Amazon Tosses More Cash into the Fire
Demitri is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Amazon (NASDAQ: AMZN) CEO Jeff Bezos wants you to know that his company "is a for-profit business." That the leader of the biggest online seller in the world -- which booked nearly $50 billion in sales last year -- felt he needed to make that statement in the wake of the company's latest spending spree speaks volumes.
For a firmly established, powerhouse of a business that grew sales 40 plus percent in each of the last two years, profitability shouldn't even be a question. But is Amazon really operating like a for-profit business? Given the company's recent history, it sure doesn't look like it.
Amazon's costs have gobbled up an ever larger percentage of profits over the last three years. The company appears to be turning the classic business strategy -- lose money when you're young, and then expand margins -- on its head. Amazon's getting less profitable over time.
You can best see this trend by looking at Amazon's costs as a percentage of sales. The difference from 100% is the company's operating margin. For comparison, Wal-Mart's (NYSE: WMT) operating costs clocked in at a steady 94% of sales each of the last three years, providing a comfortable 6% margin. Not so for Amazon:
Source: SEC Filings. Note: The y-axis begins at 75% to illustrate the expansion of non-COS costs.
Amazon's costs have grown from 95% of net sales in 2009 to 98% last year, leaving an operating income that's just 2 percentage points shy of that crucial break-even line. But more worrying than that is the composition of those costs. Amazon hasn't been losing profitability because its products are getting more expensive. This isn't a case of inflation impacting the whole industry. Instead, it's Amazon's discretionary costs, like shipping offers and tech/content spending, that are pushing the company towards an operating loss.
That's what makes last week's two announcements, that the company is plowing head first into the streaming market and the tablet market, so important to investors. Both moves promise to accelerate this worrying cost trend, perhaps by even tipping Amazon's operating income into negative territory in the coming years.
First, Amazon announced a big content deal with movie studio Epix, bringing the fight directly to Netflix (NASDAQ: NFLX) in the streaming wars. Bezos didn't pretend that this move would be cheap. He told All Things Digital that the company is "investing hundreds of millions of dollars in Prime Instant Video. It’s very expensive."
Very expensive indeed. Netflix has pegged the requisite investment at around $2 billion in annual content spending for anyone that wants to be a serious contender in its market. Amazon doesn't have anywhere near $2 billion in operating income to spare, and this Epix deal will take even more of those chips off the table.
But Amazon wasn't done spending. After announcing the Epix deal the company unveiled its new Kindle and Fire tablet lineup. And what really shocked the tech world were the price tags on those devices. Amazon's tablet offerings are now priced cheaper than many Apple iPad models and Google Nexus 7 tablets while offering the same, or better, functionality. Just how did Amazon manage to profitably beat these strong competitors on price?
The short answer is that it didn't. Bezos said in the same interview that "we don’t want to lose a lot of money on the device." The goal, then, isn't to make money on the tablets and e-readers, but to avoid losing "a lot" of money on them. The hope is that tablet sales and new Prime memberships power growth in the company's physical sales while igniting new sales of e-books and other digital content.
But for now, Amazon is quickly burning through its operating income, and last week's announcements signal that the trend will continue. Maybe extra revenue from digital content sales will justify Amazon's new hardware costs. And maybe a boost in Prime memberships will outweigh the costs of providing expensive streaming content for no extra charge. Even so, Amazon's profitability is an open question, despite what management says.
SigmaSwan owns shares of Apple and Netflix. 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.
