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Amazon stock jumps in wake of e-book antitrust suit

The big winner in the U.S. government's antitrust suit on e-book pricing is likely to be Inc.

Investors have pushed up the share price of the e-commerce giant by 2 per cent since the government announced its action Wednesday against Apple Inc. and five major publishers.

Consumers will likely soon see electronic versions of best-sellers again priced for $9.99, as Amazon resumes deep discounting to entrench its market leadership.

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The prospect means that the company's profit margins will continue to get squeezed, but investors are excited about the company retaining control of the market it launched in 2007 with its Kindle e-reader.

"This is a big win for Kindle owners, and we look forward to being allowed to lower prices on more Kindle books," Amazon said of the government's suit.

Amazon already controls about 60 per cent of the e-book market. But that share is down from as much as 90 per cent prior to 2010, when Apple and the publishers agreed to a new pricing system in time for the arrival of the iPad and Apple's iBookstore.

The new model, known as an agency model, replaced Amazon's ability to set its own prices with a process in which the publishers set e-book prices and retailers were paid by commission. The agreement led the Department of Justice to sue Apple as well as Hachette, HarperCollins, Macmillan, Penguin and Simon & Schuster for allegedly conspiring to fix prices.

Three of the publishers – Hachette, HarperCollins and Simon & Schuster – have already agreed to a proposed settlement, which requires that they terminate their agreements with Apple and allow Amazon and other retailers to set their own prices for e-books for two years.

Both Macmillan and Penguin insist that they have done nothing wrong and that employing the agency model is the only way to prevent Amazon from acquiring a monopoly in electronic books.

Terms of a settlement with the government were just too onerous, said John Sargent, chief executive officer of Macmillan.

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"We came to the conclusion that the terms could have allowed Amazon to recover the monopoly position it had been building before our switch to the agency model," he said in an open letter.

Meanwhile, best-selling author Scott Turow, who serves as president of the Authors Guild, called the government's terms "a shocking trip through the looking-glass," that would prove a giant obstacle to Amazon's competitors.

"By allowing Amazon to resume selling most titles at a loss, the Department of Justice will basically prevent traditional bookstores from trying to enter the e-book market, at the same time it drives trade out of those stores and into the proprietary world of the Kindle," Mr. Turow said.

It's still unclear what the long-term pricing model for e-books will be. One version could be a return to the wholesale model, in force for decades, where retailers set their own prices. Another could be a "hybrid agency model" where retailers' discounts come out of their 30 per cent commissions but cannot exceed the amount of the commission, said Shawn Milne, an analyst with Janney Montgomery Scott LLC in San Francisco.

Either way, investors clearly expect that Amazon will eventually use its market heft to boost profits. The shares trade at a sky-high price-to-earnings multiple of 140, even after getting knocked down early in the year on disappointing guidance for both profit and revenue. In comparison, Apple shares trade at a multiple of 18, which is slightly above the overall average for the S&P 500. For Amazon's stock to trade in line with Apple's valuation, the company would have to deliver at least 50 per cent earnings growth annually for the next six years.

Analysts say that with Amazon's ability to lower e-book prices again, revenue will likely rise but short-term profitability will be crimped still further as the company incurs losses on some books and hardware to gain customers.

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Part of the success of this strategy will depend on producing compelling and affordable e-readers and tablets, with the next version of Amazon's Kindle Fire multimedia device likely to arrive in the third quarter, Mr. Milne said.

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