Amazon, Netflix, And Me

With the economy in recession, there were concerns in early November about how strong the holiday season sales would be. But once the numbers from Thanksgiving week were out, industry players started to feel more confident, and National Retail Foundation data confirms that the 2009 holiday season was much better than expected. Specifically, December retail industry sales rose 2.3% (unadjusted) Y-o-Y. Several e-trends are in motion — e-commerce is growing, e-books are gaining adoption, and online movie rentals are are becoming more common. Let’s take a closer look.

Online retail sales during the holiday season showed good growth over 2008, which was a horrible year. According to Coremetrics, online retail sales from December 14–December 20, 2009, were up 14.6% compared to December 15–December 21, 2008. comScore reported that online sales from November 1–December 18, 2009, increased to $24.8 billion, up 4% Y-o-Y. It also said that Y-o-Y sales were up 10% on Thanksgiving Day, 11% on Black Friday, and 5% on Cyber Monday in 2009. That’s not bad when you consider the economic mess we are in.

Amazon.com, Inc. (NASDAQ:AMZN) announced fourth quarter 2009 results on January 28. Net sales increased 42% to $9.52 billion in Q409, compared to $6.70 billion in Q408. Operating income increased 75% to $476 million in Q409, compared to $272 million in Q408. Net income increased 71% to $384 million in Q409, or $0.85 per share, compared to net income of $225 million, or $0.52 per share, in Q408.

North America segment sales, representing the company’s U.S. and Canadian sites, were $4.96 billion in Q409, up 36% from $3.63 billion in Q408. Media revenue grew 20% to $2.1 billion. Electronics & Other General Merchandise (EGM) revenue grew 54% to $2.66 billion, representing 54% of North America revenues, up from 48% last year. North America segment operating income increased 113% to $278 million, or 5.6% operating margin.

International segment sales, representing the company’s U.K., German, Japanese, French, and Chinese sites, were $4.56 billion in Q409, up 49% from $3.07 billion in Q408. Media revenue grew 37% to $2.58 billion, and EGM revenue grew 68% to $1.95 billion. EGM now represents 43% of international revenue, up from 38% in 2008. International segment operating income increased 39% to $319 million, a 7% operating margin.

Worldwide Media sales grew 29% to $4.68 billion in Q409. Worldwide EGM sales grew 60% to $4.61 billion in Q409. Worldwide, EGM increased to 48% of worldwide sales in Q409, up from 43% in Q408. Worldwide unit growth was 37% in Q409. Active customer accounts exceeded 105 million in Q409, up 19% from Q408. Worldwide active-seller accounts numbered more than 1.9 million in Q409, up 24% from Q408. Seller units in Q409 were 28% of total units.

Amazon completed its acquisition of Zappos.com, an online shoe store, on November 1, 2009. Zappos.com contributed approximately $200 million to Q409 revenue.

Authors and publishers around the world can now use the Kindle Digital Text Platform (DTP) to upload and sell books in English, German, and French to customers worldwide in the Kindle Store. Amazon.com announced a new 70% royalty option for Kindle DTP, enabling authors and publishers to earn more royalties. With its Kindle DTP, Amazon is trying to change publishing by putting more money in the hands of authors.

The company introduced the Kindle Development Kit, which gives developers access to programming interfaces, tools, and documentation to build and upload active content for Kindle.

Amazon’s strategy of keeping the price of e-books at $9.99 is in danger. The company had pulled down its entire library of Macmillan books because the publisher wanted books to be priced at $15. But Amazon later did an about-face and restored Macmillan titles to the Kindle store, since like all publishers Macmillan has a monopoly on its list. For Amazon, what is of concern here is that other publishers will also try to get the retailer to sell their e-books at $15, and with the iPad perhaps soon close on its heels and rumors of a tie-up between Apple and other major publishers to sell books at a higher price, the days of cheap(er) e-books could soon be over.

For Q1, Amazon expects net sales of between $6.45 billion and $7 billion, or growth of between 32% and 43%. GAAP operating income is expected to be between $275 million and $365 million, or growth of between 13% and 50%.

