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Tae Kim 75
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Full time private investor. Formerly a fundamental investment analyst at several alternative asset management firms.
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  • Morgan Stanley's Amazon.com EBook Analysis Is Seriously Flawed 13 comments
    Feb 14, 2013 7:31 PM | about stocks: AMZN

    On January 6th, 2013 Morgan Stanley analyst Scott Devitt upgraded Amazon.com (NASDAQ:AMZN) to Overweight on the thesis the company would gain e-Commerce sales market-share and grow revenue by around 30% annually in the next 3 years (2013 +31.2% y/y, 2014 +30.3% y/y, 2015 +27.3% y/y).

    This bull thesis went out the window weeks later when Amazon.com reported Q4-2012 sales growth of only 22% y/y missing the average sell-side sales estimate by $1 billion with an epic 700bps ex-FX y/y sales deceleration from Q3-2012. The Morgan Stanley analyst quietly lower his sales estimate by 1/3 to around 20% y/y annual sales growth over the next 3 years after the report.

    Yesterday the same Morgan Stanley analyst came up with a new bull thesis. In a new sell-side note citing a U.S. consumer survey they did of 1108 owners of eReaders and tablets, Scott Devitt concluded the 2012 eBook market is 50% larger than they previous estimated.

    Using his assumptions of EBooks sold per hardware device tie-ratios, e-Reader/tablet hardware market growth, and market-share, his Amazon.com's eBook operating profit estimate ballooned higher 3 years out.

    Investors giddily bid up Amazon.com shares by +4.16% on Morgan Stanley's revised higher EBook market analysis. The problem is his methodology is seriously flawed.

    Morgan Stanley asked e-reader and tablet owners how many EBooks they bought per month. Then they multiplied the number by 12 and took a "finger in the air" 40% discount due to "annualizing" it and also guessing there probably is a lower International tie ratio.

    The end calculated results were 13.3 EBooks purchased per e-reader device and 6.4 EBooks purchased per tablet in the year of 2012. He then used these same ball-park tie ratios as a base case along with device growth to extrapolate EBook market-size and Amazon EBook revenue & profit over the next few years.

    If Morgan Stanley was going to annualize the EBook purchased per device number, why didn't they just ask how many EBooks each consumer bought in whole year of 2012 instead of per month? Wouldn't a consumer who actually bought 0.25 EBooks per month likely to say 1 instead of 0? Doesn't this introduce large rounding error issues? Isn't this a serious flaw?

    What's with the made-up 40% discount number which comes arbitrarily out of thin air?

    Why would tie ratios stay in the same range 13-14 Ebooks a year per e-reader device and 6-7 Ebooks a year per tablet device over the next 3 years? Wouldn't the tie ratio change as the market matures?

    Also the final tie ratios of 13.3 and 6.4 EBooks sold annually per each and every hardware device didn't pass the smell test to me either, so I did a survey of my readership.

    I actually asked the right question of how many EBooks they bought in the entire 2012 year instead of the errant per month method Morgan Stanley used. I got 85 responses for my survey. The 2012 EBooks bought per eReader device tie ratio came out to 4.8. The 2012 EBooks bought per tablet device tie ratio came out to 1.4.

    My reader base demographic is probably more affluent and more educated than the average American and E-reader/tablet owner. The tie ratios are LESS THAN HALF AND A FRACTION of Morgan Stanley's number, who used less accurate survey methodology.

    Morgan Stanley's assumptions and methodology garbage in = garbage out, just like Scott Devitt's original Amazon.com 30% annual sales growth bull thesis. Investors beware.

    Disclosure: I am short AMZN.

    Stocks: AMZN
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Comments (13)
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  • techstrategy
    , contributor
    Comments (38) | Send Message
     
    Well done...
    14 Feb 2013, 07:52 PM Reply Like
  • user 1869665
    , contributor
    Comments (79) | Send Message
     
    The way that MS did survey is obvious wrong. I know some of my friends who own e-reader and kindle fire never buy e-books. Some of them just buy 1-2 books/year.

     

    That's the way how those so-called analysts try hard to play pump and dump game. Based on the historical data, seems like MS owns large number of Amazon shares, and also has problem to sell them in short term. They try all different ways to pump it as high as possible.
    14 Feb 2013, 08:27 PM Reply Like
  • Tae Kim 75
    , contributor
    Comments (183) | Send Message
     
    Author’s reply » 59% of my readership who were tablet owners did not buy ONE EBook in 2012. 0. Zilch. Nada.

