The Fantasy Keeps Growing

Jul.27.12 | About:, Inc. (AMZN)

In my very first article on Seeking Alpha, back in October 31 2011, I said that (AMZN) would soon be posting losses. At the time, the earnings estimates for the quarter I was referring to were north of $0.40 per share, and those for the quarter that just reported were north of $0.50 share. has just reported $0.01 per share for that quarter, and guided towards a loss for the next one. So the losses really are about to arrive.

Meanwhile, at that time the theory for's continuous earnings underperformance was that it was investing in its future, and in more and more warehouses to bring about that future. So the story went that as soon as this investment stabilized, the earnings would flow. However, even then there were several reasons to believe was telling a bogus story, such as:

  • Investments are mostly capitalized and depreciated over time, so the earnings impact is not as large as paints it;
  • Other growth companies in the past didn't have to excuse poor profitability with ongoing investments. This is true even of companies in sectors similar to's, such as Wal-Mart (WMT). Anyone can check Wal-Mart's history and confirm that in spite of strong growth and investment, earnings never flagged;
  • More glaringly, most of's infrastructure investment is taking place in the U.S., yet most of the margin compression is taking place internationally, as can be seen from the imploding earnings contribution from the international segment.

As I said at the time, "Having arrived here, it should be perfectly clear to anyone that the reason being advanced for's margin compression is bogus. And it being bogus means it will persist.". As we know today - but wasn't the consensus expectation back then - the margin compression persisted, confirming the misleading nature of the story.

This, too, is a fantasy

So everything already pointed towards the "we are investing" theory being bogus. Yet the fantasy just keeps getting bigger and shifting. With yet another disappointment in earnings and revenues, and a further downward guidance for lower earnings and less growth in revenues, has now managed to shift the story to "it's the gross margins that matter". This too is a fantasy, because:

Gross margins are not the only variable costs in's business. For instance, fulfillment varies with the physical sales volume; 3P sales also take fulfillment higher due to payment handling; Marketing includes associates' programs which are intrinsically variable with sales volume; Technology includes the variable costs of running AWS.

The placement of costs as COGS or operating costs is arbitrary. This can be seen by looking at Equinix (EQIX), a business similar to's AWS. It has gross margins of around 50%, not 100%, because it considers the costs of running the business in COGS, whereas brings those AWS costs down to the "technology" line. There's no point in awarding a higher valuation because of an option to have costs above or below the COGS line. So basically by not including the costs to run AWS at the COGS level, and instead having them appear lower in the "technology" operating cost line, the gross margin comes up inflated. Same goes for payment processing fees, which hit online revenues in general, including those by 3P.

The story keeps shifting and is internally inconsistent. The story that it's gross margins that matter is predicated essentially on 3P sales. Now, most of these sales - and the most profitable ones at that - are fulfilled not by Amazon, but by third parties. Uh? Third parties fulfilling these sales do NOT require huge investments! Also recently, the story was that would crush retail with same day delivery. But wait, if the story is "gross margins matter" then same day delivery is out the window, after all, third parties won't get any benefit from investments made to support it (never mind that AMZN's CFO has already shot down the "same day delivery story as well).

In short, it doesn't much matter if gross margins are higher and operational costs are also higher, or if gross margins are lower and operational costs are lower as well. As far as we can know, there might even have been some shifting of costs from COGS to operational costs. After all, this is the company that classified gaming consoles as part of their media segment.

So if it's all a fantasy, what's real?

What is real is:

  • is about to show losses and has little profits already;
  • After these earnings, again estimates for next quarter are being taken down 90% (just like the last several quarters);
  • After these earnings, estimates for 2012 will go lower than $1.15, so the forward 2012 P/E is now over 200 times;
  • After these earnings, revenue growth estimates for next quarter are also being taken down;
  • The Kindle fire and Kindle eReader have mostly stopped selling;
  • will actually be at a disadvantage to other online retailers in California and Texas, because it will be collecting sales taxes before others do;
  • added another $600+ million in operating leases, so is getting more and more into debt, while showing a plunging cash pile.

Indeed, there are too many negative things to mention. Even if you believe the fairy tale stories that keep getting invented, ask yourself "Is this a company that deserves to trade at 15 times the market's multiple?".

Disclosure: I am short AMZN.