Amazon Plunges as E-Commerce Optimism Washes Away

The way investors have reacted to Amazon.com's (AMZN) shares lately, you'd think the online bookseller was mugging little kids for those Harry Potter books rather then FedExing them free.

A passel of bad news, including the departure of President and COO Joe Galli, a host of downgrades by some of its breathier sell-side fans and a disappointing earnings report, has taken most of the blame for the 26% flensing of Amazon shares this week. (TheStreet.com explored those issues in a story Wednesday.) But beyond the so-called logic of the selloff lie some less quantifiable, largely emotional, factors. And just as outsize hope drove the stock in its glorious heyday, now deep, dark fear appears ready to drive Amazon along a trail of tears.

Coming to Grips

First off, there's the fear that the company will never make money. Its second-quarter loss, counting the losses associated with investments in companies like Pets.com (IPET) and Drugstore.com (DSCM), widened to $317 million, or 91 cents a share, from $138 million, or 43 cents, a year ago. (Excluding those losses, Amazon's loss widened to 33 cents a share from 26 cents, about 2 cents better than analysts had expected.)

The great hope for Amazon is that by achieving massive enough scale -- getting enough sales, that is -- and operating with a theoretically lighter fixed-cost base than a traditional retailer, at some point extra sales will flow to the bottom line in the form of profits. But in the second quarter, sales edged up less than 1% from the previous quarter. At $578 million, revenue did not meet the company's internal growth targets, CEO Jeff Bezos told analysts and investors on the postearnings conference call Wednesday.

Sinking Feeling Investors abandoning Amazon shares

Source: BigCharts

With top-line growth slowing, many investors threw up their hands, realizing they really didn't have the slightest clue about the prospects of the business they'd invested in. "It's a classic case of 'the emperor has no clothes,'" says Jim Volk, co-director of institutional trading at D.A. Davidson. "People have been wishing this company would do better because it has such a big market cap, and now they're coming out of the closet and saying 'all right, it can't make money, let's finally admit that we have a problem.'"

Time to Go

This kind of fear is exacerbated by the market conditions, which have little regard for valuation and much regard for momentum and sector rotation. "The truth of this whole crazy market is that if hemlines are high, everyone has to have a miniskirt," says one exasperated money manager who was short Amazon but covered Thursday. "Tomorrow, who knows what it will be, but we've gotta go get that."

Amazon surfed to glory on the e-tailing boom, but now that momentum players have abandoned it for investments in Net infrastructure and optical fiber companies, investors are left holding an increasingly leaky bag. The revenue number and Galli's departure don't signify a real valuation change, opines the money manager, but merely an excuse to get out of the stock. (P.S. -- the money manager still thinks the shares are "obscenely overvalued.")

No Mr. Nice Guy

And while fear explains some of the reaction to Amazon's shares, there's some loathing there too. The company is not exactly known for opening up its Excel files to analysts and investors, and its reticence -- some say arrogance -- is now becoming a factor in the market. One could sense the frustration of sell-side analysts on the conference call as they asked management for guidance on longer-term growth targets and were politely denied. (In a previous story, TSC's Ian McDonald explored the exodus of growth funds from Amazon shares.)

A bunch of those sell-side analysts downgraded Amazon shares Thursday on the heels of the Galli departure and the earnings report. Notably, Merrill Lynch's Henry Blodget, who owes his current job to a wildly bullish call on Amazon shares back when he was at CIBC Oppenheimer, cut estimates and lowered his rating to accumulate from buy on Thursday morning, citing lost confidence in the company's long-term growth rate and his ability to project future cash earnings.

Of course, Blodget and other analysts were far more willing to accept Amazon's unwillingness to give guidance about growth or profitability when the stock was rallying. Now that things don't look so great, suddenly the absence of that data makes it impossible to put together a reliable model.

But the fact is that Amazon shares have never moved because of anything found in an analyst's or investor's model. They rallied on the fear of being left out of the e-commerce gold rush or fear of being yelled at by clients for missing same. Now they're falling on the fear of being the last one holding shares in a company that lost 91 cents per share last quarter and that everyone seems to be feeling nasty about.

The debate about whether the emperor has clothes or not isn't likely to be settled soon. While Amazon is moving toward profitability, it's a long way from achieving it. Until its progress is more clearly delineated, its stock will continue to swing -- for better or worse -- on the winds of emotion.

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