Amazon Shares Dip on Downgrade (Update 1)

(Updated from 10:38 a.m. ET to include latest share prices, more analyst commentary.)

NEW YORK ( TheStreet) -- Shares of ( AMZN) fell Monday after Bank of America Merrill Lynch downgraded the stock to neutral, saying a "protracted" investment cycle may weigh heavier on the online mega-retailer's bottom line than expected.

The firm also expects competition from Google ( GOOG), Apple ( AAPL) and others in digital media to keep Amazon's valuation multiple in check, and said it thinks the consensus estimates for the second quarter and fiscal 2013 may be too high.

"This is not an 'Amazon trades at an unjustifiable P/E call' (CSOI consolidated segment operating income margins should rebound to 6-7% from ~2% today in our view, but maybe later than most think), but with the stock up 18% YTD and for the reasons cited above, we are downgrading to Neutral," said B of A, which has a $235 price target on the stock.

The stock was down 2% to $198.47 in afternoon trades on volume of 4.6 million, approaching the issue's trailing three-month daily average of 6 million. Based on Friday's close at $202.51, the shares are up 10.7%, trading at a forward price-to-earnings multiple of 74.6X vs. 12.1X for Apple and 12.7X for Google. Since hitting a 52-week high of $246.71 on Oct. 17, Amazon shares had lost 18% through Friday.

B of A detailed its concerns about Amazon's level of investment, saying headcount is growing faster than revenue and that the company is still building out fulfillment centers in the United States to back its same-day shipping drive.

"Amazon hired 4,900 people in 4Q, and we expect heavy hiring to continue in 1Q to support additional fulfillment build-out and investment in digital initiatives including AWS Amazon Web Services , Kindle ecosystem, and digital media," the firm wrote. "Our model assumes that Amazon will increase headcount by 3,900 people in 1Q, which represents 59% y/y growth, well ahead of 31%, 43%, and 25% y/y 1Q revenue, unit and active customer growth."

Then there's the competition, which is not sitting idle. Amazon is battling it out with heavy hitters on a number of fronts. The Kindle Fire tablet competes with Apple's red-hot iPad 3, and the company's digital content efforts are up against HBO GO, Netflix ( NFLX), Google's new Google Play digital books, music and movies offering, and the various streaming services of cable companies like Comcast ( CMCSK).

"Versus eCommerce and the fulfillment build where Amazon seems to be on the offensive, Amazon may be on the defensive in media," wrote the firm, which is expecting a new low-end Kindle device to be launched in the next few months, and sees two new Kindle Fire offerings in the third quarter.

B of A expects the expansion of the Kindle line to be a "gross margin headwind" in 2012, along with continued spending to up the ante for Amazon Prime members. Like Netflix, the company is feeling the pinch of rising content costs.

"We believe Amazon is aggressively licensing video content for Prime Instant Video," the firm said. "We estimate that Amazon's Prime Instant Video content deals could cost Amazon up to $700mn/$140mn a year for domestic and International (LoveFilm) streaming. These costs are recorded in cost of goods sold and represent a significant margin headwind."

As has been the case for a while now, the direction of margins is a key factor for Amazon's stock, and B of A sees risk to its call if the company can convince investors of better days on the horizon.

"If the Street perceives that margins are on the way back to 6.4% (lower 1Q hiring or reduced capex), the stock could react favorably to 1Q results," the firm said. "Our view is that there is too much on Amazon's plate in 2012 for investment spending to slow, and we are cautious on 2Q street estimates."

Amazon is slated to report its first-quarter results on April 23. The sell side is still mildly bullish with 24 of the 41 analysts covering the stock at either strong buy (13) or buy (11), and the median 12-month price target at $219.

Check out TheStreet's quote page for Amazon for year-to-date share performance, analyst ratings, earnings estimates and much more.

-- Written by Michael Baron in New York.

>To contact the writer of this article, click here: Michael Baron.
Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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