Some wonder about which long-term bets will actually pay off.
With its stock up 44% to nearly $258 a share this year, Amazon AMZN is certainly in a good position and, some might still argue, undervalued. But last quarter, even as the e-commerce titan reported a 27% sales increase to $13.81 billion, up from $10.88 billion the same time last year, it suffered an operating loss of $28 million. (That was its first such loss in many years.) The company’s $175 million investment in LivingSocial is partly responsible. But the loss was also largely due to Amazon’s aggressive expansion efforts, its emphasis on sacrificing short-term profitability for long-term revenue and market share gains.
That Amazon is willing to sacrifice the short for the long — and always has been — is certainly no secret. In fact, it’s largely the reason why Fortune recently named CEO Jeff Bezos its Businessperson of the Year. Bezos, for instance, has said the latest Kindles, including the updated Kindle Fire and the self-lit Kindle Paperwhite, are sold at cost. Over the last year, the company has invested heavily in its fulfillment centers, with at least 19 more expected to be up and running by end of the year, bringing the total number to 88 worldwide.
Amazon’s strategy has investors divided:
“I think it’s not totally illegitimate for people to say ‘OK, you’re making these big investments. Is there going to be a return?’” says Tom Alberg, an Amazon board member and Managing Director of the Seattle-based Madrona Venture Group. Alberg, one of Amazon’s earliest investors, has owned shares since 1997. “But I think they [investors] are wrong if they’re thinking, ‘you’ve got to prove it to me next year.’ I don’t think Jeff would be making those investments unless they thought they would pay off. In other words, there will be customers.”
Alberg points to Amazon Web Services, or AWS, as an example, which has Netflix NFLX , Instagram FB , and NASA running partly — or in Netflix’s case, almost entirely — on it. Alberg recalls a lot of skepticism at the outset. “They embarked on a new area where everybody knew it was coming but it wasn’t clear exactly how fast it had come and what the competition would be, but the belief was that by making this investment, there would be a significant return over time.” Now, former Citi C analyst Mark Mahaney estimates AWS will see revenues surge from $1 billion in 2011 to $1.5 billion this year. Meanwhile, he expects the Kindle business to boom, more than doubling year-over-year to $13 billion in 2012.
Harold Goldstein, a portfolio manager with Nuveen Investments, an Amazon shareholder, believes the company’s heavy spending will also eventually pay off. “International margins are slightly negative, but that’s related to the infrastructure investments that Bezos and the company is making, which we think will lead to comparable success outside the United States, compared to the success they’ve had within the United States. So, we give Bezos high marks.”
Still, a more recent investor CastleArk Management, which purchased Amazon shares last year, isn’t quite as patient or as confident as either Alberg or Goldstein. “We feel he’s doing the right things, but we’re shareholders, so we want to see a return on our investment, too,” says Quentin Ostrowsky, Vice President and Senior Research Analyst with CastleArk. Ostrowsky and Castleark hope Amazon’s operating margins, which now hover between 1% and 2%, increase to anywhere between 2% and 5% beginning next year.
And while AWS may be paying off, CastleArk is less optimistic about Amazon’s push into digital content, namely initiatives like Amazon Instant Video. “The content world can be risky. Are you buying the right content? Are you spending money in the right areas?” wonders Ostrowsky. Risky, sure. But for Bezos, par for the course.