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Tuesday, October 15th, 2019

Amazon's falling profit just makes it more dangerous

by July 28, 2017 General

 There should be no collective sigh of relief from Australia’s retail and video streaming companies in response to news that Amazon’s earnings came in below market expectations.

Rather, they should be feeling a shiver of fear.

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Amazon CEO becomes world’s richest man

Jeff Bezos, president and CEO of Amazon has dethroned Bill Gates as the world’s richest man after Amazon stock jumped in value.

Amazon is reinvesting the cash from its massive revenue-generating machine into getting even bigger.

World domination doesn’t come cheap.

Indeed the fact that Amazon is even suggesting that its third-quarter operating income (from July to September) could fall into negative territory by up to $US400 million ($502 million) is even scarier.

Amazon’s founder, Jeff Bezos, could easily have turned the second-quarter result into a far bigger profit. He chose not to.

Operating income decreased 51 per cent to $US628 million in the second quarter, compared with operating income of $US1.3 billion in the second quarter of 2016.

But more importantly, revenue in the second quarter increased by a massive 25 per cent – easily above what Wall Street experts were expecting.

Interestingly, Amazon’s web services business accounted for a larger profit than the whole company and, of even greater significance, Amazon’s international retail operations are losing money.

Harvey Norman’s Gerry Harvey might think that’s good for Australian retail but this is probably wishful thinking.

The fact that Amazon is happy to sustain short and even medium-term losses in this division to plough money into it says a lot about Bezos’ longer-term aspirations.

Australians still don’t know exactly when Amazon will arrive here and how much of the market it will steal from existing retail operators and streaming services like Stan or Foxtel.

Bezos never promised that earnings would be anything less than volatile.

But the latest results from Amazon (which incidentally doesn’t mention Australia in its commentary) suggest that the US giant is undertaking a leg-up in its investment binge.

Bezos is spending billions to grab revenue and market share.

Sure it’s a result that hasn’t pleased plenty of investors hoping earnings would really start to move up steeply.

The shares fell 3 per cent after the second-quarter result and expectations for the third quarter were released.

But realistically those who have bought into Amazon should not be expecting it to sing from the same operational and strategic song sheet as most established companies, which, with smaller or limited growth prospects, hand most of their profits back to shareholders rather than reinvest them in the business.

They operate on shorter-term horizons, maximising short to medium-term prospects, and always keep a very close eye on shareholder expectations to enhance dividends.

Take Telstra, a company that likes to be tagged a technology stock. In a recent interview, its recently installed chairman, John Mullen, mused: “It’s fascinating that the potential competitors of the future, not the traditional Optus or Vodafone but more likely the Amazons of the world, don’t pay a dividend.

“They reinvest their ever-growing cash flow into cheaper and better products to gain market share.

“I think there’s going to be a growing divide between some of the older, established companies and the newer companies, not just because of technology but also because of the new investor models.”

He went on the say that “if Telstra didn’t pay dividends for 10 years, we would have a $50 billion war chest to take on the new competitors”.

He then woke from that lapse into dreamworld.

Those who invest in Amazon need to put traditional investment fundamentals like earnings per share and price-earnings multiples to the side and put their trust in the Bezos dream.

(And those who have done so over the past decade have made a very handsome return on their investment. Ten years ago, investors could pick up Amazon shares at $US69. Today, they are trading north of $US1000.

And here is just a taste of what Amazon has done with its cash over the past quarter, according to Bezos.

“In the last few months, we launched Echo Show (our newest Echo device with a video screen), introduced calling and messaging via Alexa on all Echo devices, debuted Inside Edgeon Prime Video (the first of 18 Indian Original Series), introduced Amazon Channels in both the UK and Germany, launched four new Fire tablets, expanded Amazon Fresh to Germany, launched Prime Now in Singapore, launched our 25th airplane (drone) with Prime Air, hired more than 30,000 new employees, opened three new Amazon Books stores, launched more than 400 significant AWS features and services, migrated more than 7000 databases using AWS Database Migration Service, and held our third annual Prime Day – signing up more Prime members than ever before. It’s energising to invent on behalf of customers, and we continue to see many high-quality opportunities to invest.”

But even if you don’t subscribe to the Bezos world plan, investors do appreciate the havoc that Amazon has caused for traditional competitors, be it in retail or video.

Bezos never promised that earnings would be anything less than volatile. The latest result suggests he is immune to the expectations of the market and is happy to run his own race.