Closes In On Its Endgame As Sales Taxes Loom

Jul.17.12 | About:, Inc. (AMZN)

In "Tax Break Nears End For Online Shoppers", the Wall Street Journal reports that the final dominoes appear to be falling in favor of providing states authority to tax online retailers. Republican governors are warming up to the idea of collecting the revenues available from online shopping, amounting to $23B according to the National Conference of State Legislatures. A quote from Tennessee Republican Senator Lamar Alexander (and a former Tennessee governor) sums up the shift in attitude (and positioning) very well:

Conservatives don't want to pick winners and losers in business…And our bill gives states the right to tax the online purchases. It's states' rights.

The position from the Democratic side seems equally well-represented in this quote from Illinois Democratic Senator Dick Durbin:

It gets down to a basic issue…of simple fairness for small businesses that create jobs and opportunities all across America. And with the sales taxes they collect, they provide for local police and firemen, for the sewers and streets.

In other words, a rare moment of bi-partisan agreement is aligning the winds of change to allow states to tax online transactions in the very near future. The WSJ describes the efforts in the meantime of (NASDAQ:AMZN) to broker deals with individual states ahead of this seemingly inevitable legislation. AMZN is apparently rolling out a new strategy to enable same-day delivery by establishing more distribution warehouses. These warehouses establish a physical presence that enables the host state to justify taxation. AMZN worked out a deal with New Jersey governor Chris Christie to build out warehouses in New Jersey in exchange for collection of sales taxes starting July, 2013. AMZN failed to reach a similar deal in Florida in which it sought to postpone taxation until 2014. WSJ notes the significant impact of these changes as AMZN explains: "By 2014, it will pay sales taxes in at least 13 states…covering nearly half of the U.S. population."

Clearly, the implementation of sales taxes makes AMZN less competitive on price and creates a more even playing field with physical stores. Best Buy (NYSE:BBY) is typically singled out as a retailer suffering mightily from AMZN's low pricing, and the use of its stores as physical showrooms for AMZN shoppers (note that as of March, 2012 Best Buy's 20% market share in electronics was three times that of AMZN's). The WSJ quoted Lowe's (NYSE:LOW) as another victim of AMZN and other online retailers. According to Vice President Scott Mason, LOW "…has a 5% to 10% price disadvantage compared with online rivals, with some customers using its stores to pick products and then ordering them online to avoid sales tax." I think this sales tax avoidance will soon become small potatoes compared to what I believe is AMZN's endgame: targeting the Wal-Mart (NYSE:WMT) shopper.

AMZN's strategy of enabling faster distribution of products to customers using more warehouses is certainly enabled by its recent $775M acquisition of Kiva Systems Inc., a maker of robotic warehousing systems. Same-day delivery of products will put AMZN in direct competition with Wal-Mart which uses its expertise in warehousing and product shelving as a key competitive advantage. Two retailing giants will soon have a warehousing face-off. AMZN already carries a large variety of products, including groceries, that have a large overlap with WMT offerings. If penny-pinching WMT shoppers can find most, if not all, of what they need on AMZN for same-day delivery, they can save some more pennies on the gas needed to drive to Wal-Mart. Caught in the cross-fire will be a host of smaller businesses who will not be able to keep up with the AMZN vs WMT arms race. As long as AMZN makes sure that its online competitors must pay sales tax, AMZN will wield an incredible competitive advantage in product delivery over them. Indeed, the WSJ claims that AMZN now supports a nationwide, comprehensive solution to taxation of online sales.

As the endgame approaches and sales taxes loom, AMZN's stock has been stuck in neutral for a year. AMZN trades exactly where it did a year ago, trailing both the SPDR S&P Retail ETF (NYSEARCA:XRT) and the Powershares QQQ Trust (NASDAQ:QQQ). Even as the S&P 500 (NYSEARCA:SPY) was stabilizing in the final months of 2011, AMZN sold off steeply. Moreover, AMZN has been stuck in neutral since reporting earnings April 26th that sent the stock soaring over 20% the next day. Since then, AMZN has traded around the $219 price level that I have noted as a bear/bull dividing line (for example, see "Amazon Flips Back to Bullish"). Losing the sales tax advantage should reduce the exceptionally high premium investors are willing to pay for AMZN, but the prospect of sucking up even more market share from traditional retailers can counterbalance the fear. continues to fluctuate around the critical post-earnings price level of $219Click to enlarge continues to fluctuate around the critical post-earnings price level of $219


AMZN next reports earnings July 26th. My general recommendation to wait until the post-earnings open to buy AMZN remains valid as an earnings-related trading strategy (see "Why Was A Buy At the Open After Reporting Earnings" for more details). However, I am much more wary now that the uncertainty around sales taxes and the widening scope of warehousing could serve as a sustained overhang for AMZN.

Disclosure: I am long SDS, BBY.