Amazon.com, One Year Later

Oct.26.12 | About: Amazon.com, Inc. (AMZN)

My very first Seeking Alpha article was on Amazon.com (NASDAQ:AMZN). What prompted me to write that article was the constant misinformation being fed to investors through the media, regarding Amazon.com's prospects.

In that article, I made a prediction which could only turn out correct if, indeed, what was being said and predicted officially was bogus. That prediction was that contrary to existing estimates which spoke of never ending growth in profits, Amazon.com would actually show losses - perhaps as soon as Q1 2012. It took Amazon.com 2 more quarters to make my prediction come true.

Again, there are many reasons why Amazon.com's "we are investing for the future" thesis is not true and does not answer for most of the margin compression. This is so because:
 

  • Most investments are capitalized and expensed over time against the operation of the assets, so if the assets are profitable they increase profits, don't decrease them;
  • Amazon.com has been using that thesis for more than 2 years now, the assets that Amazon.com invested in have long been put to use and would be producing profits by now, if they really were profitable. Amazon.com's increase in revenues makes this a certainty;
  • Amazon.com shows most margin weakness in its international operations, yet makes most investment in the U.S. (namely because the Kindle and AWS are mostly U.S. businesses, and most fulfillment expansion takes place in the U.S.). So margins are not imploding where the investments are being made, so the thesis is bogus;
  • Wal-Mart (NYSE:WMT) is supposed to be a much more capital-intensive business than Amazon.com, and it went through an investment and growth phase just like Amazon.com. Yet, it never showed any margin weakness of the sort being experienced by Amazon.com. Indeed, it would be hard to find a profitable growth business which went through such a margin implosion "on account of investing in the future".

My own thesis

Amazon.com is showing margin weakness because it's acting in an intrinsically low-margin environment. Online retail makes it extremely easy to compare prices, so retailers are forced to compete on price. Yet at the same time online retail imposes costs which don't exist for bricks and mortar, namely the picking and packing of orders and its shipment/delivery. Most customers consider those costs if they're charged for them, but don't consider their own costs when travelling to a store to make a purchase.

There are many clues to this being so. It's not a coincidence that the two largest generalist mail order houses - the Sears Catalog and Montgomery Ward - ended up folding when going against bricks and mortar retailers such as Wal-Mart. These businesses were 90% like Amazon.com - they had a catalog from which people picked items to be delivered by mail. Sure, Amazon.com's catalog is larger, might imply slightly lower costs (no printing and distribution, though much higher technology costs) and can offer customer feedback. But intrinsically it's about the same thing: An electronic catalog and delivery by mail.

Those businesses were low margin because of the associated delivery costs and Amazon.com shares those costs, so it's proving to be low margin as well. Amazon.com does seem to have an high-margin business in books and e-books, which it dominated early, but it shares no such domination over anything else, and whatever profits it makes from media, are now being eaten up in other parts of the business. I do believe third party sales are also profitable where Amazon.com doesn't service them - there the business is similar to Ebay's (NASDAQ:EBAY) in that Amazon.com is just a dematerialized intermediary.

In short, right now Amazon.com is intrinsically a low margin and high-capex business. It's certainly not worth the huge premium that's been put on it, and the stock will end up reflecting its nature by imploding by 50%-80% at some point.

LivingSocial

A small reminder for those excluding LivingSocial's charges from Amazon.com's earnings, turning the horrid -$0.60 print into an horrid -$0.23 print: where were these people when, in Q1 2012, Amazon.com included a one-off totally artificial gain in LivingSocial?

Full Year 2012

Amazon.com reported $0.28 on Q1 2012, $0.01 on Q2 2012, -$0.60 on Q3 2012 and guided towards $0.15-$0.25 - let's say $0.20 - for Q4 2012. Adding all this up we come to -$0.11. There's a very real chance that Amazon.com might end up losing money for all of 2012!! We've long talked about how Amazon.com was trading at a 300-350 2012 P/E. Well, now there's the chance that this P/E is heading towards infinity.

Also, although Amazon.com has put a lot of companies out of business, at this point it would seem it's putting itself out of business as well.

Conclusion

Amazon.com is unique in that no other large capitalization stock has ever been given so many passes and excuses while its earnings took this kind of implosion. It continues to trade on faith that down the road there are significant profits to be had, but meanwhile it's more than clear that Amazon.com is acting on a low-margin environment that permits no such illusory profits.

Amazon.com stock will end up falling 50%-80% as reality reasserts itself. This prediction is as probable as Amazon.com showing losses at some point was certain.

Disclosure: I am short AMZN. 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.