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Amazon (AMZN) is down 5% since our last article, in which we had advised investors to realize gains at the then price of $261, after the launch of its new Kindle models. We are still unconvinced that the diversification of business and introduction of new products warrant as high a valuation as AMZN's, and advise investors against buying the stock.

Low Margin Hardware:

With the cheapest seven-inch Kindle model selling at $159, it is clear that the company is earning almost nothing from hardware. The company's hardware is far cheaper than that offered by Apple (AAPL), although one can only use it for content from AMZN. To compare based on pricing, the 4G LTE Kindle Fire HD carries a price tag of $499 as compared to the 4G LTE iPad 3's cost of $729. Amazon, according to its own estimates, has 22% of the tablet market in the U.S., with players ranging from Google (GOOG) to Microsoft (MSFT). Jeff Bezos has pointed out on several occasions that the company earns money from selling content, and not from hardware. Below are quotations from two occasions:

  • "We want to make money when people use our devices, not when they buy our devices."
  • "We sell the hardware at cost. We want to make money when people use our devices, not when they buy them."

Streaming business:

The company has been the cause of much distress for Netflix's (NFLX) shares too due to its content deals. There is news that AMZN's LoveFilm service will be available in France as well from March 2013. LoveFilm has approximately 2 million subscriptions in Europe, an area where NFLX is looking to expand. On the content cost front, there is news that Amazon might have to pay more than an upfront fee for Epix content, if the service crosses a certain number of subscriptions. NFLX was paying $200 million per year for exclusive rights for its Epix deal, before the exclusivity expired. According to a Reuters article, AMZN's Prime service has 9 million subscribers. The deal shows how serious AMZN is regarding competing with players in the streaming market from NFLX to Hulu and HBO.

Other Financial News and Analysis:

Credit Suisse recently started coverage of Amazon with an outperform rating and a price target of $280. The consensus price for AMZN, according to 31 analysts covering the stock, is $277.

Amazon is a great company in the way that it has evolved from online retail to cloud computing and hardware and digital content sales. The stock is highly risky at current multiples, with a forward P/E of 101x and an EV/EBITDA of 54x. Though the quarterly revenue growth is 30%, and gross margins of 23.3% (trailing twelve months) are slightly above their 22.4% five-year average, the profit margins (trailing twelve months) are 0.69%, well below their five-year average of 2.72%. This is due to heavy spending on technology infrastructure, digital content, and setting up fulfillment centers to challenge "brick and mortar" stores further by offering same day delivery. The sales taxes in more jurisdictions will hurt the bottom line in the future, as will further content deals for streaming services. Therefore, we advise investors against buying AMZN, even after the 5% drop in price over the last month.

Source: Don't Buy Amazon: Low Margins And Expensive Valuations