Will Amazon’s Investments Pay Off in the Long Run?

Edited by Vani Rao

Heavy expenses weigh on Q2 earnings

Source: Company website
Source: Company website

Amazon.com Inc. (NASDAQ: AMZN), the world’s largest online retailer, missed analyst expectations for the second straight quarter after it posted wider-than-expected losses of $126 million in Q2, more than double of what was predicted. The loss in Q2 was the biggest since Q3 of 2012, when Amazon posted a $274 million loss. During the quarter under review, the widening of losses was mainly due to a 24% surge in expenses to $19.4 billion, even as sales climbed 23% to $19.3 billion.

While Amazon has the highest valuation in the S&P 500 Index, it has been facing the flak from investors in recent times on whether its massive investments will indeed pay off in the long run. However, CEO Jeff Bezos has firmly stuck to his game plan that huge investments are necessary to gain market share and cash in on the enormous business opportunity in new products and services. After climbing 59% in 2013, Amazon’s shares have declined 19% so far in 2014, triggering concerns about mounting expenses. After the company announced its Q2 results, its shares tumbled 9.65% to $324.01 on July 25, 2014, the most since April 25, 2014, alarming investors after many analysts downgraded the stock. The shares have further declined against the S&P Index as shown below.

Source: Bloomberg
Source: Bloomberg

Moreover, since the company is investing more funds to expand its distribution network, grocery delivery services, and launch new smartphones and tablets, profits are nowhere in the horizon as Amazon issued forecasts for wider losses in Q3.

Stuck in Investment Cycle

BC3Amazon seems to be stuck in an investment cycle that could show some results only in the long term. During Q2, Amazon took on losses by investing in new types of products and services. The company released two hardware devices the quarter, the Fire TV and Fire Phone, and launched two new services, Prime Music, for its subscription program, and Kindle Unlimited. In addition to products, Amazon also launched a new collaboration tool powered by its cloud computing unit Amazon Web Services (AWS). AWS is Amazon’s fastest growing business. Amidst the losses, Amazon’s Indian website is witnessing steady growth and is launching an average of one new category every 13 days. Amazon India now sells over 17 million products.

Among the new products launched, consumers have expressed a lot of interest in Amazon’s Fire Phone despite its limited app ecosystem. The shipments for the Fire Phone will commence on Friday, August 1, 2014. According to the company, the device is simply a way to get customers to spend more on Amazon’s services. The $199 handset lets users take a picture of a product to find and buy it on the Amazon website. Amazon expects the phone to help drive sales within its growing Prime membership due to its integration with its other services.

Will the Diversifying Strategy Work?

Bezos is spending a huge amount of funds to diversify the company’s product offerings, thereby shifting away from its core competency as an online book seller. As Amazon makes that shift, it will invariably face competition with technology giants such as Apple Inc. (NASDAQ: AAPL), Google Inc. (NASDAQ: GOOG), Microsoft Corp. (NASDAQ: MSFT), and Samsung Electronics Co.

Also, in the cloud-computing market, where Amazon rents data storage and computing power to other companies, Amazon will have to compete with stalwarts such as Google and Microsoft. It hence comes as no surprise that Amazon cut prices for its Amazon Web Services unit this year.

Lack of Transparency

While losses mount and Amazon continues with its diversification strategy, investors are clueless as to whether these investments will work in the long run. This is because Amazon does not disclose certain information and key portions of its business are absent from its financial reports. For instance, Kindle sales, including membership figures for the $99-a-year Prime program, and the profit it collects from its main online store are not disclosed to investors.

Amazon also did not provide key information on its clash with Hachette Book Group over e-book sales. Both the companies are seeking a greater share of e-book income, forcing Amazon to block pre-orders for some of Hachette’s books earlier this year, including J.K. Rowling’s new novel The Silkworm.

Facing Heat from Federal Authorities

BC4Apart from competition in e-books, Amazon is also facing the heat from a new law in France that prevents online booksellers from applying what had been a maximum 5% discount under national law to the cover book prices. Amazon can now offer only shipping discounts, but cannot offer books free.

To add to its woes, the US Federal Trade Commission (FTC) announced on Thursday, July 10, 2014, that it has filed a lawsuit against Amazon for allegedly making it easy for children to make millions of dollars of credit card purchases without parental consent while playing mobile apps like Tap Zoo, Candy Crush Saga, and Ice Age Village. The apps run on Amazon’s Kindle Fire, Kindle Fire HD, and devices that use Google’s Android operating system. FTC is seeking stricter bookkeeping and disclosure from Amazon over the next 20 years. The long-drawn legal battle and public scrutiny could harm the reputation of Amazon and cause a dent in its brand value, not to forget the millions of dollars of refunds that it is expected to pay.

Looking ahead, Amazon has projected sales of $19.7 billion to $21.5 billion for Q3. Operating losses are projected to be $810 million to $410 million.

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