     

    For Morgan Stanley to say on average every tablet owner will buy 6-7 EBooks every year next 3-4 years is beyond reason.

     

    I know so many tablet owners that just play games, surf the web, and watch Netflix, especially for their kids.
    14 Feb 2013, 08:33 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (19165) | Send Message
     
    It's pretty obvious that the game now has reverted to just make up bullish story after bullish story, preferably with the earnings only showing years after the present time. It's the modus operandi that the pumpers found to keep on pumping the stocks they choose in spite of the present fundamentals undoing their previous estimates over and over again.

     

    It's a scam, basically.
    14 Feb 2013, 08:55 PM Reply Like
  • Tae Kim 75
    , contributor
    Comments (183) | Send Message
     
    Author’s reply » If you look at the methodology Morgan Stanley used to back up their EBook market-size is 50% larger assumption, it's pretty mind boggling. They do huge rounding error mistakes and literally just make up a number to arbitrarily discount it.

     

    Instead of simply asking, how many EBooks did you buy in 2012.

     

    Just mind-boggling.

     

    Then investors ignore the fact that every EBook data-point in the last 6 months shows drastically slowing growth. Here is a sample:

     

    1) http://nyti.ms/12PJdmj
    One big reason for the lack of fireworks is that the triumph of e-books over their physical brethren is not happening quite as fast as forecast.

     

    “The e-book market isn’t growing at the caffeinated level it was,” said Michael Norris, a Simba Information analyst who follows the publishing industry. “Even retailers like Amazon have to be wondering, how far can we go — or should we go — to make our prices lower than the other guys if it’s not helping us with market share?”

     

    Adult e-book sales through August were up 34 percent from 2011, an impressive rate of growth if you forget that sales have doubled every year for the last four years. And there have been more recent signs of a market pausing for breath.

     

    Macmillan, the only publisher that has not settled with the Justice Department, said last week as part of a statement from John Sargent, its chief executive, that “our e-book business has been softer of late, particularly for the last few weeks, even as the number of reading devices continues to grow.” His laconic conclusion: “Interesting.”

     

    2) 1/3/13: Barnes & Noble reports weak decelerating holiday e-book sales. Nook -12.6% y/y, digital content +13.1% (vs. +38% last quarter), Nook units down y/y

     

    3) Price match ebooks
    http://on.wsj.com/QZqZHS

     

    4) 2012 e-readers -36% y/y
    http://bit.ly/12PJcyN

     

    5) BKS just guided down yesterday FY13 Nook revenues (ereader+ebook sales) AGAIN after guiding down already in early January 2013. Clearing this is a sign AMZN gaining huge ebook market share and ebook market super healthy! [sarcasm] Just like how AMZN selling Kindle Fire tablets 20-25% below cost every other week last few months, another great sign of super strong e-reader/tablet sales trends for AMZN. [sarcasm]

     

    http://bit.ly/14VymWn
    http://bit.ly/12PJfue

     

    6) AMZN Media sales y/y last 4 qters (includes ebooks) Q1 +19% y/y Q2 +13% y/y Q3 +11% y/y Q4 +8% y/y. How is that trend? Any different from BKS ? Nope.
    14 Feb 2013, 09:15 PM Reply Like
  • krk
    , contributor
    Comments (823) | Send Message
     
    Isn't physical books+ebooks a zero sum market?
    I mean, don’t you think most ebook buyers would have bought a physical book anyway?

     

    At the margins the convenience of an ereader might perhaps result in a little higher consumption, but some of that consumption could be to catch up on the ton of free classic works of literature. Moreover, in a world awash with material to read, watch and listen, book reading faces headwinds anyway and I am highly skeptical that the new electronic format would result in any expansion of the market for books.

     

    Now it can be argued that ebooks are more profitable in the physical production and distribution sense, but I think on average the $$ margins are skimpier than for physical books where publishers could skim early readers with high priced hard cover editions.

     

    Also, this item in Amazon's 4Q earnings press release "“..our physical book sales experienced the lowest December growth rate in our 17 years as a book seller, up just 5%.” (while boasting about how after 5 years eBooks are now a multi-Billion dollar category and grew 70% last year) might be a "tell" of the plateauing of its physical book biz – perhaps Amazon has run out of the easier B&M bookstore roadkills, and the whole book business, like the newspaper and magazine business, might be in a secular decline.
    15 Feb 2013, 12:24 AM Reply Like
  • Weirdmage
    , contributor
    Comments (3) | Send Message
     
    I follow these Amazon news here because I'm interested in books. So while I may not know much about the financial market, I know quite a bit about the book market.

