The Amazon Fire Phone, released this week, could be considered an ambitious technological achievement, with a price to match. Or perhaps it’s a glorified sales device that, in the words of one pundit, “no one will buy.”
But what if Fire Phone doesn’t really matter? Investors shouldn’t fixate on whether the Fire can take share away from Samsung or Apple. Instead, they should realize that, phone or no phone, Amazon.com Inc. is already more than “the Wal-Mart of the Internet” – and could be on its way to being Wal-Mart itself.
First, a quick review of the Fire, in case you skipped the oceans of bytes devoted to the phone’s launch on Wednesday. The phone has a sensor system that presents some things in 3-D and provides hands-free scrolling. Amazon offers free unlimited cloud-based photo backup and its live, on-screen “Mayday” help service. And its “Firefly” button allows the user to point the phone at any object and … buy it on Amazon. (This may help Amazon more than the phone’s users.)
Rather than price it as a loss leader, as it has for some versions of its Kindle e-reader, however, Amazon says it will retail for $199 to $299 (U.S.) with a two-year contract from AT&T. That’s comparable to Samsung and Apple devices that offer larger screens and greater resolutions, albeit without the Amazon features.
Analyst Robert Peck of SunTrust Robinson Humphrey Inc. suggests the Fire phone could add $2.9-billion in revenue and $550-million in gross profit in its first year. That’s not peanuts, but it’s also incremental money for a company that posted $78.1-billion in sales and $21.7-billion in gross profits in the past 12 months, according to Standard & Poor’s Capital IQ.
The problem for many potential investors is that the Fire is yet another one of Amazon’s vexing ventures that suck up cash and crush profits in the short term, all in the name of a long-term goal of dominance. Amazon’s ongoing spending has cut its cash flow below levels seen when it was just one-third the size. And net income, despite those lofty gross profits, has been nearly non-existent in recent years. Instead, the goal has been sales growth – and Amazon has met the goal.
“When we first started covering Amazon back in 1998, we debated whether Amazon could ever become the Wal-Mart of the Web,” writes analyst Mark Mahaney of RBC Dominion Securities’ U.S. arm. Now, Amazon is estimated to capture 15 per cent of global online sales, versus Wal-Mart Stores Inc.’s estimated high-single digit share of conventional retail, he says. “A more interesting debate now might be whether Amazon could ever become the next Wal-Mart.”
Mr. Mahaney acknowledges the suggestion is “radical” when comparing Amazon’s revenue with Wal-Mart’s annual sales of more than $475-billion, and Amazon’s EBITDA, or earnings before interest, taxes, depreciation and amortization, to Wal-Mart’s, which is 10 times larger.
But, Mr. Mahaney notes, Amazon went from $1.6-billion in sales in 1999 to $74-billion in 2013, just as Wal-Mart grew from $1.6-billion in sales in 1980 to $82-billion in 1994. Amazon has actually grown its gross margins more quickly over the 15-year period than Wal-Mart did. “Looked at this way, the Wal-Mart analogy for Amazon doesn’t seem too far-fetched,” he writes.
Mr. Mahaney has an “outperform” rating and $400 price target on Amazon shares. That’s 1.8 times sales and 400 times his estimate for 2014 reported earnings per share. Here’s the growth he forecasts that makes things make more sense, however: Mr. Mahaney sees Amazon continuing to add to its 20 per cent share of U.S. Internet retail as the online pie grows one percentage point each year.
Importantly, Mr. Mahaney sees Amazon returning to the 2003-to-2010 average profit margin of 6 per cent and exceeding it in the long term, thanks to scale, improved vendor terms and more third-party sales, where Amazon takes a cut for matching the buyer and seller with no responsibility for inventory or shipping.
All the attention on retail and its Wal-Mart comparison may still understate Amazon’s power, however. Morningstar analyst R.J. Hottovy says Amazon Web Services, its cloud-computing operation that provides server capacity to a wide range of customers including the U.S. government, has more than four times the computing capacity than the next 14 largest providers combined. Amazon Web Services generated $3-billion in sales in 2013, he believes, and should grow at an annual rate of 30 per cent in the near term. (He must estimate because Amazon is awful at disclosing the operating results of its various ventures.)
Mr. Hottovy also believes Amazon’s overall operating margins will rise to 5 per cent or 6 per cent by 2018. (Amazon’s operating margin was 0.9 per cent in the past 12 months.) His $400 fair value estimate, he acknowledges, “requires a leap of faith based on whether the company will be able to monetize its explosive growth.”
James Cordwell of Atlantic Equities says that contrary to the belief that investors are looking past its unprofitability, Amazon is currently being penalized by investors. Strip out Amazon Web Services – which he values at $70 per share – and Amazon actually trades at a discount to physical retailers, given Amazon’s superior growth.
“The perception that Amazon is overvalued mainly stems from its high double-digit P/E, though we believe this is an unhelpful metric to look at given the company has consistently been clear that it is reinvesting all its profits to drive future growth,” Mr. Cordwell says.
In that context, the Fire Phone is just a small part of the grand plan.
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