Bloomberg News

Amazon’s Apple War Costs Investors $13 Billion as Net Misses

October 26, 2011

(Updates with closing share price in second paragraph.)

Oct. 26 (Bloomberg) -- Amazon.com Inc.’s escalating pursuit of Apple Inc. squeezed its profit forecast for this quarter, prompting investors to erase $13 billion from the company’s market value.

Amazon’s operations could lose $200 million in the fourth quarter as costs mount, the Seattle-based company said yesterday. The shares fell 13 percent to $198.40 at the close, the biggest decline since October 2008.

The company is taking on Apple in the market for tablet computers and sales of digital songs, books and movies. To gain an edge in tablets, Amazon is selling its new Kindle Fire device for as low as $199 -- less than half the price of Apple’s cheapest iPad. At that price, the company will lose $10 per device, research firm IHS Inc. estimates.

“Competing with Apple isn’t easy,” said Colin Sebastian, an analyst at Robert W. Baird & Co. “It comes at a cost, but the traditional media business they have would wilt on the vine without Amazon making this transition to digital.”

Last quarter’s profit also disappointed analysts, missing estimates by 42 percent -- the biggest negative surprise of any technology business in the Standard & Poor’s 500 Index

The stock had advanced 26 percent this year before today and set a record of $246.71 this month, raising pressure on Amazon to deliver stronger results.

Bezos’s Stake

Chief Executive Officer Jeff Bezos, Amazon’s founder and largest shareholder, saw his stake lose $2.5 billion in value. He reported holding 88.1 million shares as of Aug. 18.

Amazon’s operating results may range from a loss of $200 million to a profit of $250 million this quarter, the company said yesterday. Analysts were projecting a gain of $512.7 million on average, according to Bloomberg data. Sales will be $16.5 billion to $18.7 billion, Amazon said.

The last time Amazon suffered an operating loss was in the third quarter of 2001, when it fell $68.9 million into the red.

Third-quarter net income fell 73 percent to $63 million, or 14 cents a share, from $231 million, or 51 cents, a year earlier. That missed the 24 cents predicted by analysts.

Technology has fared worse than most industries this quarter in meeting investors’ earnings expectations, with about a third of companies missing estimates.

Amazon added 17 new fulfillment centers this year, and that overhead has weighed on margins, Chief Financial Officer Tom Szkutak said yesterday in a conference call. It’s also building out the infrastructure for its Web services offerings.

“We’ve added a lot of capacity to support those growth rates,” Szkutak said.

Startup Competition

In addition to competing with Apple in a range of markets, including digital music and movies, Amazon is vying with startups such as Spotify Ltd., which offer streaming songs. For now, Amazon’s growth plans aren’t doing enough to spur profit, even as sales climb, Sebastian said.

“If they don’t show a corresponding increase in earnings, investors start to scratch their heads,” the San Francisco- based analyst said.

Amazon doesn’t deserve a valuation that puts it ahead of Apple by some measures, said Colin Gillis, an analyst at BGC Partners LP. With an operating margin of 30.8 last quarter, Apple squeezes more profitability from sales, even with its own investment in new products, he said. Amazon traded at 119.5 times earnings, compared with Apple’s 14.4 times before today, according to data compiled by Bloomberg.

“Ultimately, does this deserve an ultra-premium valuation? No,” said Gillis, who rates Amazon a “sell.”

Shipping Costs

The stock’s lofty value reflects investors’ belief that Amazon’s new products will pay off down the road, said Josh Stewart, a Salt Lake City-based analyst at Wasatch Advisors Inc., which oversees about $11 billion in assets, including Amazon shares. The online retailer has historically acted more like a private company, investing for the long term and ignoring quarterly earnings, he said.

“We’ve been selling some of our investment going into the quarter because it’s had a run, and it’s a really expensive stock,” Stewart said in an interview. “We own more Apple than we do Amazon.”

Still, Amazon has had unprofitable periods before, as they built up their distribution. And that paid off, he said. “They realized how important it would be to get the scale early on.”

The company’s soaring shipping expenses also are dragging on profit, Gillis said. More customers are using Amazon’s Prime program, which offers unlimited two-day shipping for $79 a year. The company’s shipping fees generated $360 million in the third quarter, dwarfed by $918 million in shipping expenses.

Sales Gains

Even as profit shrinks, revenue is benefiting from surging Kindle orders, propelled by customers ditching paper books in favor of electronic versions. Net sales climbed 44 percent last quarter to $10.9 billion, in line with estimates.

“They could invest less and add more to cash flow today, but that’s leaving room for someone else to take market share tomorrow,” Sebastian said. “As an investor, you have to share their long-term vision.”

The company upgraded its Kindle e-readers and introduced the Kindle Fire tablet to more directly challenge Apple -- something Hewlett-Packard Co. and Research In Motion Ltd. have struggled to do. The Fire tablet, due next month, has a 7-inch display, smaller than the iPad’s 9.7-inch screen. It will run on Google Inc.’s Android software and offer Wi-Fi connectivity.

Amazon is pricing its devices to spur sales, said Kerry Rice, an analyst at Needham & Co. in San Francisco.

“They don’t care that the operating margin is 1 percent or 2 percent,” he said.

--Editors: Nick Turner, Marcus Chan

To contact the reporter on this story: Danielle Kucera in San Francisco at dkucera6@bloomberg.net

To contact the editor responsible for this story: Tom Giles at tgiles5@bloomberg.net


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