Some industry observers expect the iPad to give Kindle a run for its money. But according to Scott Jacobson, a former Amazon executive, the iPad will not kill Kindle as Kindle is for hardcore readers, and its personalized recommendation will differentiate it from other e-readers. Jacobson also points out that that the Kindle is significantly cheaper than the iPad.

I like the competition that the iPad has posed for Kindle, and together, they are ruffling the book industry in a big way. My personal interest is to see how the two companies, Amazon and Apple, help to re-engineer the power structure of the publishing business such that authors — the real value creators in the book business — get a better deal. Towards that end, if the iPad becomes a major e-book reader platform, and e-books really and truly take off, I will be delighted to sell my books through both Kindle and the iPad. At present, I get 30% royalty on Kindle books on Amazon, but starting in July, this is going up to 70%. This change has happened because Apple has entered the race, forcing Amazon to offer publishers better deals. In my case, since I publish my books myself, I will be a beneficiary of the change. And, as a matter of fact, Amazon should not care all that much if readers read e-books on the iPad if they buy the books from Amazon using the Kindle app. And as far as I am concerned, I plan to sell my eBooks on both Kindle and iPad.

On the film side, online DVD rentals reign. Netflix, Inc. (NASDAQ:NFLX) reported results for the fourth quarter and year ended December 31, 2009, on January 27. Revenues in Q409 were $444.5 million, up 24% from $359.6 million in Q408, and 5% sequentially from $423.1 million in Q309. Gross margin in Q409 was 38% compared to 35.2% in Q408 and 34.9% in Q309. GAAP net income in Q409 was $30.9 million, or $0.56 per share compared to GAAP net income of $22.7 million, or $0.38 per share, in Q408 and GAAP net income of $30.1 million, or $0.52 per share, in Q309.

Subscriber acquisition cost (SAC) in Q409 was $25.23 per gross subscriber addition compared to $26.67 in Q408 and $26.86 in Q309. Churn in Q409 was 3.9% compared to 4.2% in Q408 and 4.4% in Q309. Churn includes both free subscribers and paying subscribers who elect not to renew their monthly subscription service during the quarter.

Netflix ended Q409 with approximately 12.3 million total subscribers, representing 31% growth from 9.4 million total subscribers at the end of Q408 and 10% sequential growth from 11.1 million subscribers at the end of Q309. Net subscriber change in Q409 was an increase of 1.2 million compared to an increase of 718,000 in Q408 and an increase of 510,000 in Q309.

Gross subscriber additions in Q409 totaled 2.80 million, representing 34% growth from 2.09 million gross subscriber additions in Q408 and 29% sequential growth from 2.18 million gross subscriber additions in Q309. Of the 12.27 million total subscribers at the end of Q409, 97%, or 11.89 million, were paid subscribers. The other 3%, or 376,000, were free subscribers. Paid subscribers represented 98% of total subscribers at the end of both Q408 and Q309.

In Q110, the company expects to earn revenue of $490 million to $496 million, GAAP net income of $26 million to $32 million, and GAAP EPS of $0.47 to $0.58 per diluted share. Netflix expects to end Q1 with total subscribers of 13.5 million to 13.8 million.

At the Sundance film festival this week, Netflix reached a deal with a number of independent film distributors that will allow the company to stream around 300 films directly to its members to watch via online stream. Netflix is trying to become a major alternative channel of distribution for indie movies, just as Amazon has become for books. This move should not only expand Netflix’s library but also make the service popular with audiences, as they get to watch a variety of artist-driven movies, and filmmakers and distributors, who get a much easier distribution channel. It looks like a win-win formula for Netflix.

Overall, these are solid Q4 results from Netflix. Netflix has been trying continuously to increase its breadth of content and improve its delivery platforms and user interface. I feel with the subscriber base increasing, Netflix will be in a favorable position when it renews or signs licensing agreements with the major studios, as studios will yield to the company’s market power. Also, the rapid adoption of streaming and availability of Netflix on gaming platforms should drive future growth for the company. This is a long-term story unfolding.