The Challenges Standing in Amazon’s Way

Beyond Apple's iPad and Barnes & Noble's Microsoft-backed Nook is a Japanese e-tailer that's gaining momentum

   

In Amazon’s (NASDAQ:AMZN) last earnings report, it posted net income of $130 million (28 cents per share), down 35% year over year, even as revenue increased by 34% to $13.8 billion. Much of the blame for these conflicting numbers goes to its Kindle Fire tablet. Although costly to develop and sold at a loss (sales of e-books and other content are expected to make up the difference), the $199 Kindle Fire rapidly became the best-selling Android tablet in the lead-up to Christmas 2011.

But things aren’t looking rosy for Amazon at the moment. In fact, several threats are hanging over the e-commerce giant.

Kindle Fire sales collapsed after the holiday season. The Wall Street Journal reported that Amazon moved 4.8 million Kindle Fires in Q4, 17% of the world tablet market. But in Q1, that number dropped to 700,000 — a market share of  just 4%.

Rumors won’t go away that Apple (NASDAQ:AAPL) is planning to release a smaller, cheaper iPad. Indeed, those rumblings are becoming a drumbeat. A 7-inch iPad in the $200-$250 price range could be a death blow to Amazon’s Kindle Fire, which has suffered from complaints of poor performance and an unimpressive display compared to Apple’s tablets.

While a smaller iPad was far-fetched only a year ago — because of Steve Jobs’s disdain for a smaller screen — it seems plausible now. Apple might attempt to duplicate its highly successful iPod strategy: expand to multiple form factors to dominate every market segment. Or, as the tactic is described by iMore, “leave absolutely no space for competitors.”

Before the Kindle Fire, Barnes & Noble’s (NYSE:BKS) Nook Color was the e-reader tablet of choice, moving in the neighborhood of 3 million units in 2011. After adding a more powerful Nook Tablet to the lineup, B&N announced it was spinning off its Nook business as a subsidiary, and it quickly welcomed a big investment from Microsoft (NASDAQ:MSFT), which forked over $300 million (and a commitment for an additional $305 million). The partnership resulted in the Nook business being valued at $1.7 billion — more than Barnes & Noble itself (although BKS shares spiked nearly 90% on the news). B&N has so far sold its Nook e-readers and tablets only in the U.S., but it has announced plans to go global.

Even J.K. Rowling, author of the best-selling Harry Potter books, shows a weakness in Amazon’s game plan. She kept readers anxiously waiting for digital copies of her books for years. But when she finally launched them, she thumbed her nose at Amazon, offering them for sale through her own Pottermore website.

Why was this move important? One of the best-selling and highly anticipated book series of all times isn’t available digitally through Amazon, the leading e-book store. Sure, you can shop for these books on Amazon (and even borrow them if you’re a Prime member), but to buy them, Amazon has to kick you over to Pottermore. A big-name author bypassing Amazon sets a precedent that CEO Jeff Bezos can’t be happy about.

Then there’s Rakuten, a Japanese company most Americans probably haven’t heard of. However, it’s rapidly becoming a force to be reckoned with internationally. Wired recently called Rakuten’s Kobo division “Amazon’s only global competition.” Its annual revenues are up 177% since 2007, to $4.75 billion in 2011.

Rakuten has been on a tear over the past two years, snapping up Western online retailers like Play.com, Buy.com, PriceMinister and Tradoria. Last year, it spent $315 million to buy Kobo, the e-reader/e-book seller that started out as a joint venture between Borders and Canadian book retailer Indigo. The Kobo Vox e-reader tablet goes up against Amazon’s Kindle Fire.

Rakuten just reported first-quarter results, with revenue of $1.23 billion (up 13.6%), operating profit of $214.9 million (up 13.9%) and EPS of $7.35. While those aren’t Amazon numbers — the revenue isn’t even close and neither are the profit and EPS (but in a good way) — Rakuten has been putting pieces in place to be a serious competitor to Amazon globally, and the Kobo acquisition was the capstone.

It not only sells the Kobo Vox worldwide as well as online and in U.S. stores such as Best Buy (NYSE:BBY), but the Kobo bookstore claims 2.5 million paid e-book titles. Rakuten’s expansion into Amazon Marketplace territory through retail sites like Buy.com, is helping Rakuten become more known outside of Japan.

Analysts see Amazon taking an earnings hit in 2012, down by an estimated 11%, but are much more optimistic for 2013, with expected earnings growth rates near 109%.

No single one of the factors listed represents a huge threat to Amazon on its own. But the combination of them all, at a time when the company is distracted by a prolonged battle with states over sales tax collection, amounts to a series of blows that could bruise the world’s largest online retailer.

To meet the projected earnings growth of over 100% for 2013, however, Amazon will have to cruise through each of these challenges relatively unscathed. And while it didn’t face a lot of direct rivals in the past, this year Amazon is in a staring contest with some real heavyweights, including Apple and Microsoft — with an expansion-minded Rakuten lurking in the background.

As of this writing,Brad Moon did not hold a position in any securities mentioned here.


Article printed from InvestorPlace Media, http://investorplace.com/2012/05/the-challenges-standing-in-amazons-way/.

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