Tough Love for Amazon

Investors weren't satisfied with the online retailer's strong fourth-quarter results. What will it take to please Wall Street?
Jeff Bezos Paul Hawthorne/Getty Images

There was little Amazon (AMZN) could say on Jan. 30 to allay investors' concerns about the economic slowdown and its possible impact on the company's results in 2008.

It certainly wasn't enough that the online retailer posted fourth-quarter results that exceeded analysts' expectations. Profit more than doubled, to $207 million, as sales rose 42%, to $5.67 billion, beating the consensus Wall Street forecast by $300 million. Full-year profit surged 150%, to $476 million, on $14.84 billion in sales.

Nor did it help that Amazon expects sales of $18.75 billion to $19.75 billion in 2008, better than the $18.25 billion average estimate of analysts.

Pinched Profit Margins

Instead, Wall Street focused with laser-like precision on Amazon's forecast for operating income of $785 million to $985 million. Analysts were calling for more than $1 billion. "They have to cleanly guide up [for 2008] or the stock is going to go down," says American Technology Research analyst Tim Boyd, who has a "sell" rating on the stock. Down it went, tumbling 12%, to $65.29, in extended trading.

This, despite reassurances from company executives who say they see little sign of a slowdown in consumer spending on their site. On a conference call discussing the results, Amazon Chief Financial Officer Tom Szkutak said that shopping activity on the site was strong. "In terms of the economy, what we are seeing is that our business is doing fine," he said.

The concern is that Amazon's lower-than-anticipated profit guidance indicates the company is sacrificing profits to fuel shopping activity. Citigroup (C) analyst Mark Mahaney summed it up like this in a Jan. 30 research note: "Revenue results and outlook outstanding. Margin results and outlook disappointing." Amazon offers buyers free shipping on everything they purchase for an annual fee of $79. The program, known as Amazon Prime, has brought more shoppers to the site, says Amazon CEO Jeff Bezos. But it puts pressure on Amazon's profit margins. Outbound shipping costs for the fourth quarter were $449 million, up 42% from the prior year.

Free shipping is one of the ways that Amazon offers lower prices than competitors. "Lowering prices is easy," Bezos said during the call. "Being able to afford to lower prices is difficult, and we have been working on that for many many years now, and we expect to continue to work on it for our entire corporate existence."

Quick Start for Kindle

Despite the margin pressure, Amazon offered reasons that 2008 could turn out better than expected. International sales, which are shielded from the slowdown hitting the U.S. economy, grew 45%, to $2.6 billion, in the fourth quarter. "We are pleased with what we see there," said Bezos of the international business. However, in part because of free shipping, international sales bring in less profit for Amazon than its North American business, which grew a more modest 40%, to $3.1 billion.

Amazon executives also said they're pleased with demand for the company's recently debuted electronic reader, (BusinessWeek.com, 11/19/07) the Kindle. Though it did not break out sales numbers, the company said it's struggling to fill all the orders in a timely fashion. "The Kindle is outpacing our expectations, which is something that we are very grateful for," Bezos said. "We are super excited by the very strong demand."

Amazon also has seen some success with its digital media business, which as of this month became the first online music store (BusinessWeek.com, 01/04/08) to carry songs from all four major music labels free of the copyright protection software that limits what consumers can do with digital music. Analysts speculate that the service is currently operating at a loss to grab customers. In the future, however, the company could turn the service into a needed profit source, capable of countering softening demand for CDs. "The bulk of the sales today are in the physical world," said Bezos. "But our relative advantage over time should improve."

Amazon will need that improvement if it wants to please investors antsy for another stellar year.