Amazon Investors Weigh Short-Term Turmoil Against Long-Term Promise

Amazon (AMZN) is never a boring stock. Investors routinely value it at more than 50 times earnings. The company rolls out products predicted to be costly failures -- Prime, Web Services, Kindle -- that end up being profitable and effective. It faces periods of volatility as bulls battle bears -- with the bulls typically emerging as victors.

Strangest of all, Amazon functions like two stocks. One of them is more of a speculative stock, with unusually high valuations and epic bull-bear fistfights. Amazon's stinginess with internal metrics -- the company won't disclose how many Kindles it has sold -- adds to the speculation. Investors read into the company's silence and often disagree over how to interpret it.

It was this speculative Amazon that fell as much as 10% last Friday after Amazon reported earnings after the previous day's market closed. Amazon reported that margins slipped because the company is starting to invest more heavily in its distribution centers. Since then, Amazon has recovered little of that decline. The stock closed at $173.71 Thursday, down some 6% from its price before it reported earnings.

The second Amazon is a stock that rewards the patience of long-term investors with capital gains, delivering consistent growth as it finds new ways to build onto its share of the online retail market. That's the Amazon that warned its profit margins might be weighed down in 2011 so that the company can continue to expand around the globe.

What Are Investors to Think?

Amazon has shown time and again that such investments have paid off, despite skepticism. So, many analysts are holding to the long-term view, even as jittery investors sell the stock based on one quarter's number.

But in discussing the investments it's making, Amazon offered vague explanations. Chief Financial Officer Thomas Szkutak said Amazon was adding distribution centers to increase its ability to provide fulfillment services around the globe for its own store, as well as for other retailers who use Amazon to fulfill orders. Fulfillment costs were equal to 8.2% of revenue in the recent quarter, up from 7.7% in the same quarter a year earlier.

Szkutak also said Amazon "added a lot of infrastructure capacity to support our fast-growing Amazon Web Services business." Technology and content costs, which include Web services infrastructure, increased to 3.5% of revenue from 2.8% a year earlier.

Margins, a Touchy Issue

So, while Amazon is seeing impressive revenue growth -- net revenue jumped 36% in the quarter -- operating costs are growing even faster. That caused some, like Pacific Crest analyst Steve Weinstein, to wonder why Amazon isn't gaining leverage on its investments in fulfillment and technology, even as it hints that it may continue the pace of investments for much of this year.

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Margins have long been a touchy issue with Amazon and its investors. When the company introduced its Amazon Prime service -- which offers free two-day shipping for a $79 a year fee -- it eroded margins at first. But Prime ended up deepening customer loyalty, pushing revenue growth higher in the long run.

Despite the lack of details on how Amazon plans to invest in new fulfillment facilities, shareholders seem to take Amazon's word that they're necessary to maintain revenue growth. After all, the company has a strong track record on delivering returns from investments.

But this latest round of increased investments has so far been accompanied by lower-than-expected revenue growth. Amazon posted revenue of $12.95 billion last quarter, below the $12.98 billion the Street had been expecting. And the operating profit that Amazon is forecasting for the current quarter -- between $400 million and $525 million -- is short of the $567 million analysts had been looking for.

New Enticements for Prime Subscribers

Since Amazon reported its earnings, reports have emerged suggesting yet another reason why its margins could be weighed down further and longer than many have been expecting. Amazon may be adding unlimited access to free streaming of 5,000 movies and TV shows for its Prime subscribers. Rather than offering the movies as a new revenue stream, Amazon is offering them as an enticement for subscribers to its Prime service.

That could bring in many new members to Amazon Prime, which could in turn entice more shoppers to buy goods on Amazon's site and receive free two-day shipping. If so, that could generate a much higher volume of transactions for Amazon in coming years.

But in the near-term, the streaming of all those movies could require more investments in networking infrastructure. And the addition of new Prime memberships would mean greatly increasing the discounts on shipping costs it offers to customers. Both of those could push down margins more than investors are expecting.

So expect more turmoil as bulls and bears tussle over how much these moves will weigh on Amazon's profit margins. But for those with longer-term views, it's easy to imagine Amazon continuing to expand for years.

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