Bringing Clear Focus to Amazon

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

"Worse or better?" the optometrist questions you as he adjusts the lenses you are looking through until the blurry letters start to come into focus.

As financial news writers our goal is similar to bring a company's prospects into clearer focus, as without being a high level insider there's almost no possibility that you have 20/20 vision. 

Recently at the Motley Fool there have been two contrasting editor choice columns written by Daniel Sparks and Douglas Ehrman about Amazon (NASDAQ: AMZN), both with differing opinions about the stock. I thought that I would summarize some of their arguments, as well as throw my opinion into the ring, and hopefully give you, the investor, a clearer understanding of the company.
The following points were argued:


1. Will the added sales tax Amazon is forced to collect affect growth?

For years Amazon has avoided collecting state sales taxes from their customers. This has led consumers such as myself to purchase products from Amazon which I might have just gone to the grocery store and bought previously, especially if I didn't immediately need them. Specifically I remember a time when I was purchasing Tide Pods to do my family's laundry. Walmart.com (NYSE: WMT) had the exact same price as Amazon, but would charge me taxes making it substantially more expensive. As a rational consumer, I of course purchased from Amazon.com.

To quote from Mr. Ehrman's article: "There is evidence, however, that the sales tax factor is not critical to the company’s success. In a recent interview, Topeka Capital Market’s Victor Anthony explained to Jeff Macke that there is “no material difference between revenue growth rates in markets where Amazon is taxed and not taxed.”

As I explained my own behavior above, to me this quote makes absolutely no sense! Kind of like banks in 2006 making $750,000 home loans to strawberry pickers making $14,000 a year and telling me statistically 98% of home loans are repaid. Obviously the Amazon situation is not nearly as extreme as my example, but to think that Amazon sales will be unaffected by the collection of sales tax is pure malarky. Would you lend $750,000 to somebody making $14,000 a year?? Are you, as a consumer, more or less likely to shop at a business which has lost its pricing advantage? Sometimes analysis can be that simple. If you disagree with me, feel free to explain why in the comment section below.

2. Streaming video- will it add to Amazon's bottom line?

Mr. Ehrman argues that Amazon's Prime membership, which includes free access to many streaming videos, is less expensive than Netflix (NASDAQ: NFLX), while Mr. Sparks argues that when you throw quality into the equation Netflix easily bests Amazon.

Here I believe that both optometrists have you looking through dirty lenses.

First off, Mr. Spark's is correct in one aspect, the selection of free streaming videos currently offerred by Amazon is not competitive with Netflix. When I signed up for Prime membership, I temporarily dumped my Netflix subscription as I believed it to be redundant; I was wrong. In addition to selection, Netflix is easier to navigate, and is also coming out with its own original content, the first of which was "Lillyhammer" which was surprisingly good.

That being said, Prime membership also includes free two day shipping so if you order something with Amazon you get your goods more quickly, versus paying for that privilege. Today I maintain memberships with both companies, but with Amazon beginning to collect sales tax, I would be more willing to drop my Prime membership, than my Netflix account.

3. Cloud Computing is a big winner for Amazon?

Amazon has long been deemed the 800 pound gorilla of cloud computing. Ask anyone in the tech world, and they'll sing high praises of Amazon Web Services (AWS) However, according to Mr. Sparks and Amazon's financial statements, the AWS division represents only approximately 4.2% of net sales.

Additionally, there is a flood of competition coming in from huge players like Google (NASDAQ: GOOG) Oracle (NYSE: ORCL), and Hewlett Packard who will either be offering a differentiated product, or a superior price to steal away business from Amazon. That being said, there are tons of companies out there who are saving massive amounts of money they formerly spent on their IT departments by outsourcing these needs to the big cloud players.

To quote from the NY Times, "For one, the big incumbent Silicon Valley companies, like Hewlett-Packard and Oracle, are taking cloud computing for business very seriously. They plan to go up against cloud challenges from Amazon and Google by promising better security, reliable industry standard practices, and a higher quality of services. They are selling these aspects to the top levels of the company, while Amazon and Google have succeeded by reaching to individual engineers and department heads. In other words, the incumbents are using their existing business relationships, and their knowledge of how much big business values peace of mind."

There's tremendous room for growth in this field, and even with the new competition, this should still be a big winner for Amazon with expanding sales as demand invariably increases.

Valuation

Mr. Sparks rightly points out that Amazon has a forward price to earnings ratio of 127, and that this leaves little margin for error, and that is assuming it isn't already overpriced.

Amazon does not generate a lot of free cash flow, or immediate profits, in part because CEO Jeff Bezos continually reinvests in projects he thinks will bring future revenues to add to the bottom line.

For example, Amazon no doubt invested a ton of money into producing the Kindle, and each successive generation of the product. A few weeks ago, I purchased the Kindle Fire, in part because of the free book rental which Amazon grants to customers using their Kindle, which at about $10 a pop, would within two years pay for the Kindle purchase itself.

That being said, I found the tablet a surprisingly wonderful way to read books, and have often found myself purchasing more electronic books from the company (giving the e-commission every corporation dreams of) which means that their marketing strategy is a success. Amazon has me entwined in their web.
These profits, however, are not immediately showing up, but are long term and residual, which explains to a degree the reason investors are willing to pay such a high valuation.

Bottom Line

I tend to side with Mr. Sparks- as much as I love Amazon, the company, I believe that finally being forced to collect sales taxes from consumers will have a deleterious effect on revenues, and because I don't have 20/20 vision into the valuation of the company, I have to pass and move on to greener pastures.
If anyone has a thought that will help me gain closer to 20/20 vision, feel free to comment below.


margiecfl has long positions in Google and Wal-Mart. The Motley Fool owns shares of Amazon.com, Google, Netflix, and Oracle. Motley Fool newsletter services recommend Amazon.com, 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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