One unnerving aspect of Amazon’s otherwise fine second quarter (AMZN) was the fact that the US media business–which accounts for a quarter of the company’s sales–was flat.
In our opinion, Amazon’s ongoing dependence on physical book, music, DVD, and video-game sales is still the biggest long-term risk to the company and stock–and it’s a risk that most people pay no attention to.
The Kindle is off to a great start, but Amazon still generates more than half of its sales from a business that is in long-term secular decline (physical media). Navigating the transition to digital delivery–and continuing to grow profits during the transition–could prove a major challenge.
In any event, Doug Anmuth at Barclays is worried that the sudden collapse of the video-game industry will hammer Amazon’s near-term performance:
NPD data Thurs evening showed U.S. video game industry sales fell 29% Y/Y in July, below broader expectations of -15%, & slightly worse than the -25% Y/Y in 2Q. We view the ongoing weakness in video games as a negative for AMZN as it will likely continue to weigh on N. America Media growth which was flat Y/Y in 2Q09.
- Largest decline was in console sales which fell 37% Y/Y. Software sales fell 26% Y/Y while accessories sales declined 12%.
[This is horrible, by the way. Remember when video games were supposed to be recession-proof?]
- Consoles are a high ASP/low margin biz. for AMZN (likely low/mid single-digit gross margins). Lower console sales would negatively impact revenue & gross profit $, but likely result in higher margins. We estimate video game related sales are ~15-20% of AMZN’s NA Media biz.
- Despite current weakness, declines could moderate in coming months as: 1) comps get materially easier from Aug; 2) widely expected console price cuts could spur demand; & 3) a stronger roster of titles is coming including Halo, Madden, & the Beatles: Rock Band
- Still, we believe AMZN shares could come under N-T pressure in light of the data. We maintain our 2-EW & our $83 PT is based on 18x 2010E FCF.
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