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Smoking that Good Ol' Amazon Hopium

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There are many reasons to like Amazon.com (NASDAQ: AMZN) the company, but Amazon the stock is increasingly problematic, unless you are a trader.  If you are a trader and have made money buying Amazon low and selling it high, then great for you!  But if you are an investor rather than a trader, you might want to consider the recent price strength as an excellent opportunity to put in a stop-loss sell order, as Amazon may be due for a tumble.

Why?  Well, I would say that all the good news is already priced into the stock, except that there isn't any good news.  Instead, what is increasingly driving the share price of Amazon is blind hope, pure and simple.  Don't get me wrong -- I like hope; hope is a good thing, in that it is better than despair.  But is it better than realism?  Hope is a great thing for a kid going up to bat in the Little League game, but it is not a good investment strategy, nor even a strategy at all.

Strategies are based on facts.  Of course, in a normal investment situation, different people develop different strategies in relation to the exact same facts; for every rational buyer, there is a rational seller.  But in a typical investment scenario, at least the participants are looking at the same mutually-understood information.  I don't believe that is the case with Amazon.  I believe that Amazon longs are so enamored of Amazon the company that they are not being rational in regard to Amazon the stock.  Instead, they are engaging in the willful suspension of disbelief, or cognitive dissonance, the ability to believe things that are manifestly not true.

A typical Amazon bullish formulation is exemplified in this quote from an article in TheStreet:  "It [Amazon] spends money to make money."  Sounds great, only it isn't really true:  as my Foolish colleague Ser Jing Chong pointed out in this excellent article, Amazon has been investing huge amounts of money into their business over the last decade, with virtually nothing to show for it.  In fact, over the last nine years Amazon has "invested"  (thrown away?) $25 billion to increase earnings by $740 million; in other words, they have invested $33.78 for every additional dollar of earnings.  By contrast, Apple (NASDAQ: AAPL) has over the same period spent $4.23 for each additional dollar of earnings, and Google (NASDAQ: GOOG) has spent (over the last seven years) $17.20 for each additional dollar in earnings.  So, given that Amazon earned all of one penny a share last quarter, and has forecast a loss for this quarter, it is far more accurate to say that Amazon "spends money to not make money," or "spends money with the hope of making money, some money, someday."

And that is the bottom line with Amazon bulls.  They don't have earnings, so instead they have hope.  Hope of what?  Hope that, to take one example,  the new Kindle Fires will, will, will . . . will what, exactly?  Disregarding, for a moment, all the new versions of the Kindle with their different prices, consider the overall grand plan for the Kindles.  By all reports, Amazon did not make money from the prior Fire, selling them for $199, at or near cost.  Instead of making money from the hardware itself, the idea was to get the devices to as many people as possible, at or near cost, and then make money by selling physical goods from Amazon and downloadable content such as streaming video to the Fire owners.  

The ol' razor blade model -- you give them the razor at cost and then make a fortune on blades once you've got them locked into your, er, "shaving platform."  It worked for Gillette, though I'm not sure how, since they always did have competition.  But will it work for Amazon?  I don't know.  

I don't own a Kindle Fire, and I shop at Amazon all the time (I, too, am a big fan of Amazon the company.)  Quite honestly, I think that everyone by now is fully aware of Amazon, and that everyone who wants to shop there already does, whether from their Apple, their Dell, whatever.  Would the mere fact that I was holding a Kindle Fire, with ads popping up at me make me buy more stuff?  I suppose it is possible: "Oh look -- I could buy that blender for only $16.97."  But I don't know that amping up sales from compulsive shoppers really has that much upside, does it?  I don't know, and I don't think anyone else does either.  But people do have hopes that that is the case.  Will fragmenting the market into several Kindles going against several iPads and Google devices affect the overall scheme to profit from sales and content rather than hardware?  Who knows?  Not me, and not Amazon bulls, either.

Another area where Amazon bulls have high-apple-pie-in-the-sky hopes for the Kindle Fire is with respect to content sales.  Just this week Amazon investors cheered a deal Amazon signed with cable channel Epix to bring more content, such as the recent movie The Hunger Games, to Amazon's streaming video service.  This deal will strengthen Amazon's ability to compete with Netflix (NASDAQ: NFLX).  

But for myself, I have a couple of reservations about the Kindle Fire as a profit-driver.  The first of these has to do with the ultimate size of the mobile-device streaming-video market: why would anyone want to watch a movie or TV show on a 7-inch screen instead of a 70-inch screen?  If the advantage is that you can take your Kindle with you to work or school and watch TV there, then one has to assume that it won't be long until employers and schools react.  So my own opinion is that watching movies and TV on small, mobile screens will always be a niche market.  Remember Sony Watchman TVs?  No?  They had a screen roughly the size of a half a matchbook.  They didn't catch on.

Second, even assuming that watching TV while walking around turns out to be the Next Big Thing, and heaven help the American economy if it does, the idea of keeping your customers captive in your content and your device is largely an illusion.  Customers don't like being captive -- remember AOL?  Amazon's deal with Epix is non-exclusive.  So, for now, customers can watch The Hunger Games either on their Kindle Fire through the Amazon-Epix arrangement, or on their iPad, through Netflix.  The only real way to rope customers into your "ecosystem" is to have exclusive content.  This then puts you in the movie production business.  Though I can easily imagine Amazon jumping face-first into the movie business, I am not sure it would be a good idea for the bottom line; instead, it might be another way to invest billions to get millions.

Third, although Amazon investors cheer reflexively at Netflix's ongoing series of woes, Netflix's troubles may ultimately be disastrous for Amazon.  After all, if Netflix continues to struggle, they will have no choice but to sell themselves, to someone, like Apple, or Google.  Such a combination of a profitable company selling extensive Netflix content to the current Netflix subscriber base of 30.1 million customers would pose huge problems for a not-profitable company like Amazon.

My last Kindle Fire concern has to do with pricing power.  If the various versions of the Kindle are sold at or near cost, and it turns out that Amazon does not make as much money from selling content as they had anticipated, will Amazon have room to raise prices on Kindles enough to generate a profit on them?  Can a not-profitable company initiate a price war against profitable companies and then raise prices?  Wouldn't Google and Apple then gain market share?  Because if Amazon can't raise prices on their Kindles, then the whole idea of giving away the devices to create a captive customer base, could, I believe, soon be turned on its head:  if your customers are your customers only as long as you give your devices away, just who exactly is the captive?  


boriskabinov is short Amazon via long-dated puts. The Motley Fool owns shares of Apple, Amazon.com, Google, and Netflix. Motley Fool newsletter services recommend Amazon.com, Apple, Google, and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.

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