In a bid to steal some thunder in the burgeoning market for
handheld electronic readers,
Barnes & Noble (NYSE:
announced this week that it will cut prices on its Nook e-reader.
Bad move. Rival
was waiting for such a development, and quickly offered up its own
price cuts for its Kindle 2. Falling prices and rising
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
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
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
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.
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
. So shares are trading at a more reasonable 20 times that
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
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
Amazon is sitting on more than $6 billion in cash, and generating
another $3 billion in
every year. If shares keep falling from current levels, management
may look to do a first-ever share buyback. Or perhaps a
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
Disclosure: David Sterman does not own shares of any security
mentioned in this article.