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February 1, 2007
Updated: Adventures in Amazon Margins
Since first (!) achieving profitability back in 2002 online retailer Amazon's gross margins have mostly gone one direction: down. It's been a bumpy and unpleasant ride, with just-announced margins the lowest full-year figures since the company's fiscal 2001. Operating income margins have fared a little better, but not much.
So, what's going on? It's a combination of things, including, at the gross level, a change in sales mix (media is down from 67% to 63%, while electronics is up to 38%), with low-margin electronics increasingly replacing higher-margins books and other such stuff. At the operating margin line it's the preceding mix change, plus aggressive spending on new initiatives ranging from Unbox, to S3 and EC2.
Put plainly, Amazon has been promising for a decade it would eventually find scale and become obscenely profitable, and that has never happened. Instead, the company has been spending heavily since inception on technology and content, and that spending accelerated in 2006, and shows little sign of materially abating in 2007.
As I've been saying for some time, this is going to be a tough year for Amazon. It is multiple companies in one -- an online retailer, an analytics company, a web services firm, etc. -- and other longer it tries to be all things (it is up to 38 categories in retail alone) the more likely it becomes that the eventual disentanglement of all these overlapping commitments becomes unpleasant to all concerned.
[Update] Mark Mahaney at Citi puts a nice point on the issue as he reiterates his Sell -- it's all about negative leverage on a 50 P/E stock:
This HAS TO HAVE BEEN A THESIS CHANGER for AMZN Bulls. After an '06 investment year, the Bull argument was that leverage would be material in '07. The debate was the level of margin expansion. But AMZN's '07 midpoint guidance implies 20 bps of margin DECLINE. Put another way, AMZN's '07 guidance includes the possibility of a decline in absolute profits vs. 2005 despite a 50%+ increase in revenue. This is NEGATIVE LEVERAGE. This can't support a stock trading at a 50X P/E.In other words, Amazon is heading back towards losing money on every sale, while trying to make it up on volume. That is always entertaining to watch, but rarely tends to turn out well in the real world.
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I had to scan thru twice, and then search in Firefox to make sure I wasn't mis-reading, but Paul, aren't you MISSING something from this post? I mean a whole buncha Amazon analysis without any mention of your favorite scenario!? (At least Dave McClure squeezes in a reference)
Let me remind you folks that there are profits, and then there are "actual profits." I'm not so sure Amazon has EVER been actually profitable.
The company was the poster child for Pro Forma accounting. Then they moved to GAAP -- sort of. They excluded a host of items such as stock-based compensation, goodwill, restructuring charges and one-time gains. I haven't torn apart their balance sheet in years, as it was an exercise in futility. I have no idea what is and isn't included, off-balance sheet, etc.
What actually IS impressive to me is sales of $3.78 billion for the Q4 -- thats a helluva big number for them. Even if it is electronics and low margin food.
Dave's right; AMZN may be worth more to another player -- I vote for Target -- and if its an all stock deal, it makes even more sense.
I just thought I'd add that the stock has doubled since your long-standing negative views on Amazon were proven true in February #:^)
Actually, I'm just kidding; I'd written then off too, but mainly for lack of knowledge; Amazon is arguably more secretive than Google, and we really just don't know much about their business until they reveal it.
I know, I know. I'll cheerfully admit I utterly fucked this call. Flexible fellow that I am, I stopped being bearish on the stock, but nevertheless, a bad call.
More importantly, why did I get it wrong? In a word, my AMZN view was too stuck in the past. I couldn't see that while margins had slid, Amazon's capital spending was slowing sufficient such that the company was finally become a profitable retailer. Sure, blame secrecy at Amazon, but nevertheless, a bad bearish call on my part.
Live and learn.
wonder if/when jeff decides he'd rather just be running the incubator part of the biz (EC2, S3, etc), and might entertain either a succession plan or buyout offer for the main biz?
gotta think AMZN assets are substantially more valuable to EBAY or MSFT (or Walmart) than to themselves.
my read is that jeff is a geek at heart, a really smart guy, tho perhaps a victim of ADD (like many of us ;). guessing he'd rather play at innovation again instead of focusing on optimizing for increasing margins.
pure speculation, but if the shoe fits...
- dave mcclure
http://500hats.typepad.com/