Headwind for Amazon.com

2010 was a good year for many online retailers. Being the biggest of them, Amazon.com AMZN saw its stock advanced almost 40% from $130/share to $180/share last year. Aside from its online retailing operations, Amazon.com pioneered many of the cloud hosting solutions we see today. It was estimated that its web services (AWS) revenue would have reached $500M in 2010. Also, while enthusiasm of its Kindle eBook reader was dampened a bit by the success of the iPad, Amazon is still the leader in eBook sales. All in all, a great company with great growth opportunities on many fronts. Nevertheless, when investors think about Amazon, they are thinking about the online retailing, and rightfully so, as most of the company's revenues and profits are still being generated by its online store, itself growing healthily. Seeing the momentum in online sales growth this past Christmas, it's difficult to think of anything that can derail Amazon's growth story. One of them would be the peril of high expectation, as Amazon now spots a forward P/E ratio > 50, so any result or guidance less than perfect could prompt a sell-off. Another could be that the economy falling off again, decimating retail sales along the way. However, there is a third one that was sometimes mentioned, but not nearly getting enough coverage even it could cause a sea change for online retailing. As everybody now knows and aware that many state governments run large deficits, there are a lot of talks about how these states should cut their budgets, but not enough about how they generate more revenue. Other than the conventional methods of increasing revenues such as tax increases, one of the ways to generate revenue would be to stop the revenue loss on sales tax due to online purchases from companies operated outside their states. As suspected, this is not an easy problem to solve, thanks to a 1992 US Supreme Court decision. For the moment, many states have the 'use tax' law, which asks consumers to pay the sales taxes when they made purchases online. However, that is both ineffective and inefficient in detection and collection. As you can imagine, most of these purchases are not reported and thus no sales tax are recouped. This gives a huge advantage to online retailers such as Amazon, and makes brick and mortar stores much more difficult to compete with them. For a state like California with a high sales tax rate of 8.25%, this loss of revenue is substantial. State budget proposals will be coming out soon, and as newly elected governors ponder how they can balance their budgets, this is one of the issues they must tackle. For all the 2011 surprise lists I read, including the latest one by Byron Wien, none of them mentioned about this issue. Nevertheless, if a solution to this can be hammered out, this could be the biggest surprise for all online retailers after all. Daniel Ho is the founder of 10xreturn.com, a financial portal providing financial information and market statistics for investment professionals.