New Reasons Not To Bet On Amazon's Smartphone

| About: Amazon.com, Inc. (AMZN)

Few markets are evolving more rapidly than that of smartphones. Just a decade ago, few could have imagined the level of technology we'd be walking around with in our pockets. After the wild success of Apple's (NASDAQ:AAPL) iPhone many other companies followed suit, with Research In Motion (RIMM) developing the popular BlackBerry series and Microsoft (NASDAQ:MSFT) developing the Windows phone. And every day it seems a new Chinese tech startup is working on the latest phone to try and compete in the market. While there have been rumors of Facebook (NASDAQ:FB) developing its own phone, those just seem to be rumors for now. Speaking of rumors, another popular one has been that Amazon (NASDAQ:AMZN) was looking to develop its own smartphone. Well, it does not look like those are just rumors anymore. Not only has Amazon reportedly been developing a smartphone, it is already being tested as we speak. While some are bullish about a potential Amazon phone, I'm not so sure. Because of this, as well as the potential decline of its Kindle Fire, I would steer clear of Amazon for now.

Some analysis first: Amazon recorded a revenue of over $13 billion for the first quarter of 2012. That's an increase of about 30% from the same quarter of 2011. Still, the company peaked in the last quarter of 2011 (revenue of over $17 billion) and its profit margin percentage has been on a slide down from 2009 (its under 1% now, down from about 4% in 2010). This is a bit of a concern, especially as it forays into new industries like phones. Its P/E is over 178, suggesting some excitement on the part of investors, but little to be gained right now. Its price/book ratio is now over 13, after starting 2011 under 12.

So where's it going? Well that depends on how much faith you have in Amazon, though I think it will take something huge, combined with success in its other ventures (where its already embedded in), to keep faith in Amazon.

Currently trading at around $245 per share (near its 52-week high), some believe getting into the smartphone market could send Amazon soaring even higher. As reported by the Wall Street Journal, Amazon could begin production on a smartphone as soon as the end of 2012. While little is known about the phone's features/capabilities, it is believed the screen will be between four and five inches. It is also reported Amazon is looking to purchase patents to guard against the legal challenges that would likely come once the phone is released.

But I'm not so sure getting into an already saturated smartphone market is the best move for Amazon right now. The company has been wildly successful with its online retail business, and many shoppers swear by Amazon as the only place worth shopping at online. Its development of the Kindle e-reader was equally as successful and continues to be the benchmark for e-readers. But when the Kindle was developed, the e-reader market was nonexistent. Sure, there were some companies that had tried, but Amazon was the first to see success with the general public. The current landscape of the smartphone market is markedly different. If you have a smartphone, chances are you have an iPhone or an Android-based phone, and you probably swear by it and are not looking to change companies. And the number of people who fall into this sort of camp are growing by the minute. Throw in the upcoming Windows Phone 8, and you have a pretty crowded smartphone market. And there are other reasons to be skeptical. CNET's Roger Cheng recently penned a faux letter to Amazon CEO Jeff Bezos, warning him against getting into the smartphone market:

Of course, Apple had no experience in mobile devices before the iPhone, and that turned out pretty well. But Apple did have a rich history of hardware and software development, and the cachet of a hip brand thanks largely to the success of its iPod line of digital music players. … The smartphone business is a completely different beast. What advantages will you bring to an Amazon or Kindle-branded smartphone?

Admittedly, there's little reason to question the competency of Amazon. It has shown itself to be an extremely solid company, and it is indeed very possible that a venture into the smartphone market could be extremely profitable. But there's also some other recent news that ought to give investors pause. Apple recently announced plans to develop a smaller iPad, which could siphon many Amazon customers, as the Kindle Fire has arguably stayed afloat thanks to that small size. Gene Munster, an analyst for Piper Jaffray, told CNBC, "If I'm the people who are running their Kindle division, I'm basically bracing for an atomic event as soon as this comes out because they really have the primary market share with those smaller tablets, so they're the ones that are going to get really sideswiped with this."

In addition to Apple, Amazon has other tablet competitors to worry about. Google's (NASDAQ:GOOG) latest tablet, the Nexus 7, is by all accounts extremely impressive, leading one Seeking Alpha analyst to declare the Kindle Fire effectively dead, citing a faster processor, better display, battery and other features all for the same price. While this is most likely a bit of hyperbole, it certainly does look like Amazon ought to be concerned about the health of its Kindle Fire division, considering these challenges from Apple and Google. Then there's the Nook, the e-reader by Barnes & Noble (NYSE:BKS), which -- while still focused on books -- does have the advantage of supporting an expansion SD card to load your own movies, music, etc., onto the device. Amazon is also facing pressure from Microsoft with its cloud services, as the tech giant just announced a new strategy for cloud services aimed at businesses. This could take some of the market share away from Amazon in this area, and while there is no need to panic, the sailing might not be quite as smooth for Amazon from now on.

Amazon is still a great company. And who knows -- its smartphone currently in development could blow everyone away when it's released next year. But, considering how crowded the smartphone market is (different from the e-reader market), I'm not sure how many people there are out there who will be clamoring for an Amazon phone. Getting into the smartphone market could also be a disaster, as it is an extremely expensive undertaking. When you combine this with the pressure on its Kindle Fire, I think there's good reason to be cautious about Amazon right now. The honeymoon may be over and a failed entry in this market could send Amazon's price tumbling down below $200, where it sat in 2011 before it tried to expand beyond its means.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.