Amazon's spending spree raises margin concerns

Fri Jul 25, 2014 8:56pm IST

A worker packs a box at Amazon's logistics centre in Graben near Augsburg December 16, 2013. REUTERS/Michaela Rehle/Files

A worker packs a box at Amazon's logistics centre in Graben near Augsburg December 16, 2013.

Credit: Reuters/Michaela Rehle/Files

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(Reuters) - Amazon.com Inc's heavy investment in content and technology to fight off deep-pocketed rivals is proving to be more costly than many had expected, raising fears that operating earnings will be remain under pressure indefinitely.

Amazon's shares fell 12 percent to $314.76 in early trading on Friday, wiping out about $18 billion from its market value.

At least 13 brokerages cut their price targets on the stock, by as much as $60 and to a low of $340, after the company reported a bigger-than-expected second-quarter loss on Thursday. At least two downgraded ratings to the equivalent of "hold".

Amazon is engaged in "a massive ecosystem war" with Apple Inc, Google Inc and Microsoft Corp Macquarie Research analyst Ben Schachter said.

"Within that context, it is clear that this ... is going to be expensive and will impact margins," he wrote in a note to clients.

Chinese e-commerce giant Alibaba Holdings Group Ltd [IPO-BABA.N] also looms as a threat to Amazon as it expands in the U.S. market, Schachter and others say.

Amazon is spending billions of dollars to expand its network of warehouses, build up its business in China and India, and to buy digital content to help its Prime online video service take on Netflix Inc.

Google forced Amazon to cut prices for its Amazon Web Services (AWS) cloud computing service earlier this year by offering big price cuts earlier this year.

Sharp price cuts for AWS - which also faces competition from Microsoft's Azure cloud service - hurt Amazon's revenue growth in the quarter, coming in below analysts' expectations.

Amazon's digital content store, which offers mobile and tablet apps, ebooks, music and video, competes with Apple's App Store and Google's Play store.

Google is also taking on Amazon through its Shopping Express home-delivery service.

It has been a busy year for Amazon. The company has also unveiled a subscription book service, a TV streaming-box, and the "Fire" smartphone - all of which required investment.

ANOTHER OPERATING LOSS

Amazon forecast an operating loss of $410 million-$810 million for the third quarter ending Sept. 30, a sharp increase from a loss of $25 million a year earlier.

"The primary bear case against Amazon is, and always has been, that (Chief Executive Jeff) Bezos will never ramp margins, as he will always find new investments," Schachter said.

"We have to admit that after this 3Q guidance, it is frustratingly difficult to dismiss such concerns."

Pacific Crest analyst Chad Bartley said the poor operating earnings outlook would weigh on the stock in the second half.

Amazon shares should be valued at $36.67, based on analysts' expected earnings growth rates over the next decade, according to StarMine.

"In our view, the company clearly has solid growth prospects for the foreseeable future as it invests in new businesses," BMO Capital Markets analyst Edward Williams said.

"However, heavy spending is hampering profitability in the near term, placing pressure on the margin structure."

More than 10 million Amazon shares had traded by late morning, more double the 50-day moving average.

(Reporting by Soham Chatterjee and Supantha Mukherjee in Bangalore; Editing by Savio D'Souza and Ted Kerr)

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