Amazon.com, Inc. (AMZN) has recently been testing the $250 level (a new all-time high). With the company projected to earn less than $1/share in 2012, Amazon has understandably been targeted by numerous bears as a monster short opportunity. However, investors shorting the stock have not been rewarded thus far. While the stock pulled back last fall, it has since recouped those losses, and the 5-year chart is impressive.
The problem for shorts is that many investors are convinced that earnings volatility is the result of heavy investments in the business that are bound to pay off eventually. Negative earnings surprises and guide-downs have done nothing to tame the stock's outperformance. The issue is that if revenue growth is projected to continue unabated, bullish investors can simply pencil in a 5% (or even 10%) margin for the "mature" period five years or more down the road.
However, when investors see a revenue slowdown for a growth stock, a haircut is almost automatic. We saw it last year with Netflix, Inc. (NFLX). We saw it this year with Chipotle Mexican Grill, Inc. (CMG). Shorts had been saying for months (and even years) that the stocks were overvalued relative to their earnings potential, but poor revenue played a bigger role than poor earnings in taking down the stocks.
Amazon is heavily reliant upon revenue growth to maintain its share price. The company trades at a Price to Sales ratio slightly over 2. This is more or less unheard of for a mass-market retailer. If you look at some of Amazon's main competitors, Wal-Mart Stores' (WMT) P/S ratio is 0.53, while Target Corporation's (TGT) P/S ratio is 0.59. Struggling retailers have even lower P/S ratios: Best Buy's (BBY) sits at 0.12, while Barnes & Noble (BKS) has a P/S of only 0.10.
Over the long term, it is unrealistic to expect Amazon to command a better P/S ratio than Wal-Mart and Target, two highly efficient and successful retailers. In order to grow sales enough to justify its current share price, Amazon needs to maintain its current 30% revenue growth rate for at least the next five years. However, as I discuss below, several impediments will put the brakes on Amazon's revenue growth as soon as next quarter.
Sales tax: I can't emphasize the sales tax issue enough. I believe that Amazon's ability to avoid charging sales tax in most of the U.S. has been one of the biggest drivers of its growth over the past decade. With state and local sales taxes rising in much of the country recently, tax avoidance gives Amazon as much as a 10% advantage over bricks-and-mortar competitors. There may be some consumers who don't think about tax when deciding whether to buy from Amazon or from another retailer, but the vast majority of Amazon's customers are very aware of the tax savings they are receiving.
However, Amazon has been charging sales tax for orders shipped to Texas since July 1. Since September 1, Amazon has been collecting sales tax in Pennsylvania. Moreover, on September 15, Amazon (and other out-of-state merchants) will have to start collecting "use tax" in California. These three states join Kansas, Kentucky, New York, North Dakota, and Washington as states where Amazon collects tax. This more than triples the population from which Amazon must collect tax, from less than 35 million to roughly 110 million.
Amazon's management has argued in response that the company has seen strong growth in the markets where it already collects taxes. These are mostly international markets at this point. But the international markets are much less mature, as Amazon got its start in the U.S. They are thus likely to have higher growth rates regardless of tax issues. California, Texas, and Pennsylvania represent about 15% of Amazon sales (my own estimate based on population), and if the imposition of sales tax slows growth there, it will prove a significant headwind for the company as a whole.
Running out of Bullets: Amazon has been growing sales by about 40% annually over the past two years. That growth is expected to slow to 30% this year. Even that estimate relies on a strong Q4 performance. But as I have discussed elsewhere, I have become increasingly bearish on the retail sector as a whole. (Amazon.com has one advantage, insofar as consumers are likely to do more online shopping in a high gas price environment. Still, I don't think this compensates for the broader risk of macroeconomic weakness.)
More to the point, Amazon has relied heavily on adding new product lines to drive revenue growth. I don't entirely agree with my Seeking Alpha colleague Paulo Santos, who has pointed to this as one sign of mismanagement at Amazon.com. Wal-Mart has done just fine over the years as a seller of just about everything. However, I don't think Amazon has many remaining opportunities to add additional multi-billion dollar product lines. Last year's introduction of the Kindle Fire was successful, and many news outlets have suggested that a smartphone could be coming soon. However, the smartphone market would be much harder for Amazon to penetrate. Whereas Amazon essentially created the low-cost tablet market, consumers already have lots of options for "free" smartphones with a new 2-year contract. Without the ability to compete on price, Amazon will have trouble making a compelling value proposition vis-a-vis strong competitors like Apple (AAPL) and Samsung (GM:SSNLF).
Kindle Fire Shift: The successful Kindle Fire debuted last year in Q4. It's an open secret that Amazon will be revealing the new Kindle Fire this Thursday, and the new device is expected to go on sale immediately in the light of Amazon's announcement that the old Kindle Fire is sold out. This could result in a significant revenue shift from Q4 to Q3 this year. Estimates for Kindle Fire Sales in Q411 are in the 4-5 million range. That translates to as much as $1 billion in revenue.
With an earlier release date this year, a strong launch could give Q3 a revenue boost of perhaps $500 million (there was no Kindle Fire at this time last year). But the company would then be facing a tough comp figure for Q4 without the benefits of launching a new device. If this timetable was baked into Amazon's Q3 revenue forecast (likely), but not analysts' Q4 revenue estimates (also likely), this factor alone could negatively impact Amazon's Q4 revenue by 2-3% or more.
Beyond the effects of the calendar shift, Kindle Fire sales will also come under pressure this year from the introduction of stronger competitors. Google's (GOOG) Nexus 7 has seen impressive demand over the past two months, and has been highly rated by most reviewers. It offers more features than the original Kindle Fire, at the same price point. Moreover, most industry-watchers expect Apple to introduce a lower-priced "iPad Mini" this fall; it will likely be a huge hit (at the expense of Amazon and Google). Amazon may be able to compensate partially by selling the new Kindle Fire overseas, whereas the original was a U.S.-only product. Nevertheless, I expect Q4 Kindle Fire sales to be lower year-over-year. (We may never know, since Amazon has never released official sales figures for the Fire.)
Conclusion: I think a negative revenue surprise could be looming in the near future for Amazon (when it issues Q4 guidance next month). The combination of increased sales tax collection and weaker Kindle Fire sales in particular could decrease revenue growth to 20-25% year-over-year, well below what the market currently expects. This makes Amazon a promising short opportunity at today's levels. If shares rally further after Thursday's Kindle launch event, that could also provide a good entry-point for investors looking to short the stock.