I just took a hard look at the Amazon (AMZN) app store. Chances are you didn't even know that Amazon had an app store.
Wait-Amazon has an app store?
Yes, and soon you will be using it too. Here's why.
How It Works
Amazon's app store will be a huge asset to its business model, and is a strong hit to other app competitors. First, Amazon gives away one paid app for free every day in an effort to gain users.
More importantly, however, Amazon just launched a beta mobile version of its service called Test Drive. Essentially Test Drive allows users to use an app for free without paying for it - long enough to see if the user wants to purchase the app.
Amazon originally launched Test Drive one year ago, but limited the service only to desktop users. But now the company has unleashed its tool in the very marketplace where nearly all mobile apps are downloaded - on mobile phones. Even more impressive, the feature allows users to try out 5,000+ Android apps for free, which I expect to drive premium purchases while also creating more "sticky" customers who will download more free apps from its store.
The interesting part is how Amazon goes about this entire process. According to Amazon's post about its updated beta service, the company accomplishes the test drive in a unique way:
Amazon brings the Test Drive experience to Amazon.com and Android phones using the massive server fleet that comprises the Amazon Elastic Compute Cloud (EC2), a web service that provides on-demand compute capacity in the cloud for developers. When customers click the Test Drive button, we launch a copy of the app on EC2. As customers interact with the app, we send those inputs over the phone's WiFi Internet connection to the app running on Amazon EC2. Our servers then send the video and audio output from the app back to the customer's computer or phone. All this happens in real time, allowing customers to explore the features of the app as if it were running locally on their mobile device.
Amazon is essentially explaining two things - its massive resources and its brilliance.
One obvious implication of the service is an increased awareness of Amazon's app store as more users flock to it in order to test out premium apps and to get premium apps for free. Another implication is that Amazon is stealing away valuable market share from Google (GOOG).
Amazon Slaps Google
Google's Google Play is an enormous marketplace for Android users to download apps. Amazon's store is an opportunity for Amazon to snag app sales from underneath Google's nose, as the company sells apps to Kindle Fire users and other mobile device users. Its app store is only for Android. Moreover, Amazon hopes to grab up developers of applications by waiving the $99 developer initiation fee.
Apple (AAPL), in comparison, is highly profitable and takes 30% of the sale price of each app and 30% of the ad revenue generated from each app. Amazon's move is still a competitive threat to Apple's store, but Amazon only supports Android apps at this time, so Apple appears to be mostly unaffected.
Improving Amazon's Margins
Amazon's Kindle Fire, selling for $199, produces an unimpressive $10 loss per tablet sold. Amazon is trying desperately to monetize the product, but is running into problems doing so. (The company is planning to sell ad space for the Kindle welcome screen, with the lowest package starting at $600,000.) Initially the Fire did incredibly well, soaking up 17% market share in Q4 2011, but the product has since dropped to a stagnant 4% share in the tablet market.
This problem comes on the coattails of Amazon's already razor thin margins. In the past three years, Amazon has produced decreasing profit margins of 3.7%, 3.4%, and 1.3%, mainly because of the high costs of the Kindle Fire.
Thus, Amazon's Test Drive feature comes at the perfect time.
The new feature accomplishes two very important tasks. First, it steals some of the powerful Android market share away from Google. This is important because Amazon users can purchase directly from their Amazon accounts, further giving Amazon the ability to cross-sell. Second, the feature will spur both new and old users to use Amazon's app store.
Amazon's mobile traffic is important because the company wants users to use its free e-reader, which comes on most mobile phones and is supported by ads. With more e-readers, Amazon can begin to gain valuable revenue from selling more Kindle books, and also from selling more advertising, both of which offset the $10 loss on the Kindle Fire. It is estimated that Amazon already rakes in $1 billion from advertisers using Amazon's website, so Amazon already has the advertisers in place to cross-sell its ad services.
Weighing Amazon's Share Price
While I absolutely love Amazon's business model and its strong base of customers, I cannot justify purchasing the stock right now. On a qualitative note, you never want to go against Goldman Sachs (GS), widely considered to house the world's best traders. The Goldman team has Amazon, along with IBM, Intel (INTC) and Exxon Mobil (XOM), on its "Very Important Short Position" list. Going against a Goldman short is like a small monkey fighting a gorilla. Typically not a good idea.
Quantitatively, the company's price-to-earnings ratio is lingering somewhere in the stratosphere. A stock price of $217 implies a price-to-earnings ratio of approximately 180 and a forward price-to-earnings ratio of near 87. In short, the company is way overpriced.
Amazon is continuing to come out with excellent, game-changing products and features that will continue to ramp up its business and compete with the largest tech giants. However, now is not the time to go long.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
