The End of the Amazon Era?
James is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Well, it was a good run while it lasted, but as we know, nothing lasts forever. Amazon.com, Inc. (NASDAQ: AMZN) -- the long-time king of e-commerce -- may have finally jumped the shark.
That's not to say it's a bad company. It's a fine company. But, when earnings start to trend lower despite sales growth pushing the top line to record levels, the blind eye we've been turning to a triple-digit P/E ratio all of a sudden gets opened, and investors start to get understandably nervous.
The red flag from Amazon isn't being waved by last quarter's top line either. Indeed, the company rocked in Q4, turning in revenue of $17.4 billion this year versus only $12.9 billion for the same quarter a year earlier. Nor is the red flag the shrinking bottom line -- despite the record-breaking fourth quarter revenue, net income fell from $416 million in Q4-2010 to $177 million last quarter. If it were something we could chalk up to unusual or one-time expenses, again, it would almost be forgettable. That's also not what this is though.
The red flag is simply that we've seen year-over-year earnings dwindling for nearly a year now, and 2012's per-share total income isn't expected to be any better than last year's. In fact, it's expected to be worse, falling from $1.37 to $1.31. To be fair, some pros are looking for per-share income to bounce back to $2.74 in 2013 after the Kindle Fire starts to generate digital content traction, but there's nothing about the current trend that says it's in the cards.
Bluntly though, even falling profits are forgivable. You don't have to like it -- and probably don't -- but it's forgivable; that's just the nature of competition.
The part that's most troubling: Amazon.com hasn't actually done anything wrong per se, yet has started to pay the price in earnings all the same.
The addition of on-demand movie rentals to compete with Netflix (NASDAQ: NFLX) was the right thing. The unveiling of its Kindle Fire to compete with Apple and other tablet makers was the right thing. Diving neck-deep into digital media (e-books) was the right thing. At this point though, it's pretty clear that those initiatives have cost more than they've helped, and there's not exactly a clear end in sight to the outlays.
That's not just me saying that either; the numbers on the chart below are saying that. For the first time in years, trailing-twelve month earnings are falling. And I don't mean they fell once -- they've been falling since the middle of 2011. It's a simple case of Amazon needing to spend more and more just to stay competitive.
Sure, to some extent we have to be a little tolerant of earnings volatility because the development of things like the Kindle Fire isn't free, and the migration from printed books to digital books is a profit-margin crapshoot. But how long does Amazon need to take losses on Kindles until its digital ecosystem is self-sustaining?
Yes, Amazon knows it's giving away the Kindle Fire for its cost, but is willing to do so hoping it will more than make up for it with sales of e-books and other digital content. So, it's not really an illogical bet in that light. At this stage of the game though, it's not a slam-dunk either. Indeed, it's a bet Amazon can't afford to lose.... the proverbial "all in." And considering Netflix already lost its similar bet due to its lack of consumer pricing power with digital content, one would think Amazon would be treading lightly.
The debacle Netflix suffered last fall wasn't a big secret; the stock fell from $295 to $66 per share after the company announced a pricing plan revamp that was essentially a price hike. Investors feared consumers would balk and cancel their subscriptions, and sure enough, they did.
The heart of the issue, however, wasn't Netflix trying to be difficult or greedy. It was simply looking to pass along rising costs to consumers in a way that (1) didn't scare its customers off, and (2) left some room for net margins.... quite a tight-rope in the highly competitive digital content world. The revamped pricing structure could be considered more of a failure than a success, given the outcome. The lesson Amazon (hopefully) learned from the Netflix fiasco is that the more successful it becomes with digital content, the bigger the piece of pie digital content suppliers like Starz, Disney, and Fox expect to reap for themselves.
In other words, Amazon may face the same margins crimp Netflix did, at least when it comes to video.
Either way, I can't help but wonder if what's really going on with the numbers is something bigger than just development costs and expansion spending. Perhaps we've finally reached the point where Amazon can't fruitfully out-size and out-spend the competition. If that's the case -- and I think it may well be -- then Amazon.com has a lot of philosophical thinking to do about how it's going to stay ahead of its growing competition. In the meantime, net margins are under fire.
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