April 28, 2014
Wall Street finally says maybe Amazon should, you know, make some money
by Dennis Johnson
Poor Amazon.com. For two decades—aka the entirety of the company’s existence—critics like me have pointed out the hard-to-believe fact that it’s never posted an annual profit. Granted, for a lot of that time there were few of us observing this. But lately, like the gobsmacked emerging from an infatuation, a growing number of people have begun to experience the first stages of an occasional, fleeting discomfort with their beloved—such as becoming aware of the weird fact that the company with the exhilaratingly high stock valuation had, uh, never made a profit. (Make no mistake, though — most of the world remained infatuated with the Seattle behemoth and increasingly talked about its growth-over-profit strategy as if it was the most logical thing in the world.)
But then last Thursday Amazon announced to its critics and the world at large that, for once, it had made some money. The company released its quarterlies and, in addition to the fact that it had grossed a jaw-dropping $19.74 billion in gross revenue, lo and behold it also had a positive net income—a profit—of $108 million dollars.
And within hours its stock had plunged and a wealth of articles had appeared announcing that Wall Street was fed up with Amazon.
Well, for one thing, there’s the fact that making $108 million off nearly $20 billion in sales is seen in some quarters as “skimpy.” That’s what a Wall Street Journal report called it. By most standards, though, that’s putting it mildly. Making $108 million net income off $20 billion dollars in revenue represents a profit margin of .05%, whereas most business shoot for an annual margin of between 5-10%.
Then there’s the fact that even that minuscule profit was fleeting. In a conference call related to the release of the quarterlies Amazon revealed that in the next quarter it expects to lose as much as four times that amount.
The media almost missed this at first—the initial New York Times report is nearly over before it notes, “And the company said it anticipated reporting an operating loss of between $55 million to $455 million … in the second quarter.”
Investors didn’t seem to get it at first, either, and right after the release of its quarterlies, Amazon’s stock actually went up a few points in after-hours trading. But by the next morning, it had begun to fall dramatically.
Here’s how a Forbes magazine report by Brian Solomon explained what happened:
Amazon’s guidance scared investors. While net sales are expected to grow between 15% and 26% compared to 2013, Amazon admitted they expect a return to the red—with an estimated operating loss between $455 million and 55 million. In last year’s second quarter, the company posted a small $79 million operating income.
Amazon has long traded at a massive multiple of its near-nonexistent earnings, but Wall Street appears to be getting tired of billionaire founder and CEO Jeff Bezos’ aversion to profits. Analysts everywhere lowered their price estimates for Amazon on Friday, including Bank of America-Merrill Lynch, J.P. Morgan, RBC, Deutsche Bank, Wells Fargo, SunTrust, and Citi.
Investors seem to agree. After the stock tipped up in after hours trading on Thursday, Amazon shares opened down on Friday morning and stayed that way. As of 11:10am EDT, shares were down nearly 10%.
A lengthy New York Times report by no less than James B. Stewart was even more damning.
Is a 20-year honeymoon coming to an end?
When it comes to suspending disbelief about a lack of profits — the only thing that ultimately matters when it comes to stock valuation—Amazon.com has been in a class of its own. Its price-to-earnings ratio, a common measure of stock valuation, has at various times topped 3,000 (the market average is about 18) — and that’s when it actually has had a profit.
Investors never seemed to care. “Over the long history of the last eight years, this stock went from $60 to $400, which made all the doubters look stupid while all the believers got rich,” said Bruce Greenwald, a professor and head of the value investing program at Columbia Business School. “The fact that Amazon did this in the face of deteriorating operating performance—slower growth in sales and the evaporation in profit margins—has made fools of the people who looked at the reality of its operations.”
That may be changing.
It’s an amazingly wide-ranging report that observes a certain special treatment for Amazon in comparison with Google—a company that’s never had trouble making money—and describes an environment where critics of Amazon are made miserable:
Until this week, downgrading Amazon—no matter what its valuation—hasn’t been a path to popularity, as Eric J. Sheridan, an Internet analyst at UBS Securities, found out in February, when he reduced Amazon to neutral from buy. “Amazon is the third rail of investing,” he told me this week. “I had hundreds of angry people calling me for days. How dare I say anything negative about Amazon?”
By contrast, investors punished Google last week after it reported strong revenue gains and billions of dollars of operating profit. “Investors won’t cut Google any slack,” Mr. Sheridan said. “I like Google. The valuation is very reasonable. The quote unquote shock, in their earnings, was that margins were a little weaker than expected. Google is spending on new initiatives. It’s just a reminder that they’re ambitious and innovative.” That’s exactly what investors have always said they loved about Amazon.
But perhaps the most piercing analysis to Amazon investors is the observation that Amazon’s growth, finally, may be slowing down:
“With Amazon you’ve had a cult investor group that believed that all that matters is revenue growth,” Mr. Sheridan said. “The problem is, in the last year and a half, the growth rate has started to slow quickly. It was 40 percent two years ago and now it’s close to 20 percent.” He said there were plenty of other Internet companies growing in the midteens to 20 percent, including Google, Priceline and eBay, and they’re much cheaper. “Reality is starting to settle in,” he said.
And Professor Greenwald noted that product sales — the core of Amazon’s business — grew by only 18 percent in the quarter, and the projections for the next quarter also suggested slower revenue growth. “And profits were a disaster,” he added.
Is it, indeed, Amazon’s live-by-the-sword, die-by-the-sword moment? Elsewhere in Stewart’s piece, a financial analyst calls Amazon representative of “our second tech bubble in 15 years,” and it seems clear many may be beginning to agree—Amazon wasn’t the only stock downgraded Friday. As a Bloomberg News story reports, investor umbrage at Amazon’s quarterlies seems to have triggered wider sell-offs, and Netflix, Twitter, Facebook and LinkedIn all dropped quickly in value, leading one analyst to echo the Stewart report in calling it a “prick in the bubble” of stocks like Amazon.
So what could it all mean? Well, don’t look for Amazon to collapse. It’s been getting away with this for 20 years, and may indeed be “too big to fail” by government standards. (Never forget how Wall Street got off the hook for 2008, nor how President Obama visited the Amazon warehouse in Chatanooga, Tennessee last summer.)
But you can’t be king forever, and what these developments may signify is, simply, the fact that Jeff Bezos can’t necessarily win for losing … forever …
Dennis Johnson is the founder of MobyLives, and the co-founder and co-publisher of Melville House.