Higher spending on new technology has been doing a number on Amazon.com's profit in recent quarters. But the company -- and its investors -- may be seeing the light at the end of the tunnel. Amazon executives said on Apr. 25 that spending growth on new tech and content initiatives will slow considerably later this year. "It's going to be substantially lower in the second half," Amazon Chief Financial Officer Tom Szkutak said on conference calls with the press and analysts.
The remarks are also a hint that the online retailer's new digital media and other tech-driven services may soon find their way onto users' screens -- and help Amazon's bottom line. Music and film industry sources believe Amazon (AMZN) will unveil a music store and possibly a digital video service of some kind as early as this summer. And it has been quietly rolling out other high-profit-margin services, such as a pay-as-you-go data storage service for other Web companies that use idle space on Amazon's existing computer systems.
ENDING A CYCLE. News that spending growth will slacken cheered some investors whose patience had been wearing thin. "Over the next three quarters, we're going to see what they've been spending all this money on," says Allison K. Thacker, co-portfolio manager of the RS Investment Age Fund, which holds Amazon shares. "I'm really excited that they see an end to this perpetual cycle of tech investments."
That wasn't the only good news. Amazon's first-quarter profit met analysts' expectations. And it reported that sales rose 20%, to $2.3 billion, from a year ago, a pace that beat the fourth-quarter 17% sales increase -- indicating that customers like what they're seeing.
As a result, Amazon's stock rose about 1% in extended trading. While hardly a barn burner, it was a noticeable improvement from the fourth-quarter report in February, when the stock fell 10% (see BW Online, 3/3/06, "Amazon's Costly Bells and Whistles"). Since the start of the year, Amazon's stock had fallen 25%, to $35.55 on Apr. 25 just before the earnings report.
TOY TROUBLE. All that said, Amazon's move to ease off the pedal on tech spending won't translate immediately to profits. Amazon's first-quarter net income fell 35%, to $51 million, thanks to the impact of stock-option expensing as well as free-shipping promotions and continuing tech spending.
There's also a big wild card to consider: a court case between Amazon and Toys 'R' Us. Each side claims the other failed to live up to all the terms of Amazon's agreement to run Toys' Web site. A recent decision in the dispute could end the long-standing deal. Amazon said it will appeal, but noted that a defeat could whack $50 million off operating income.
And for now, Amazon's tech investments continue to drag on profits. First-quarter tech spending rose 59%, to $146 million. Some investors worry that as rivals such as Google (GOOG) and eBay (EBAY) keeping upping their tech spending, Amazon may be forced to keep pace, reducing profits for the foreseeable future.
LEADING THE WAY. . Indeed, the list of Amazon's investments keeps growing. Chief among them is an ongoing buildup of technologies for planned digital media services, the timing of which Amazon still won't reveal. It's also spending big bucks on its A9 search site. And the company is investing heavily to develop so-called Web services that help merchants and others tap into its massive e-commerce systems so they can sell products and services on Amazon.com or their own Web sites.
In addition, Amazon continues to toss out innovative new services aimed at improving the customer experience. For instance, it recently debuted ProductWikis, group-editable pages on which customers can comment on products. Finally, it is constantly applying new technologies to its own distribution operations to improve their efficiency.
Arguably, there's a potentially broader benefit to all this spending. Traditionally, Amazon has pioneered a number of technologies that others come to adopt, improving the experiences for customers overall. Amazon innovations such as reader reviews of products and its online wish lists, for instance, have become staple features for many leading online retailers.
CUSTOMER FAVORITE. But those features didn't yield an immediate payoff for Amazon, or at least not one that Amazon was willing to document in detail. Yet it's reasonably clear the initiatives have helped maintain Amazon as the gold standard for online commerce, and kept shoppers coming.
So it's no surprise that Amazon Chief Executive Jeff Bezos appears unapologetic about the need to keep investing. "Amazon has always spent more heavily on technology than its retail competitors," says Ken Cassar, an analyst with Nielsen/NetRatings. "It has been a real differentiator for the company."
Even as Amazon taps the brakes on tech-spending growth, the benefit may not be applied to the bottom line anytime soon. Amazon traditionally plows most of the benefits of its technology spending right back into the business. Case in point: It continues to offer free shipping on most orders of $25 and up, as well as its Amazon Prime program, which offers free two-day shipping on most orders, for $79 a year. Bezos noted that program has been popular, with subscriptions doubling from last November to December.
THE SHIPPING NEWS. But the incentives don't come cheap: Amazon said shipping losses were $68 million in the quarter, up 22% from a year ago. And all indications are that Amazon will continue those free- and reduced-price shipping offers. Partly as a result, Amazon said, operating income this year could range from $390 million, or a drop of 10%, to as much as $520 million, which would translate to a 20% gain.
Not bad -- but it may take more than that to get investors interested in buying again. "It doesn't feed the bear case," says Scott Devitt, an analyst with Stifel, Nicolaus & Co. "But it also doesn't make you want to run out and buy the stock."
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