AMZN's Miss Makes DangDang an Easy Short

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

BEIJING ( TheStreet) -- Shares of Amazon.com ( AMZN) slid as much as 10% in afterhours trading following its release of disappointing fourth-quarter results on Tuesday. The AMZN selloff led shares of Ecommerce China DangDang ( DANG) to fall by 3% to 4% in afterhours, after it was already down by more than 10% during the regular trading session. The question for investors is: what conclusions about DANG can we draw from AMZN.

DANG is often referred to as "The Amazon of China." I have frequently disagreed with this label because ecommerce in China is not dominated by one behemoth like AMZN, but instead is split between a number of substantial competitors. DANG probably ranks about third or fourth based on traffic and revenue (coming in behind such non-listed names as Taobao and 360Buy.com). The reason that Wall Street refers to DANG as the Amazon of China is that we don't really have any other U.S.-listed alternative, so we are stuck playing with the third- or fourth-place player. In the competitive world of ecommerce, there is likely to be no prize for coming in fourth.

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On Monday, as DANG was still ripping higher on the back of the surge in RenRen ( RENN), I decided to go short DANG at a price of $8.21, and I expect to stay short through earnings (which are due out shortly) because all signs point to a very disappointing fourth quarter. I believe this will take the stock back below $6, which incidentally is where Wall Street analysts already have a share price target for the stock. The stock currently trades at about $7. At the extreme I see DANG trading back at around $5, where it was a few weeks ago.

In early November (before the recent run up) DANG was still trading above $6, but a "surprise" earnings disappointment caused the stock to drop 27% to around $4.40 over the period of about two weeks. Revenue grew substantially as expected, but the net loss was significantly larger than expected at around $12 million for the quarter.

The ongoing price war between DANG and its competitors has been well publicized in the Chinese press, so why this came as a surprise to anyone (especially Wall Street analysts) is a mystery to me. The Chinese press continues to note the price war, and consumers continue to celebrate the discounts with joy. So once again, it is very easy to predict substantial revenue growth for DANG and an even larger loss than last quarter.

Given the early onset of Chinese New Year, I am expecting that DANG could even hit its first quarter ever of achieving 1 billion RMB (about $160 million) in revenue. Yet I expect the net loss will easily exceed 100 million RMB. If there is one thing to be learned from the AMZN earnings miss, it is that revenues don't matter -- profits do.

DANG's loss will be mostly due to the ongoing price wars, but will also be due to the ongoing build-out of logistics facilities that DANG is undertaking. This is also frequently mentioned in the Chinese press and will be a significant contributor to DANG's Q4 loss. AMZN has cited similar plans that are expected to lead to a Q1 loss for the company.

So how does AMZN compare to DANG? In the table below I assume that DANG will have its first ever 1 billon RMB quarter in Q4.

The conclusions from this comparison are fairly obvious. DANG is still a tiny player in this space, doing less than 1% of the revenue of AMZN. Even AMZN only squeaks by with a 1.3% profit margin, while DANG is still experiencing very substantial losses relative to sales. AMZN is growing revenue at a scorching 35%, while DANG is only logging 12%. Yet DANG has seen its stock run up by 67% this year vs. AMZN's 2% due to a simple resurgence in investor preference for all things related to China Internet plays.

Many investors hold DANG because they see it as having the potential to be China's ecommerce giant like AMZN is in the U.S. This may eventually come to pass, but even if DANG can make that type of progress it is obviously quite a few years away. So an investment in DANG needs to be considered on a four- to five-year timeframe at a minimum. In the meantime, Wall Street will continue to judge DANG on a quarter-by-quarter basis.

With AMZN's disappointing results now out and with a reversal in the surge of RENN and other China Internet plays now under way, shorting DANG at $7 or above is an extremely attractive proposition. However, given the notable volatility in the stock, long or short positions in it are not for the faint of heart. The stock can easily move as much as 20% up or down in a day, so investors who choose to play either direction should make sure they have the nerve for it.

In any event, however you choose to play, good luck to both longs and shorts in DANG. It is unfortunate that both sides can't be winners, but hopefully both sides will make the most informed decision possible.

At the time of publication, the author held a short position in DANG, although positions may change at any time.
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

Rick Pearson is a private investor focusing on U.S.-listed China small-cap stocks. Until 2005, Pearson was a director at Deutsche Bank, spending nine years in equity capital markets in New York, Hong Kong and London. Previously, he spent time working in venture capital in Beijing. Mr. Pearson graduated magna cum laude with a degree in finance from the University of Southern California and studied Mandarin for six years. He has frequently lived, worked and traveled in China since 1992.

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