Despite Amazon’s Margin Squeeze, Kindle & eCommerce Sales Offer Upside
Although not entirely surprising, Amazon’s (NASDAQ:AMZN) Q3 2011 results showed a significant drop in the company’s operating margins. [1] The reduction in operating income reflects the heavy costs Amazon has incurred on its hardware, namely the Kindle Fire tablet which saw a enthusiastic response at its launch in September. Amidst some jitters from investors, we expect Amazon to come out strongly as the Kindle Fire acts as a major platform for Amazon’s e-commerce and e-content segments in the coming years, providing stiff competition to Apple (NASDAQ:AAPL) in the mobile content market.
See our full analysis for Amazon’s stock here
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Margin Drop Should Not Deter Amazon
Apart from the hardware cost itself, heavy discounting and promotions that came along with the Kindle Fire also had a large role to play in significantly squeezing operating margins, which actually fell below 1% for the quarter. By providing free services such as Amazon Prime and Amazon Prime Instant Videos for a one-month duration to Kindle Fire users, Amazon is hoping to build major scale through its tablet. This could provide a significant upside to Amazon’s share in both e-commerce and e-content spaces.
Additionally, Amazon has invested heavily in expanding its e-content offerings this quarter, such as the licensing agreement between Twentieth Century Fox and and PBS. Hefty investments such as these were done to achieve the best possible content offering for the Kindle Fire, and played a part in reducing company margins.
Fortunately for Amazon, user adoption of the Kindle Fire has already gathered enough steam, with sales expected to cross 5 million in the holiday season. [2] As the tablet garners popularity and sales volume further, Amazon can be expected to ease out some of the heavy discounts it currently offers. We expect this to lead to some recovery in the company’s operating margins.
We are revising our price estimate for Amazon’s stock, which is currently around 15% above the current market price. Our estimate has stayed strong relative to the market as we believe the expected sales from merchandise and media should offset the decline in operating margin forecasts. Our price estimate has also varied based on the company’s net cash/debt position.
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