.
Worst trade of the year.

[Greg Feirman]

Amazon's other businesses make up such a small part of its revenue (4.3% of revenue for the first 9 months of 2007) and profit as to be negligible when analyzing their business.

Shorting is all about timing. Amazon's valuation shows that it is trading as a speculative stock and now is not the time for speculation. Note how Amazon got crushed today, down 7% in a down 2-3% market. Speculative stocks always get hit harder.

It's going down more.

[LouieJunior]

Greg - I agree. I am short amazon and believe the momentum has ended. There was much talk in '07 about amazon's improving margins. I just don't see it happening. Sure they did better than '06, but margins are shrinking over time -- see the attached chart.

bp2.blogger.com/_Q5i63...

Bulls think third party margins will help! Meanwhile, Amazon adds music downloads, an electronics store and groceries. These low-margin goods, along with growing competition, will keep a lid on margins. If/when the revenue growth slows, this stock will be cut in half.