Amazon margins raise concern

LOS ANGELES Tue Oct 23, 2007 6:55pm EDT

A worker collects products for shipment to customers at the Amazon.com warehouse facility in New Castle, Delaware, November 24, 2006. Amazon posted a sharp rise in third-quarter net profit on Tuesday, helped by robust domestic and international sales and the latest Harry Potter book. REUTERS/Tim Shaffer

A worker collects products for shipment to customers at the Amazon.com warehouse facility in New Castle, Delaware, November 24, 2006. Amazon posted a sharp rise in third-quarter net profit on Tuesday, helped by robust domestic and international sales and the latest Harry Potter book.

Credit: Reuters/Tim Shaffer

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LOS ANGELES (Reuters) - Amazon.com Inc reported on Tuesday a drop in profit margins from the previous quarter, unpleasantly surprising investors betting on continued improvement at the world's largest Web retailer, and its shares fell 9 percent.

Third-quarter results topped Wall Street average targets, and the company forecast fourth-quarter revenue ahead of many analysts' views, but that was not enough to satisfy investors who have pushed the shares up to a valuation far beyond peers.

"The stock is down because there was some speculation that Amazon would blow the quarter away and it came in 1 cent above consensus. It certainly took a little bit of the sizzle out," said Robert Toomey, an analyst with E.K. Riley Advisors.

Amazon shares dropped to $91.49 after a frenzy of trading before the bell pushed them up more than 10 percent to $100.82 on Nasdaq -- its first close above the $100 mark since 2000.

"It is still trading at twice Google's multiple on 2008 estimates," said Global Crown Capital analyst Martin Pyykkonen, referring to the after-hours share price.

"That's priced to perfection and you're not getting perfection here," he added, pointing to a decline in operating profit margin to 3.8 percent of global sales from 4.0 percent in the previous quarter.

Despite recent bullish sentiment, some on Wall Street had warned that recent gains in Amazon's operating profit margin were not sustainable, and that more periods of investment spending, which tend to depress margins, were inevitable.

Amazon, after delighting investors with impressive results in the first two quarters, said third-quarter net income more than quadrupled to $80 million, or 19 cents per share, from $19 million, or 5 cents per share, a year earlier.

Revenue, boosted by the latest Harry Potter book and double-digit growth both at home and abroad, rose 41 percent to $3.26 billion. Excluding "Harry Potter and the Deathly Hallows," sales rose 35 percent, Chief Financial Officer Tom Szkutak said.

The results beat average Wall Street estimates of 18 cents per share in profit on $3.13 billion in revenue, according to Reuters Estimates.

The popular Harry Potter book, which was heavily discounted, had a negative effect on gross margins in the quarter, which fell to 23.4 percent of worldwide sales from 23.8 percent a year ago and 24.3 percent in the prior quarter.

Operating income rose to $123 million from $40 million, above Amazon's own forecast for $75 million to $110 million.

For the fourth quarter, Seattle-based Amazon said it expects net sales of $5.1 billion to $5.45 billion, with operating income of $221 million to $291 million.

Analysts, on average, have been expecting fourth-quarter net sales of $5.14 billion, according to Reuters Estimates.

MORE SALES FROM OTHER SELLERS

Amazon, the second-most-popular e-commerce site, behind auctioneer eBay Inc, has pared the rate of its spending growth in 2007, improving margins and boosting profit while lifting its share price by 136 percent since January 3.

But many analysts deem Amazon fully valued -- its price-earnings ratio is far higher than Internet companies and retail rivals. Amazon had been trading at 59 times projected forward-looking earnings, compared with eBay at 22 times, and Wal-Mart Stores Inc at 13 times forecast 2008 profit.

Still, investors see as positive the greater percentage of sales by other parties selling through Amazon.com -- which rose to 32 percent of total units sold in the third quarter from 30 percent a year before. Under this higher-margin model, Amazon takes a transaction commission from the sellers while avoiding inventory and fulfillment issues.

Asked on a conference call with analysts whether 2008 would be a year of margin expansion, Szkutak declined to give an outlook but said analysts should keep in mind that "our base is bigger and so we can afford to invest with this higher base."

In the third quarter, for example, technology and content spending rose 22 percent, slightly above the 20 percent growth seen in the second quarter, but far below the 42 percent growth seen a year earlier.

(Additional reporting by Daisuke Wakabayashi in Seattle)

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