Analysis: Amazon's Bezos stares down Wall Street again

SAN FRANCISCO Wed Oct 26, 2011 8:30pm EDT

Amazon CEO Jeff Bezos holds up the new Kindle Fire at a news conference during the launch of Amazon's new tablets in New York, September 28, 2011. REUTERS/Shannon Stapleton

Amazon CEO Jeff Bezos holds up the new Kindle Fire at a news conference during the launch of Amazon's new tablets in New York, September 28, 2011.

Credit: Reuters/Shannon Stapleton

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SAN FRANCISCO (Reuters) - Amazon.com Inc Chief Executive Jeff Bezos is thumbing his nose at Wall Street again and some investors don't like it.

The world's largest online retailer has hovered dangerously close to the red with razor-thin margins for several quarters now, but investors have given Bezos leeway to spend on future growth, from the Kindle to its Fire tablet. Now, Wall Street wants results to justify a sky-high valuation.

Amazon warned on Tuesday that it could lose money in the fourth quarter as it spends heavily on the Fire and other projects that may not generate quick returns.

That sparked a 13 percent share-price plunge to $198.40 on Wednesday that wiped more than $2 billion off the value of Bezos's stake in the company.

"What they're willing to do is trade earnings for ever-increasing market share, but at some point you have to make a meaningful profit," said Chris Cordaro, head of Regent Atlantic Capital. "We can't be buying something at 100 times earnings. That doesn't make investment sense."

Investors say Amazon represents the latest example of Internet companies sacrificing short-term profit for long-term gain, forcing investors to trust in executives' vision.

Take Google Inc , whose co-founders Larry Page and Sergey Brin are known to distrust Wall Street. The world's largest Internet search company has a history of taking big bets that leave analysts scratching their heads -- say, their $12.5 billion acquisition of Motorola Mobility.

Bezos also takes huge bets that cost a lot upfront. But unlike Google, Amazon's valuation leaves little room for slip-ups in executing his vision.

Even after Wednesday's slump, shares of the world's largest Internet retailer trade at about 100 times forward earnings, while Google changes hands for roughly 13 times profit, according to Barclays Capital.

Bezos runs Amazon as if earnings "aren't relevant," said Jeffrey Sica, chief investment officer for Sica Wealth Management. "You run a risk, and shareholders eventually rebel against those sorts of mind-sets."

THINKING BIG

But others argue that Bezos still deserves the benefit of the doubt -- for now.

Amazon, Google and even recently hammered Netflix Inc have charismatic leaders who pursue opportunities that require major upfront capital but can generate large and predictable revenue years later, said Eric Best, chief executive of e-commerce company Mercent Corp.

Bezos had very clear leadership principles at Amazon, and one of the main ones was thinking big, said Best, who joined Amazon in 1999, working in what became the company's third-party marketplace business.

Amazon's employee handbook warned that thinking small is a self-fulfilling prophecy. It urged leaders to advocate bold directions that inspire results, according to Best.

"The challenge is when thinking big meets Wall Street reality, and the inherent short-term risk reward calculations that institutions have to make on behalf of clients," Best said.

Page and Brin were among the first technology executives to memorialize this type of approach.

"If opportunities arise that might cause us to sacrifice short term results but are in the best long term interest of our shareholders, we will take those opportunities," they wrote in their 2004 IPO filing.

"Many companies are under pressure to keep their earnings in line with analysts' forecasts," they added. "Therefore, they often accept smaller, but predictable, earnings rather than larger and more unpredictable returns. Sergey and I feel this is harmful, and we intend to steer in the opposite direction."

INVESTMENT CYCLES

Some investors like this sort of long-term approach.

"In difficult, uncertain environments, some companies do spectacularly well because they don't focus on producing specific results in the short run," said Bill Smead of Smead Capital Management. "They do what they need to do to reach their long-term goal. It's super-healthy behavior."

Amazon's own track record encourages some patience. It has gone through several heavy investment cycles that paid off: when the company developed the first Kindle e-reader, built its first substantial network of fulfillment centers, and expanded beyond books into other products.

While investors doubted the company back then, the investments produced revenue growth and then profits, according to Scot Wingo, chief executive of e-commerce software company ChannelAdvisor, who personally owns Amazon shares.

"When long-term investors see that kind of track record and feel good about the market size, competitive picture, etc., they can get behind the CEO's vision and long-term mentality," Wingo argued.

Bezos has plunged headlong into another investment cycle because he sees huge opportunities in e-commerce, Smead said.

"The smart people are focused on how much market share they can get of this wonderful action that's going to happen in the next five to 10 years," he said. "They're sacrificing market capitalization now. Who loses? The only people who lose are the momentum investors who are trying to meet short term performance targets."

LONGER LEASH

The giant valuation gap between Amazon and Google suggests Wall Street remains (mostly) willing to give Bezos a longer leash than Google's leaders, Anthony DiClemente, an analyst at Barclays Capital, said.

Richard L. Brandt, author of books on Bezos and the Google founders, said Amazon gets a higher valuation because Bezos -- despite his seeming indifference to Wall Street -- understands the industry, having worked at hedge fund firm DE Shaw before starting the online retailer in 1994.

"Bezos had a passion for just being an entrepreneur. It almost didn't matter what the business was," Brandt said. "He settled on books initially because that's where the biggest opportunity was."

In contrast, Page and Brin started Google because they were passionate about giving people access to information online, according to Brandt.

The Google founders do not like the way Wall Street works and they made that clear by running their IPO as a Dutch auction, depriving investment banks and big institutional investors their usual payday on such deals, Brandt explained.

"Wall Street has never quite forgiven them for that," Brandt added. "Wall Street just doesn't trust Larry and Sergey. They trust Bezos because he wants to make as much money as possible."

Amazon's growth opportunity may also be bigger than Google's, according to DiClemente. Google's Internet search advertising business may be maturing, the analyst said.

Amazon may generate about $50 billion in revenue this year, but some investors think the company can become the Wal-Mart of online shopping.

"Wal-Mart is eight times larger, so we're still in the early innings of that growth," DiClemente said. "That's what the growth investors are thinking. If that doesn't happen there's risk." (Editing by Edwin Chan and Richard Chang)

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