|
Published: June 23, 2010
In a bid to steal some thunder in the
burgeoning market for handheld electronic readers, Barnes &
Noble (NYSE: BKS) announced this week that it will cut
prices on its Nook e-reader. Bad move. Rival Amazon.com (Nasdaq:
AMZN) was waiting for such a development, and quickly
offered up its own price cuts for its Kindle 2. Falling prices
and rising market share are part of Amazon’s long-term playbook,
and many past rivals have been bloodied by trying to compete
with Amazon’s global scale.
At first blush, this is a real win for consumers. For those who
don’t want to pay the $500 to $700 for Apple’s (Nasdaq: AAPL)
iPad, the new $200 price point for the Nook and the Kindle 2
should prove enticing. These firms know that they won’t make
much money on these devices, but they do offer the chance to
build a loyal customer base for many years to come. That’s just
what Apple did with iTunes nearly a decade ago.
Of course, both Barnes & Noble and Amazon should see sales of
their readers rise at a solid clip this year, though it’s safe
to assume that Amazon will retain its hefty lead. That’s because
in several respects, Amazon’s Kindle 2 comes out ahead in terms
of usability, and if history is any guide, the company will make
sure that Barnes & Noble is always saddled with a slightly
inferior offering.
Both devices look and feel the same, but the Kindle 2 can be
used internationally, supports more formats, is opening up to
third-party application developers, and offers thousands more
book titles. Amazon recently changed its relationship with book
publishers, and will now earn roughly $2.50 for every title
sold. As many Kindle readers have noticed, this policy has
involved a mark-up to more than $10 from less than $10 for many
titles. Similar relationships are being pursued with newspaper
and magazine publishers.
To be sure, this whole segment is still less than 10% of each
firm’s revenue base. And to some extent it will cannibalize
existing book sales. But for Amazon, that’s OK. As with all of
its market development efforts, Amazon simply wants to patiently
build a very strong moat around this business, perhaps to the
point where Barnes & Noble looks to exit the market.
Seemingly Expensive
This price war comes at a time when investors have lost their
enthusiasm for Amazon. Shares have fallen -20% since late April
amid concerns that the stock looked pricey and that torrid
growth can’t be sustained. The stock may look expensive, trading
at 40 times next year’s earnings, even after the recent
pullback, but
free cash flow is actually twice as high as
net income. So shares are trading at a more reasonable 20
times that multiple.
And even as
investors fret that
Amazon is too big to
keep growing
quickly, it’s worth
noting that sales
will probably rise
another +35% this
year, and another
+25% in 2011. The
market opportunities
are hardly
saturated: Amazon
controls only 10% of
the U.S. e-commerce
market, which itself
controls a paltry
3.8% of the total
retail market.
Thanks to steady
margin gains, the
bottom line is
expected to grow at
an even faster pace.
CEO Jeff Bezos
recently ran through
a wide range of
growth drivers at
the company’s annual
meeting, including
new online
categories, further
international
expansion, and a
much more aggressive
push into cloud
computing, or the
delivery of hosted
services on demand
over the Internet.
Amazon is also
testing the waters
once again on
grocery deliveries,
which could prove to
be a large market.
All of these
initiatives may
dampen earnings in
the near-term, but
set the stage for
the next round of
margin gains once
those investments
are completed.
Amazon is sitting on
more than $6 billion
in cash, and
generating another
$3 billion in
cash flow every
year. If shares keep
falling from current
levels, management
may look to do a
first-ever share
buyback. Or perhaps
a newly-issued
dividend could
be offered. The
company has so many
organic growth
prospects that
acquisitions make
little sense at this
point.
Action to Take
--> Every
few years, investors
start to question
whether this growth
machine is running
out of gas. And
every time, the
company goes on to
develop yet more
legs to growth.
Shares are out of
favor recently,
which could make
this a good time to
pounce.
-- David Sterman
Staff Writer
StreetAuthority |
