Amazon: Buying growth at a price

  @Money October 25, 2012: 6:15 AM ET
kindle fire new

Amazon's Kindle Fire is sold virtually at cost.

(Money Magazine)

Ever since it was founded in 1994, Amazon.com has been all about transformation.

The Seattle-based online retailer started off by reinventing the way books were sold. Then it redefined itself by hawking everything from furniture to electronics -- in the process challenging giant retailers such as Wal-Mart head-on.

More recently, the company doubled down on its dotcom roots through tablets, streaming video, and cloud computing. Transformation, though, comes at a steep price.

Can Amazon (AMZN, Fortune 500) afford to keep being so daring?

Tech 2.0

Amazon is re-embracing its inner nerd. The company struck a blow against Netflix by signing an agreement with Epix, giving Amazon Prime subscribers access to thousands of additional streaming videos.

EC2, the firm's cloud-computing unit, leads Google and Microsoft in market share. And with the Kindle Fire, which controls 22% of the U.S. tablet market, Amazon is taking direct aim at the iPad and Apple's iTunes platform.

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The stock is already reaping benefits -- investors are valuing it like an Internet startup circa 1999.

Morningstar analyst R.J. Hottovy says, "Amazon's P/E shouldn't scare investors off because its profitability is still being sacrificed for investments in rapid expansion." Of course, you've probably heard that one before.

Reinventing retail

The e-tailer, which accounts for almost 2% of retail industry sales, is growing rapidly and poses a threat to traditional big-box stores. To keep up with the company's expansion, Amazon is building 18 new fulfillment centers, which will further speed up delivery times.

"Amazon is already testing out pilot programs in certain cities which would allow for same-day delivery service," says Wells Fargo analyst Matt Nemer. "If successful, the online behemoth could pose an even greater threat to brick-and-mortar stores."

The threat could be slightly muted, though, by new laws forcing Amazon to collect sales tax on behalf of states where it previously hadn't, shrinking the online seller's price advantage.

Big sales, little profits

While revenues are thriving, reaching $48 billion last year, profits have seen better days, as the company is in spending mode.

Amazon recently paid $775 million for Kiva Systems, makers of warehouse robots. That followed last year's acquisition of U.K.- based LOVEFiLM to help compete against Netflix (NFLX) globally.

Amazon's $199 tablet costs $148 in parts

And in an effort to gain market share, Amazon's new Kindle Fire 2 will be sold virtually at cost.

"Amazon isn't trying to make money on hardware," says Morningstar's Hottovy. "It's using devices to lure consumers into spending more on e-books, digital content, and Prime subscriptions."

The strategy is a gamble: Wal-Mart (WMT, Fortune 500) and Target (TGT, Fortune 500) have stopped selling Kindles for competitive reasons, potentially slowing Amazon's plans.

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