Amazon Faces Profit Pressure: Honeymoon Over?

8 Data Centers For Cloud's Toughest Jobs

Amazon.com's sales were up 23% in its first quarter of 2014, but it seemed to be profits that its stockholders were looking for this time around. Shareholders had previously been able to ignore the fact that they were paying a premium for a stock in a company that had skimpy or no profits at all. Instead, they could point to the healthy rate of growth that Amazon kept displaying. But profitability seemed to rear its head in the stock market's reaction to this year's first quarter. Amazon's shares were down nearly 10%, or $33.32 per share, to $303.83 at the close of the first day's trading following the announcement on April 24.

Overall sales in the first quarter once again posted a big rise, to $19.74 billion from $16.07 billion in the first quarter of the year before.

But operating income decreased 19%, to $146 million, compared to $181 million in the first quarter of 2013. The first quarter's operating income would have been even lower, below $130 million, if favorable exchange rates hadn't driven money to the bottom line. Net income or profit was a modest $108 million, or 23 cents per share, compared to $82 million, or 18 cents per share the year before.

"Perhaps more unnerving was the company's forecast for next quarter: flat revenue and a loss that might be as big as $455 million," wrote James Stewart in the New York Times on April 25. The stock plunged 9.9% and he questioned whether investor patience had worn thin. "Is a 20-year honeymoon coming to an end?" he asked.

Maybe not. Amazon's stock has bounced back from reverses before because the company occupies such a strong position in both online retailing and providing cloud services. On the other hand, its stock dropped 9.5% in trading the day after it reported revenues grew 20% in 2013. That drop was from a high for the year of $403. Instead of recovering the loss, it's dropped further since that January 30 report.

After the end-of-the-year report, one Wall Street analyst, Eric Sheridan at UBS Securities, downgraded his estimate on Amazon from buy to neutral. After the first quarter report, a dozen analysts downgraded the company.

"Until this week's earnings report, they were overwhelmingly positive about the company, with 35 of 44 analysts rating the stock a strong buy or buy. Until this week, downgrading Amazon -- no matter what its valuation -- hasn't been a path to popularity," wrote Stewart.

The Amazon Web Services portion of the business is estimated to amount to $3 billion of the $3.2 billion in revenues listed as "other" for 2013. That portion of the business is growing strong and is expected to continue to grow, given Amazon's lead in the public cloud market. At the same, AWS revenues, already a small portion of Amazon.com's $24 billion total, may not show much growth at all, since Google kicked in 30% to 40% price reductions last March across several basic services, and Microsoft soon followed suit. AWS, as the self-proclaimed price leader, had to better or match those reductions.

On the other side of the coin, Amazon's $20 price increase for two-day delivery customers, its Prime constituency, hasn't driven customers away, at least not at a faster rate than it is acquiring new ones. The total Prime customer base is growing once again, reported CFO Tom Szkutak. With the price moving to $99 a year, that's one boost to revenues.

Chairman and CEO Jeff Bezos in the earnings announcement preferred to talk about all the new offerings and services being built out by Amazon. It's entered a multi-year licensing agreement with HBO for popular television series content, like The Sopranos, Deadwood, and Six Feet Under. Amazon also is testing its own same-day delivery service and creating a Prime Pantry grocery order service where customers may fill a 45-pound box and get it delivered for a flat fee of $5.99.

Instead of addressing the issue of profits, he seemed to borrow a page from the late Steve Jobs in describing how a new product was flying off the shelves. "Our device team launched Fire TV, offering great content, including our recently announced exclusive deal with HBO" through a device that plugs into a high-definition digital TV screen. "The team is working hard to keep Fire TV in stock," he added.

That will probably satisfy tried and true investors in Amazon, whose faith seems to defy the rules of gravity and to assume that Amazon profits are just out of sight over the horizon -- again. The continued stock drop, on the other hand, suggests that capital to finance expansion is getting harder to come by, and that at some point Amazon retail and Amazon cloud may have to play by rules that govern less lucky competitors, such as Microsoft and Rackspace. There's always cash-rich Google, who with price cuts in cloud services like its last one could take AWS's price-leader mantle away for longer than a few days.

Could the growing movement toward open source hardware rewrite the rules for computer and networking hardware the way Linux, Apache, and Android have for software? Also in the Open Source Hardware issue of InformationWeek: Mark Hurd explains his "once-in-a-career opportunity" at Oracle.