If You Invest In Amazon, You're In For A Bad Time Over The Long Term

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


Amazon looks to be in the fast lane to more growth.

Amazon cannot sustain such magical growth.

Microsoft is sneaking up on AWS.

Amazon's shares trade at around 175 times earnings.

Amazon is a house built on sand.

Contrary to popular opinion, Amazon (NASDAQ:AMZN) is not a good long-term investment. Most, if not all, analysts will disagree with the previous sentence because they're bedazzled by Amazon's growth. Nothing succeeds like success. And there's no denying Amazon has achieved success. In 2001, the company's share price was $6. Fifteen years later, it is $769 and trending upwards. If that's not enough to mesmerize you, analysts expect Amazon's revenue to grow 20% per year through 2018.

The icing on the cake, according to most analysts, is the firm's cloud-computing services, AWS, which launched in 2006. Frankly, when AWS first launched no one expected much. But AWS thumbed its nose at the doubters, taking off like a rocket. In the third quarter of 2014, AWS's revenue hit $1.17 billion. Then when 2016's third quarter rolled around, and revenue from AWS reached $3.23 billion. In other words, AWS's margin continues to increase, even while Amazon periodically cuts prices on its EC2 on-demand service.

At this point, it may well be asked how, with the growth described above, one can assert that Amazon is not a good investment play. While conceding to a certain degree of arbitrariness, I will define the criteria that in my mind raise red flags and set off warning alarms.

First, Amazon cannot sustain such magical growth. Sooner or later, the margins will even out. Right now, Amazon is gaining market share with AWS by cutting prices and constantly adding services. But when growth levels out, Amazon will be forced to operate on value. Amazon has no experience with value, which implies profitability. Heck, even at its best, Amazon is not very profitable. Its operating margin in 2015 was a meager 2.1%. Faced with the need for profitability, Amazon would probably begin raising prices to cloud-based customers. The dazzle of extraordinary growth will diminish; investors will become disaffected and look around for a more thrilling, explosive company.

Second, Microsoft (NASDAQ:MSFT) is sneaking up on AWS. The manner in which Microsoft reports revenues from its cloud services makes it difficult to know precisely where the company stands compared to AWS. Simply put, Microsoft combines the revenues from software, infrastructure and cloud into what is designated as commercial cloud. This reporting method tends to conceal what's really happening, while simultaneously bloating the numbers. But by dividing the number by twelve, we can come up with a ball park figure that is fairly accurate. For the first quarter of 2016, which concluded at the end of September, Microsoft's yearly commercial cloud revenue topped $13 billion, which breaks down to $1.083 billion, or slightly over $3 billion per quarter. During the third quarter, which also concluded at the end of September, AWS indicated revenue of $3.23 billion.

Since Microsoft's number includes SaaS revenue, it is clear that AWS remains dominant. On the other hand, the fact that Microsoft offers SaaS, along with IaaS, means Microsoft's cloud-based services have more to offer. According to GeekWire, a survey by Morgan Stanley predicted that Microsoft's Azure will dominate IaaS and PaaS by 2019, surpassing AWS.

Third, don't count out either IBM (NYSE:IBM) or Google (NASDAQ:GOOGL) (NASDAQ:GOOG). IBM is constantly adding features to OpenWhisk, the company's server-less platform for Bluemix. New features include NodeJS, Swift actions and Python. And Google just launched Android Things, which is integrated with Google Cloud Platform and Firebase. Although both IBM and Google lag behind AWS, IBM in particular appears ready to compete in the cloud arena.

Fourth, Amazon's ambition is to establish its own delivery network. If this ambition attains fruition, the impact on UPS (NYSE:UPS) and FedEx (NYSE:FDX) would be huge. However, the task of implementing such a delivery network is tantamount to the Twelve Labors of Hercules. The cost of building out the infrastructure to support Amazon's "Consume the City" directive boggles the mind. The long-term investment and expenditures needed are astonishing and ignore every precedent. Still, Amazon has a ton of cash on hand. They can afford it. But when the massive expenditures begin, Amazon's share price will pull back drastically. Any alteration, the slightest change, in the macroeconomic situation would severely punish Amazon. For example, a recession, or the impact of the highly improbable, what Nassim Taleb calls The Black Swan, would decimate Amazon. A change in tax laws would damage Amazon's tenuous hold on profitability.

Fifth, at the present juncture, Amazon's shares trade at around 175 times earnings. In other words, for a company that substitutes growth for profitability, Amazon is vastly overvalued. Still, bullish analysts have set a target price for Amazon at $1,000. Chamath Palihapitiyah asserts Amazon will eventually become a $3 trillion company.

Finally, and sufficient unto itself, I cite the examples of America Online, Yahoo, Atari, and Hitachi. Profitable, successful companies excel in two areas: they produce profit and innovate. The latter area means creating the Next Big Thing. Amazon excels in neither area. Admittedly, it scored big when it launched AWS, but the cloud already existed. And although AWS continues to grab market share, its profitability is questionable. Establishing an efficient and economical delivery network is a sensible idea, but it's nothing new. Essentially, what Amazon does is move into established sectors, spend oodles of money conquering the sector, and then moves on to the next sector, like Alexander the Great looking for new territory to vanquish. In effect, Amazon wants to rule the world. The bottom line - profit - is fugitive. Amazon has no value.

In Biblical terminology, Amazon is a house built on sand. In secular terminology, Amazon is Kim Kardashian. Kim is famous for being famous. Amazon is famous for growth, but the growth is unsustainable.

Investors should eschew Amazon, and should look for Microsoft and IBM to overtake AWS in the next few years. Amazon will go on a spending spree sooner rather than later, which will result in a pullback in share price. Once that happens, look for Amazon to fall out of favor. Over the long term, Microsoft and IBM are better investment options.

Disclosure: I/we 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.

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