     

    According to the figures quoted by people in the book business, Amazon's market share in e-books dropped from about 60% at the end of 2011 to about 48% at the end of 2012. And some even say their market share is down to 40%. Every single statistic in the book business show Amazon's market share is dropping.

     

    As for reports on earnings for publishers, they generally show that the "huge" gain in e-books and the slow drop in paper books (, about 5% a year,) translates to revenue being about the same.(Someone who's more experienced with finance may get more out of looking at those figures than what can from the reports I read.)

     

    So yes, there is a growth in volume of e-books sold, but that doesn't necessarily translate into a growth in revenue for publishers. But for Amazon that doesn't matter much. They often sell paper books at a loss, and up to now the growth in e-books would have given them a growth in revenue.
    But now that the agency sale model for e-books is gone, Amazon will be able to discount e-books down to the price they pay publishers. Historically speaking Amazon has grown their market by taking losses their competitors can't handle. So there's every reason to believe that they will discount e-books as much as they can. And that means they will not be making money on them.

     

    The only place left for Amazon to grow earnings on e-books is on the self-published books on their Kindle platform. The only ones who know the figures there is Amazon, and they aren't telling anyone. But lately several KDP (Kindle Direct Publishing) authors have reported sharp drops in sales. And there is talk in the book business of the "self-publishing bubble" bursting in the near future.

     

    Based on what I know of the book business, I wouldn't gamble any money on Amazon making me a profit on my investment.
    15 Feb 2013, 06:30 PM Reply Like
  • Tae Kim 75
    , contributor
    Comments (183) | Send Message
     
    Author’s reply » Thanks for you comments Weirdmage,

     

    Can you provide links to any articles with the 48% and 40% Amazon EBook market-share data? Thanks.

     

    I wouldn't be so sure about Amazon price discounting. Since they gotten permission to discount EBooks again, they tried it and both Apple and Barnes & Noble instantly matched Amazon's pricing.

     

    Since then if you look at the best-selling EBooks, the pricing is almost exactly the same across Amazon, Apple, Google, and Barnes & Noble EBook stores.
    15 Feb 2013, 07:31 PM Reply Like
  • Weirdmage
    , contributor
    Comments (3) | Send Message
     
    Unfortunately I haven't bookmarked the linnk to an article on Amazon's e-book market share. (I will do that in the future. I understand you wanting hard facts. I do too.) But a google search got me this: http://bit.ly/W53j5d
    Generally speaking, what I see on Seeking Alpha about Amazon, doesn't necessarily add up to what independent figures about the book business show..
    -I'll look for more links later, and post them here. I MIGHT be spending the weekend drunk, and don't want to post something that I want stand for when sober. I have some integrity :-P
    18 Feb 2013, 08:24 AM Reply Like
  • disfiguredskating
    , contributor
    Comments (19) | Send Message
     
    None of this matters (sorry about all your work) because it is moving UP based on momentum. No news will be bad news. "AMZN employs Neo-Nazi's to force workers to work harder" will be interpreted as "imagine when they get rid of those neo-nazi thugs...more money to the bottom line! BUY BUY BUY".
    One day, it will just sell off and that will continue for several days. People will be surprised to find it down 10% or so. It will pop a little bit and from then on all pops will be sold and all news (positive or negative) will be viewed as negative.

     

    Same thing happened to AAPL except it had all the profits.
    15 Feb 2013, 10:12 AM Reply Like
  • Robert Wu
    , contributor
    Comments (62) | Send Message
     
    I have three tablets in my household. I did not but any e-book last year. My local library allow me to download some books for three weeks which is more than enough time for me.

     

    There is no question that e-books will eventually replace printed ones. But the margin will be very low. I won't be surprised if some plans like 19.99/year for unlimited download.
    15 Feb 2013, 10:42 AM Reply Like
  • maximumvalues
    , contributor
    Comments (610) | Send Message
     
    Great points. Me too... short at $273 and considering adding.
    15 Feb 2013, 01:07 PM Reply Like
  • maximumvalues
    , contributor
    Comments (610) | Send Message
     
    Added more short today at $265.50 and if you look at the weekly chart pattern it bears similarities to the chart OCT 2011 before a $60 move lower. Sitting on hands unless it makes new highs.
    15 Feb 2013, 01:43 PM Reply Like
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