Quick Thoughts: AMZN – Are Investors Breaking their Covenant with Jeff Bezos, and Does He Care?

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–          For years, investors have allowed AMZN to invest potential profits into new product development, new geographies, infrastructure deployment, and now content acquisition.

–          This freedom has been an enormous competitive advantage, enabling AMZN’s relentless innovation and expansion in areas like same day delivery, AWS, Prime Video, Kindle, Pantry, etc.

–          The market response to a weak 4Q13 and to guidance for losses in 2Q14 hit AMZN’s market cap by 25% and raises the question as to whether the free pass on margins has been revoked.

–          Bezos could throw investors a bone in 2Q, taking his foot off of the accelerator to deliver an upside margin surprise. The question is – does he care enough about share price to do it?

Jeff Bezos has been playing with a stacked deck. While his competitors – WalMart, Barnes and Noble, eBay, et alia – suffer from the quarterly scrutiny of their P&Ls by armies of investors with their fine toothed combs, Amazon has had no real obligation to deliver profits at all. As long as the top line continued to skip along at a brisk 20%+ growth rate, and as long as the promise of the company’s manifest destiny roll over the rest of retail appeared intact, Bezos was welcome to plow all of Amazon’s potential profits right back into the business. Billions spent building stunningly innovative warehousing facilities ever closer to population centers to facilitate wider product selection and faster deliveries. More billions spent on world class distributed cloud data centers to handle the primary e-commerce application, to run the global logistics of a company differentiated on logistics, and to equip AWS to go after hundreds of billions of dollars in global IT spending. Other billions spent developing and launching new products – like the Kindle, the Fire, Prime Instant Video, Prime Pantry, same day grocery delivery, Fire TV – while also producing and acquiring the content necessary to compete with the likes of Netflix. Still more money has been spent on breaking into new geographic markets and on yet-to-be launched ideas like an Amazon smartphone or automated delivery drones.

Most of this money flows right through Amazon’s income statement. In a lengthy piece published early last year, I calculated that Amazon’s real margins were likely in the 8-10% range (http://live.ssrllc.com/2013/01/11126/) and that the difference between that and the company’s barely breakeven performance was this massive investment. Investors seemed to accept this. In the two years between January 2014 and January 2014, Amazon delivered a net loss in 3 of the 8 quarters that it reported, yet the stock appreciated by more than 120% over that time as the company delivered nearly 27% average sales growth. After the 4Q13 report, which featured surprisingly strong net earnings, the stock took a 15% dip, largely because the top line abruptly slowed to just 20% growth.

For 1Q14, Amazon’s revenues handily beat expectations, reaccelerating to 23% YoY growth, while margins were positive and vaguely in line with consensus, yielding an in line EPS of $0.23. As per usual, guidance was wide enough to drive a fleet of trucks through, but the firm insistence that 2Q14 will bring a loss seems to have rankled investors. As I write this, Amazon shares are off more than 9%, bringing the decline since the previous conference call in February to more than 25%. For a company that has had losses in 3 of the past 8 quarters, it’s hard to see why its call for yet another one in July would be so compelling for investors. The top line story seems to be back on track – 23% growth is a meaningful recovery from the disappointment of 20% growth in 4Q13 and better than the 22% growth that Amazon had posted in the year ago quarter. The expansion story is there – Prime Video is gaining momentum and will get a further kick from the newly launched Fire TV and from new content agreements with HBO and others, Prime Pantry and Grocery are rolling out, and the rumors of an Amazon smartphone are everywhere.

My concern is that the fickle investing community may be calling Jeff Bezos’ bluff. Amazon’s behavior – random quarterly misses, massive investment, but a relentlessly strong top line – hasn’t changed from the long period when its stock did little but go up despite the howling from the valuation focused investor contingent. This weakness may be a temporary expression of the nervousness in the broader market over the past couple of months – high multiple stocks are always perceived as risky, even if the drivers of future growth and the potential for profit are rock solid. Still, this may be something more. If I were Jeff Bezos, I might look to take my foot off of the accelerator this quarter, just enough to deliver a real upside margin surprise and remind investors why they have been so interested in my stock over the many years. Then again, Jeff Bezos may not care.

For our full research notes, please visit our published research site.

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