August 27, 2008

Amazon Beefs Up Kindle Franchise

Amazon.com wants to add some social media savvy to the growing e-book business that's helping justify its lofty share price.

On Aug. 26, online bookseller Amazon (AMZN) said it bought Web site Shelfari, owned by Seattle startup Tastemakers, for an undisclosed sum. Shelfari, which Amazon had already funded, lets users organize online book groups and create "virtual shelves" of titles to share recommendations with fellow readers, who post profiles of themselves and tout their literary tastes. Along with the early August purchase of a stake in another online startup, Shelfari could help Amazon add community-building tools to its Kindle e-book store, potentially enhancing sales.

The Digital Age of Books "Kindle has hit a nerve, and it represents the future of electronic books," says Tim Bajarin, president of industry consultant Creative Strategies. "Over time, these social networks [will] add great value to the experience." Buyers of the portable reader for electronic books, released by Amazon in November, had been "early adopters and avid readers who travel a lot," Bajarin says. Plugging Kindle owners into a community of commenters about titles they're considering buying could convince more users to plunk down $10 or so for new titles, which can be purchased wirelessly from the device.

The Shelfari deal fits with a growing awareness that the book publishing industry needs to embrace interactive Web 2.0 technologies. In addition to the profiles and discussions on its own site, Shelfari makes an application for Facebook that could help Amazon tap into traffic on one of the most quickly growing social networks. On Aug. 1, Amazon said it plans to buy online used-book dealer AbeBooks, owner of a 40% stake in social media site LibraryThing. Amazon will inherit the stake when the deal closes by the end of the year. In January, Amazon dropped $300 million on digital books-on-tape site Audible.

Amazon's marketing savvy CEO, Jeff Bezos, has called books "the last bastion of analog," even as music, TV, and other media have moved to the Web. Kindle, which Amazon sells for about $360, represents an ambitious bid to usher book publishing into the digital age, doing for reading what Amazon earlier did for book purchasing. The paperback-size device holds about 200 books, which users can buy over the Internet through Sprint Nextel's (S) high-speed cellular network. Kindle users can also subscribe to newspapers and blogs.

Amazon Valuation Too High? BusinessWeek.com has estimated that Kindle has generated perhaps $100 million in revenue [BusinessWeek.com, 8/25/08] since November. A second version, possibly due in September, is expected to be thinner, feature a better screen, and cost less than $300.

Now the question on investors' minds is whether Kindle can extend gains in a share price that's already trading at a premium to other Internet company stocks. On Aug. 26, shares of Amazon slipped 1.09, or 1.3%, to 81.76. The shares have risen 7% in August, buoyed in part by an Aug. 10 research report by Citigroup (C) analyst Mark Mahaney, who said Amazon could sell 380,000 Kindles this year. Kindle "is becoming the iPod of the book world," and sales could reach $1 billion by 2010, wrote Mahaney, who rates Amazon a "buy."

Despite the August gains, Amazon shares are still down almost 12% this year. Amazon hasn't disclosed sales of Kindle, and some Wall Street analysts say the company's stock has rallied on what are still theoretical estimates for future sales of the e-book device. Amazon trades at 52 times expected 2008 earnings, a valuation level that American Technology Research analyst Tim Boyd said in an Aug. 12 research note is too high, given Amazon's exposure to the U.S. dollar. "In terms of valuation, sanity has left the building," wrote Boyd, who has a "sell" rating on the stock. By contrast, eBay (EBAY) trades at 14 times 2008 earnings and Google (GOOG) at 24 times forward earnings.

Tipping the Balance Amazon isn't saying much about its plans for the recent purchases. A spokeswoman says Shelfari and LibraryThing "are innovating in ways that are great for book lovers," but declined to elaborate. In an Aug. 25 blog post, Shelfari co-founder and Chairman Josh Hug wrote, "With more resources and Amazon's expertise in building a platform where people come to share ideas, there are a lot of new opportunities."

In the meantime, Amazon will need to contend with LibraryThing's outspoken president, Tim Spalding, who wrote in an Aug. 25 blog that "once the Amazon/Shelfari deal goes through, we are competing against Amazon."

Kindle's potential alone may not be a reason to buy or sell Amazon. Even if Kindle meets Wall Street's most bullish expectations, sales of the devices and e-books would still account for just 4% of projected 2010 sales. But with investors divided on whether Amazon should be valued like a cash-rich tech company or an economically risky retailer, a breakout e-book performance this year could tip the balance in Amazon's favor.