Story corrected to note the RidgeWorth Large Cap Growth Fund has $425 million in assets under management, not $100 million as originally reported.
is prepared to lose $50 on every Kindle Fire sold as the company attempts to undercut the
Amazon hasn't revealed how much it costs to produce each
, but Piper Jaffray analyst Gene Munster pins the cost at about $250 per unit, above the $199 selling price. For investors in a company that has held gross margins constant around 22% since 2006, this seems like one fire they would like to put out.
Amazon Kindle Fire
"While we are not changing estimates until more data surfaces on the Kindle Fire product cost, we point out that our assumed 2.5 million unit number for December with a $50 loss per device could result in a 10% to 20% downside to
earnings per share for the quarter," Munster wrote in a research note released Wednesday. By comparison, Munster estimates that Apple enjoys a 30% gross margin, as it costs approximately $350 to produce a $499 iPad 2.
Amazon shares have rallied 30% this year as the broader market, measured by the
, has tumbled 8%. Even though net income fell in the second quarter from a year earlier, due to an increase in costs as Amazon expands its business, revenue surged 50%. Gross margins over the trailing 12 months average 22.5%. With all of this momentum, why would Amazon jeopardize profit margins simply to beat Apple in the tablet market?
The short answer is "ecosystem," something Apple has excelled at. The long answer is that Amazon is willing to sell the Kindle Fire at a loss because of the potential to keep users thanks to its app store, memberships to its Amazon Prime and Amazon Cloud services, and purchases of digital content. Much like Apple, Amazon is hoping to keep consumers on its devices by making it too expensive to switch to another platform.
Mutual fund managers who own Amazon shares, including Michael Sansoterra of the
RidgeWorth Large Cap Growth Fund
, argue that Amazon's move into the tablet space makes sense when the Kindle Fire is viewed not as an iPad killer it has been hyped as, but instead as a lower-cost alternative with a similar ecosystem as the Apple iTunes and app stores.
"Apple has done one of the best jobs taking what is traditionally a hardware business, which ultimately gets commoditized, and turning it into a service business by selling digital content," says Sansoterra. "Amazon is doing the same thing and they have the potential to have the same success." The $425 million RidgeWorth Large Cap Growth Fund counts both Apple and Amazon as holdings in the portfolio.
To be successful, though, Amazon doesn't need to displace Apple in the tablet market and have the Kindle Fire become the mythical iPad killer that tablets before it, like the
Galaxy or the
Research In Motion
PlayBook, were touted to be. Instead, Amazon needs only to expand its user base and then get people to spend more on everything from movies to music to shoes. Sansoterra makes the analogy that Amazon is selling disposable razors.
"Amazon is saying they can sell the handle of the razor blade at a reasonable price or take a slight loss because they expect to sell a lot of razor blades down the road," Sansoterra. "We can see a slight gross margin hit, as long as they're getting more users and downloading more content. They'll make it up. It's hard to judge yet, but it looks intriguing enough and it could be successful."
Bryan Keane, co-portfolio manager of the
Alpine Global Consumer Growth Fund
, is also a believer in Amazon's long-term prospects. He notes that if Amazon is indeed willing to sell the Kindle Fire at a loss, it's not surprising considering how the company frequently sacrifices near-term wins for long-term success.
"From an investment perspective, we've seen that Amazon is willing to look more long-term than short-term," Keane says. "We've seen them reinitiate investments in the business and forgo profits in the near term. And so far, that really has paid off. I think people should look at this as more of a longer-term thing."
Through all the hype of the Kindle Fire, the ultimate question for investors is whether Amazon is the stock to buy now. If the hypothesis is correct and the Kindle Fire has the halo effect Apple has enjoyed for years now, this could be a critical moment to invest in the company. But if the Kindle Fire flops like the
TouchPad, investors will second-guess Amazon's decisions from here on out.
"From a longer-term perspective, the growth needs to continue to be there. If you think the growth will continue to be there, you would have to buy the shares today," Keane says. "The investment case for Amazon is that more things are moving online. Amazon offers solid competitive pricing and they continue to add new businesses and evolve. The Kindle Fire announcement is an extension of all the reasons to own Amazon prior to today."
"We own Amazon because we like it and we think it will continue to exceed investor expectations," Sansoterra says. "I don't expect anything to go perfectly, but Amazon continues to do the things that no other retailer can do. It's beyond selling stuff online. It's a very similar approach to Apple's approach. Of all the companies that can make a run for it, Amazon is the one best suited."
-- Written by Robert Holmes in Boston
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