Amazon.com (AMZN) is set to release a tablet computer into a strange market. The tablet industry is still clearly dominated by Apple's (AAPL) iPad, but it is also crowded by a steady stream of competitors using the Google (GOOG) Android open source operating system. While these tablets have met with little success, pricing trends and inevitable entrances from Amazon and Microsoft will continue to make the space more competitive than it appears based on historical unit sales.
Amazon Gambling With House Money
1. If reports are true, Amazon developed a new 7-inch tablet computer and they are set to show it off this Wednesday. Amazon is one of the stock market's hottest stocks right now. Their pricey valuation is largely based on the stunning revenue growth of its domestic and international online retail presence. With intensifying fears of a global slowdown, investors are increasingly desperate for sales growth and they are valuing the AMZN's stock accordingly. The stock has a trailing P/E of 101.39, a forward P/E of 71.60 and a price/sales of 2.59 despite reporting profit margins of only 2.58% in the last 12 months. This rich valuation is a major source of strength. It gives Amazon cushion from shareholder scrutiny and valuable currency for potential acquisitions. With rumored interest in Hulu, Netflix Inc (NFLX) and other high growth companies, the sky is the limit for the former book retailer.
As such, Amazon.com does not need a huge success here to maintain its stock valuation - at least not in the short-term. While NFLX's recent struggles clearly illustrate the market's quick trigger when it comes to high valuation stocks, we should remember that the heart of the AMZN valuation is centered on the fact that the company provides almost equal exposure to domestic and international markets and that its online retail presence is growing significantly faster than Internet retail as a whole. This domination and success gives AMZN leeway when it comes to developing new products like the Kindle tablet. Unlike other tablet entrants, Amazon had the freedom to wait until they had a finished product. In addition, if the product is not a success, they have the leeway to go back to the drawing board to improve the tablet for the future. Make no mistake about it, this is an enviable position and this trait makes them dangerous to Apple and other tablet makers.
Pressure Mounts for Apple Inc.
We have been and continue to be bullish of Apple's stock. The company's stock offers a rare instance where a growing market leader trades at cheap valuations. But still, all companies should be aware of investment risks and for Apple, the risks are increasingly worrisome.
1. Struggling economy could reduce demand. The computer company's products have defied the gravity of worsening consumer economics, but are we finally witnessing the end of Apple's retail exceptionalism? Recent unconfirmed reports from JP Morgan point to a 25% cut in Apple's orders to vendors. First, this story is totally unconfirmed and could very well be merely a sign of poor investigative work or maybe a transition to new vendors, but still the story raises interesting concerns. The real economy has been a struggle for other retailers, maybe Apple is suffering from the same headwinds.
2. The last couple of years have provided fond memories for Apple. During this time, companies like Research In Motion (RIMM), Hewlett Packard (HPQ) and Dell Corp (DELL) tried to sell inferior tablets for the same price as the iPad. As such, it was not a big surprise to see competitors come and go. But recent events suggest that the strategy may be changing. Hewlett-Packard created the biggest frenzy in recent consumer electronics history by liquidating its Touchpad tablets for $99 and $149, which was well below manufacturing costs. The pricing created sell-outs around the world and left people scrambling around the Internet looking for excess supply. As we highlighted in our article, Hewlett-Packard's Accidental Genius, there is a silver lining to the Touchpad's failure but also an interesting precedent for the industry. Amazon's new tablet is expected to price at $250. While it is only a 7" tablet, the pricing could still undermine the iPad and ultimately drive down Apple's profit margins.
3. Competitors continue to come out of the woodwork. Amazon's entrance into the tablet market has not been a big surprise. And to be truthful, there have been so many iPad failed iPad competitors introduced in the last two years that I don't blame Apple bulls for brushing aside the short term risks of competition. But Amazon is a serious competitor and Microsoft will be another serious and persistent competitor in the next 12 months as it begins to bear fruit from its Nokia (NOK) relationship. While previous tablets may have been rushed to the market, these two deep pocketed companies have taken their time to refine their offerings and as a result, they are last, but certainly not least.
Summary
If everything that we have heard about the upcoming Kindle tablet is true (upgraded Android front end, 7-inch touch screen, $250 price), we think AMZN will have another big product success. While its stock price upside may be somewhat limited by its already rich valuations, we think investors should also pay close attention to Apple. In addition to the Amazon tablet, Apple faces a growing number of risks.
Disclosure: I am long AAPL.
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