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Fire Scorches Amazon Stock

Fire Scorches Amazon Stock

Investors aren't demonstrating the patience that's going to be necessary to allow Amazon's Kindle Fire strategy to play out. The company's stock fell sharply on a disappointing Q3 earnings report and dire forecast for Q4. It's all part of Amazon's "spend now, profit later" plans for the new tablet, which it's selling for a song in the hope of reaping handsome profits on associated content sales in the future.

By Rob Spiegel
10/26/11 11:11 AM PT

Amazon missed expectations with its third quarter earnings report and projected a loss for the current quarter. The double-down on its Kindle Fire is at the heart of the matter. With razor-thin profits projected for the tablet, Amazon is betting it all on content sales. The market is not so sure. Amazon stock fell 20 percent after its earnings report was released Tuesday after the market closed.

The e-commerce giant reported earnings of US$63 million, or 14 cents per share, for the quarter ending Sept. 30, compared with $231 million, or 51 cents per share, in the year-ago quarter. Analysts had been hoping for 24 cents per share. Revenue climbed 44 percent to $10.9 billion for the period, indicating the slump had to do with spending, not sales.

Amazon is now projecting a possible operating loss for Q4. Profits could range from a $200 million operating loss to a $250 million operating gain.

CEO Jeff Bezos explained that profits are down because Amazon is spending money on expansion. CFO Thomas Szkutak noted in a conference call that Amazon is building 17 new fulfillment centers. Plus, a lot of cash is going into its digital business, in particular development of the Kindle Fire.

The Kindle Fire -- Amazon's answer to the iPad -- will start shipping in November. Bezos noted that advanced orders are much higher than expected, but as with past Kindle sales, Amazon did not reveal any details.

Stocking Up for the Holidays

In addition to costs associated with expanding its distribution network, Amazon will invest a sizable amount in Kindle production to meet holiday sales expectations. Part of the downward projection for the current quarter may be due to a ramp-up in Kindle Fire manufacturing based on higher-than-expected initial orders.

"There is no question that a lot of Amazon's earnings and revenue miss is because of costs associated with the new Kindles and Fire," Carl Howe, director of anywhere consumer research at the Yankee Group, told the E-Commerce Times. "It's not just development costs, but also the manufacturing costs of building up inventory for the holiday season."

The investment in Kindle Fire may take years to recover. Since the Fire doesn't provide a profit center of its own, Amazon won't see real return on the product until a massive amount of Fire-related content has been sold.

"Given that Amazon is selling these hardware devices at a loss, the return on their sales won't show up in Q4, but farther into 2012 and beyond," said Howe.

One of the problems associated with losing a little on every device and making it up in volume content sales is that a huge success at promotion can bankrupt the company.

"The more devices they sell, the more money they lose," said Howe. "Amazon is betting the company on the associated media sales for these devices. If those sales don't materialize quickly, Amazon could lose money on the devices for many years."

Amazon Makes the Bet - Apple Gets the Winnings

Amazon is entering an uphill battle in the tablet market, where Apple's dominance has been unchallenged.

"Amazon has certainly poured a lot of money into Fire, and it looks like the pot of gold at the end of the rainbow is going to be lucrative," Zeus Kerravala, principal analyst with ZK Research, told the E-Commerce Times. "Yet I'm not sure it will be there for anybody but Apple."

There were lots of MP3 players, Kerravala noted, but nobody made a dent in Apple's iPod dominance.

"To do well in the market, you not only need to do something really earth-shattering -- which I'm not sure Amazon is doing -- or you have to become the leader," said Kerravala. "Apple certainly doesn't look like it's going to give up any marketshare anytime soon."

The key Amazon may be missing is a step forward in tablet functionality. To sell massive content for the Fire, Amazon may need to take tablets to a new level.

"It doesn't look clear to me there is anything market changing about the Fire," said Kerravala. "Apple has enough of a lock on the market that application companies will build something for Apple first. So Apple becomes even stronger. It's tough now if you're a tablet company. It looks like Apple is the one that's going to get the pot of gold."

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