Amazon wins some skeptics over, shares surge

SAN FRANCISCO Fri Apr 27, 2012 3:42pm EDT

A box from Amazon.com is pictured on the porch of a house in Golden, Colorado July 23, 2008. REUTERS/Rick Wilking

A box from Amazon.com is pictured on the porch of a house in Golden, Colorado July 23, 2008.

Credit: Reuters/Rick Wilking

SAN FRANCISCO (Reuters) - Amazon.com Inc's stellar quarterly results are helping convince skeptics on Wall Street that a bout of intense spending is beginning to pay off for an Internet retailer trying to transform itself into a technology company.

Shares of Amazon leapt 16 percent on Friday, after it reported first-quarter earnings and margins late on Thursday that were well above investors' most bullish expectations. The gains tacked on some $10 billion in market value and marked its biggest single-day gain since October of 2009.

Chief Executive Jeff Bezos has tried to convince investors to stick with the company for the long term as it flirted with losses in recent quarters. He is trying to transform Amazon from an online version of a big-box retailer like Wal-Mart into a provider of technology services.

Some investors argue that its valuation of over 70 times forward earnings - dwarfing companies like Apple Inc and Google Inc that produce record profits - is justified because Amazon is on track for enormous margin expansion as it expands into more-profitable services from hosting websites to providing an online marketplace connecting buyers and sellers.

"These services will become an increasingly important part of Amazon's overall business and will be a driving force of profitability going forward," Bernstein Research analyst Carlos Kirjner wrote.

Amazon is trying to be "not a bookseller or a retailer, but a company that uses technology and (now) its scale to transform whole value chains" from retail to publishing and video distribution, Kirjner said.

Heavy spending has pressured profit margins in recent quarters, hitting the company's shares. But in the first quarter, gross margins rose by about 120 basis points to roughly 24 percent, Macquarie analyst Ben Schachter estimated.

Amazon shares rose to $227.95 in afternoon trade on the Nasdaq.

CONCEPT STOCK

Bulls argue that Amazon will grow into its rich valuation as earnings increase several-fold over three to five years. The company's ability to influence e-commerce - its "fulfillments" business is expanding rapidly and fuelling buying and selling among individuals for instance - and its burgeoning cloud-hosting business is already leading consumer Internet trends, they say.

But others remain wary about the high level of uncertainty in a fast-evolving industry. Bill Smead of Smead Capital Management owns shares of rival eBay Inc and is avoiding Amazon because the valuation is too risky for a long-term investment.

"We greatly respect what they're doing at Amazon but have virtually no interest in seeking out those risks," Smead said. "Amazon is a concept stock. The company will change our lives, therefore investors feel like pioneers buying the stock now."

Once Amazon's earnings become clearer in three to five years, investors will be able to compare it to valuations of similar companies and excitement around the shares will likely dwindle, Smead said.

"Four years ago, Apple traded at a much higher multiple," he added. "But it is earning a lot more now and that's measurable. They have the curse of being able to be valued."

David Berman of hedge fund firm Durban Capital agrees that Amazon is a "concept" stock, but owns the shares.

He is focusing on Amazon's future domination of an e-commerce market that is growing fast and taking share from traditional retailers.

"I don't have an edge in looking at the valuation of Amazon shares. What is more relevant is whether I think they will dominate more than the market currently thinks," he said. "I think they will, because rivals like Best Buy will struggle."

Apple shares are valued lower than Amazon because Apple is exposed to new rival products that could threaten its now-dominant iPads and iPhones.

"Amazon is a completely different company," Berman said. "No one can catch Amazon. There are too many barriers to entry. Amazon is going to be around forever."

Even if Apple's devices keep selling well, Amazon will benefit from that as more people use iPads and iPhones to shop online, he added.

Amazon makes its own hardware now too, but its Kindle business is not about the devices making money, Berman argued.

"It's about getting the devices out there as conduits to facilitate shopping at Amazon," Berman said. "Whether it's a Kindle or an iPad or iPhone, Amazon is happy either way."

A FLURRY

Amazon's surprise increase in first-quarter gross margins prompted a flurry of price target increases by analysts.

Faster growth at its online marketplace business and cloud unit Amazon Web Services, along with sales of digital goods, drove the improvement in margins, analysts said.

Amazon's 34 percent revenue increase to $13.18 billion also impressed Wall Street which had expected revenue of $12.9 billion, according to Thomson Reuters I/B/E/S.

"The biggest surprise in the quarter was Amazon's gross margin increase of 120 basis points year-over-year, the largest uptick in 10 years," RBC Capital Markets analyst Ross Sandler said.

During the first quarter, nine of the 10 top-selling products on Amazon.com were digital products, including Kindle e-books, movies, music and apps.

"Bulls have been waiting a long time for this gross margin upside and it finally came in the first quarter," Macquarie's Schachter said.

The company's shares had been hit by margin pressure over the past few quarters.

Schachter expects gross margins to continue to ramp up in the long term as the company benefits from the increasing use of the Internet.

Analysts at Macquarie, RBC, Citigroup and at least nine other brokerages raised their price target on the stock. Nomura upgraded it to "buy" from "neutral.

According to Thomson Reuters StarMine, 12 analysts rate the stock "strong buy," 11 a "buy," 15 a "hold" and one a "sell." Only one rates the stock "strong sell."

(Editing by Phil Berlowitz and Tim Dobbyn)

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