Wednesday, October 25, 2006

Color on quarter: (NASDAQ:AMZN)

Several firms are commenting on (NASDAQ:AMZN) after the co announced its Q3 earnings and issued guidance:

- Bear Stearns notes revenues of $2.31B (up 24.2% YoY) was ahead of their/Street estimates of $2.26 / $2.25B. Excluding FX, revenues grew 23.1% YoY. After normalizing for Harry Potter 6 and attachment sales in 3Q05, YoY growth approached 26% YoY, driven by outperformance in the international segment, which grew the top line by 28.5% YoY to $1.05B or 26%, excluding FX. Gross margin stood at 23.8%, ahead of firm's estimate of 23.0%. Pro Forma operating income was $72M, or 3.1% margin, ahead of their estimate of 2.8%. GAAP EPS was $0.05, ahead of firm/street estimates of $0.03.

Amazon increased full year revenue guidance, the midpoint of which implies accelerating revenue growth for 2006. However, the midpoint of the Pro Forma operating income guidance of $180M-$270M for 4Q06 was 4% below firm's expectations, implying that Amazon is anticipating higher than anticipated pressure on gross margins in the quarter, offset by the decline in the growth rate of technology and content costs. Maintains Outperform.

- Deutsche Banks maintains HOLD rating on shares of Amazon after the company in their view reported in-line to slightly better 3Q results (near the top-end of previously issued guidance). Sentiment on the stock was once again meaningfully negative heading into the quarter as investors fretted about margin contraction and slowing top-line growth. However the solid quarterly performance put these concerns to rest, thereby pushing shares up 15% in after-market the firm is encouraged by the upside delivered by Amazon, they think that the stock likely gives back the overnight gains (into the mid-$30s range). Considering that firm's views for 4Q & 2007 operating profitability remain largely unchanged (save for higher revs), they think that investors wait for incremental bottom-line upside to aggressively step up in the stock.

Spending on technology and content increased 44%Y/Y to $156mn, lower than their estimate of $160mn and a slower growth rate than previous quarters of 60%+. Firm highlights that technology spend as a percent of revenue decreased from 7.1% in the last quarter to 6.8% in this quarter suggesting that Amazon is beginning to leverage its substantial investment spend and that its reinvestment in the business is nearing completion.

However, sales & marketing spend did jump to $63mn in the quarter (2.7% of sales) and represented an acceleration in Y/Y growth to 50% (vs. 25-30% in previous quarters). Deutsche does not believe this is the start of a long-term trend. Given the substantial new product roll-outs, e.g. Prime, Unbox, Web services etc. Amazon has stepped up its efforts to market these products to consumers/businesses and raise awareness.

Firm's 4Q06 revenues are now $3.8bn (up from $3.70bn), representing 28% Y/Y growth. New proforma (cash-tax) adjusted EPS is $0.49 (vs. $0.50 previously). For 2007, they now expect revenues of $12.4bn and pro forma EPS of $1.24 vs. previous Rev/EPS estimate of $11.900/$1.24. Raise Price Target to $35 (from $31).

- Goldman Sachs notes that neither 3Q2006 results nor the updated outlook changes their long-term view on growth or valuation. Results continued to highlight increasing costs of
growth with stable 23% (ex FX) yoy revenue growth but a 34% yoy decline in operating income. A 50% yoy increase in marketing (2x eBay) leaves them to question the sustainability of revenue growth if and when Amazon tapers spending to expand margins. Firm has no meaningful estimate changes but are moving to a 12-month price target of $35 versus prior year-end 2006 price target of $30.

The stock will likely be strong in the near term due to short covering, a view that margins and ROIC have bottomed, and investors trading around the positive holiday season rhetoric through Thanksgiving. Several factors could make the gains short lived: 1) a realization that AMZN lowered the previous 4Q2006 margin outlook again; 2) margins post the seasonal expansion of 4Q will decline qoq in 1Q and will likely not improve enough in 2007 without a corresponding revenue slowdown to warrant a higher valuation; and 3) competitive and secular issues continue to increase.

Maintains Neutral.

Notablecalls: Deutsche called the fade in YHOO last week. I didn't think it would work but it did. Think they will be right about AMZN too. A 15% move is a bit excessive in case of AMZN. Especially if there are still legit concerns regarding margins. Shorting AMZN is likely a money-maker.

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