By Rob Hof What pleases customers doesn't always please investors. That's what Amazon.com (AMZN) found out in spades on Oct. 21, when the leading online retailer reported third-quarter earnings a tad below what analysts had expected. Its stock plunged more than 8% in after-hours trading, and it's still getting pounded on the 22nd. The main worry: Increased spending on free shipping and Web-site improvements -- which could keep a lid on profits next year -- may not spur enough growth to justify Amazon's $16 billion market value.
Compared with traditional retailers, Amazon is still going gangbusters. The Seattle-based company reported its fifth straight profitable quarter following years of big losses. Earnings shot up 238%, to $54 million, from a year ago on a 29% rise in sales, to $1.46 billion. And Amazon succeeded at its key goal of increasing free cash flow at a rapid rate: It jumped 76%, to $420 million.
But investors are most concerned about signs that Amazon's growth -- which got going good with a 34% jump for 2003 -- could be stalling. For next year, Amazon only slightly upped forecasts, predicting sales from $7.4 billion to $8.15 billion. That implies a slowing growth rate, ranging from about 9% to 20%. "People don't understand why this company's growth is decelerating," says David Garrity, analyst with Caris & Co.
FREE SHIPPING STAYS. It's not that analysts think anything has gone seriously awry. Amazon could be taking a conservative stance on forecasts, as it often has. Moreover, it's getting big enough that high growth becomes much tougher to maintain. Yet another factor could be rapidly increasing sales on Amazon's site by other merchants, a la eBay's (EBAY) marketplace (see BW Online, 10/21/04, "Can eBay Keep the Mojo Going?"). Non-Amazon sales reached a record 28% of units in the third quarter as unit growth grew 30%.
Since Amazon books only commissions and fees on those sales, which can replace sales of Amazon-stocked goods, that tends to depress overall sales. But the fact remains that "investors buy for growth," says Safa Rashtchy, an analyst with Piper Jaffray & Co., who has a neutral rating on the stock.
That's why Amazon is upping investment in initiatives that Chief Executive Jeff Bezos and his team hope will spur continued growth. For one, it's dead set on continuing free shipping on most orders over $25, even though that resulted in a net loss on shipping of $41 million. Bezos has said repeatedly that he's using free shipping as a marketing tool to bring in new customers and get them to buy more. He views that as more effective than TV advertising, which Amazon has no plans to do this year. Amazon also said it's testing even steeper discounts on books than the 30% off it offers on top sellers.
HAPPY SHOPPERS? Amazon is hiring hundreds of computer scientists and engineers this year to work on a number of new efforts to beef up the site. One is its new search subsidiary, A9, which recently launched its service. Another is new technology to help other merchants sell on Amazon more easily.
Even though those projects are one reason operating profits are forecast to grow more slowly than sales, Chief Financial Officer Tom Szkutak says Amazon is committed to them. Says Szkutak: "Those are things that will help our future."
Problem is, Amazon hasn't been able to explain to investors why those costly initiatives aren't yet pushing growth into high gear. Customers this holiday season may be happy that the e-tailer is spending on things that could make shopping cheaper, faster, and easier. But Amazon will have to prove that those efforts are paying off before it can persuade investors to click the buy button. Hof is BusinessWeek's Silicon Valley bureau chief