Will 'This Brick-And-Mortar' Giant Dominate Online?

Joseph is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The online merchant was, for a good amount of time, a unique entity. An entity that also enjoyed a unique and wide moat. Is this still the case, however?

It seems that the drawbridge has slowly been lowered over the former online merchant moat, and now the big "brick-and-mortar" stores are crossing the bridge. The barriers of entry for online sellers is being lowered, and now retail companies like Wal-Mart (NYSE: WMT) are beginning to digitally compete with online dominators like Amazon.com (NASDAQ: AMZN). This bridge also goes both ways, too.

From digital to physical....

As eBay (NASDAQ: EBAY) has seen its PayPal revenues drop from 32% to 18% year-over-year (according to Bloomberg), the company is looking to expand into brick-and-mortar retail. PayPal will soon be made available in over 2 million physical stores, primarily through in-store partnerships with established retailers such as RadioShack, and will offer new competition in the mobile payments field.

PayPal is aggressively looking to take out mobile payment rivals such as Square as well. Beginning in June, eBay-owned PayPal will start processing payments for free through the end of 2013 if a merchant chooses to replace its existing cash registers with one of PayPal's new point-of-sale services.

PayPal expanding into retail will give eBay access to the lucrative physical retail market-- which does about 20 times more in sales than the online world eBay is currently limited to. This also allows eBay to get into retail without directly competing with well-established retail giants like Wal-Mart, allowing the company to instead work alongside them with PayPal.

It's harder to penetrate into physical retail as an onliner by opening new stores than it is for a physical retailer to open an online store to compliment an established chain of physical stores. This seems like a smart move by eBay to slowly seep into retail, as well as provide already established merchants incentives to help them do it.

The new retail wars...

Wal-Mart is a leader in physical retail and Amazon is the clear king of online retail. But what happens when these two behemoths clash? This is happening now, as Wal-Mart is pursuing online retail to compliment its physical presence. So, will it work? 

Wal-Mart's online sales increased over 30% in its most recent quarter, as opposed to a revenue increase of about 22% for Amazon in its most recent quarter. This is a very naive, narrow-minded and short-term fact if used to exclaim "Wal-Mart is beating Amazon at its own game!", but it does show that Wal-Mart is successfully increasing revenues online (which now accounts for around 10% of total revenues).

While Amazon still had over three times as many unique visitors in March as Wal-Mart, Wal-Mart also seems to be gaining some significant ground. Also, don't forget that Wal-Mart also owns the second largest amount of online web property.

So where is the trend heading?

While Amazon has its cloud services and Kindle lines, from a pure retail sellers' perspective, Wal-Mart already has many things that may not only help it close the gap with its online competitor – but also differentiate itself. Wal-Mart's incredible physical store footprint and economies of scale are almost impossible to reproduce or compete with, and it cannot only use this to leverage against relying solely on just online sales, but it can also offer an online store that is seamlessly integrated with its physical ones. This allows Wal-Mart to provide services Amazon simply can't, such as the ability to return and exchange items bought online at physical stores. 

Amazon's online retail moat is being breached and attacked by Wal-Mart, and at the end of the day, Wal-Mart has a very good chance of possibly even overlapping the current leader. Wal-Mart is also attracting customers who are without a traditional bank account (who also can't shop online without a bank account or a credit card) with its Bluebird Program that it has launched in conjunction with American Express. 

Price wars?

Wal-Mart has for years been the global leader in being "the cheapest." If it can convert the same formula online, it may oust Amazon as the leader digitally like it did with many of its competitors physically. Amazon already has razor-thin margins and negative earnings, so how much lower can they go? Maybe Wal-Mart can stay solvent longer than Amazon can stay irrational? 

The reason I say irrational is because Amazon no longer has a near monopoly in online retail where it can continue to defend its minuscule margins in the name of expansion. Wal-Mart could easily steal away even more of Amazon's thunder over time by slowly chipping away at its online customers as well. If this happens, Amazon's only claim to online retail fame will be its "cheapness."

This may be a problem for Amazon down the road, because Wal-Mart already knows how to stay consistently profitable while being the cheapest, where Amazon hasn't proven it can yet. Plus, if Amazon loses online retail dominance, it loses a lot of its business. Wal-Mart? Not so much. It still has a massive physical retail empire to fall back on. Every online gain for Wal-Mart is just a cherry on top of its already enormous empire.

The bottom line

While Amazon is a great business and a great company for the consumer, that doesn't necessarily make it a great stock. Currently carrying a negative P/E and an extremely expensive forward P/E of over 80 times earnings, the company looks like it is being priced in the times of the dot-com era. Sure, the opportunities for growth are there with its cloud services and Kindle line, but the company's online moat isn't as secure as it used to be and I just don't see the current valuations being justified going forward. 

Wal-Mart is getting into online retail, and is attractively valued now. The retail giant trades at around 15 times earnings and sports a cheap forward P/E of only about 13. The company also carries a dividend yielding around 2.40%, which adds more safety as well. Wal-Mart is heading into the future with an increasingly digital presence in mind, and its presence may be felt further down the road in a much more powerful way than many people currently think.

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Joseph Harry owns shares of Wal-Mart Stores. The Motley Fool recommends Amazon.com and eBay. The Motley Fool owns shares of Amazon.com and eBay. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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