The Great Amazon Debate: Should You Keep the Faith?
BUSINESS WEEK ONLINE
November 4, 1999
STREET WISE by Amey Stone
The Great Amazon Debate: Should You Keep the Faith?
Impatient investors have to guess whether this time next year, Jeff Bezos' star will have faded or be shining even brighter. Here are the arguments
Will the real Amazon.com (AMZN) please stand up? Is it an e-commerce superstar that in just over four years has moved well beyond its initial incarnation as an online bookseller, attracted 13.1 million customers, and is on track to generate $1.5 billion in sales in 1999? Or is it the ultimate Net-stock bubble waiting to burst -- a company with a $22 billion market cap that, as of its latest quarterly earnings report, is losing money at a faster rate than it is increasing sales? Since Amazon reported earnings after the market's close on Oct. 27, its stock price has fallen every day, closing on Nov. 3 at 65 13/16 -- a five-day decline of 13%.
Like many longtime observers of the company, I have mixed feelings about Amazon right now. I'm rooting for CEO Jeff Bezos to prove that with a top brand, a superior technology backbone, and a strong emphasis on customer service, he can sell just about anything on the Web. On the other hand, I'm frustrated that he still seems so blase about profits. Merrill Lynch analyst Henry Blodget epitomized investors' new ambivalence about Amazon in an Oct. 28 research note. He downgraded the stock and complained testily about the company's "numbingly routine" estimates of bigger losses in the future. But Blodget then commented: "We continue to believe that Amazon will win the e-commerce game, one day becoming a huge, profitable powerhouse."
Well, Wall Street can afford to seem wishy-washy. But with the holiday shopping season nearly upon us, few investors have that luxury. The fourth quarter will be pivotal for many e-tailers, and investors in Amazon need to decide now whether to keep the faith or bail out. Amazon's most recent slide is nothing compared with what could happen if the fourth quarter proves disappointing. On the bright side, however, the stock is 40% lower than its all-time high of $110 last April, when enthusiasm over Amazon peaked. So there could be a big upside if the fourth quarter's numbers are strong and Bezos finds himself back on a pedestal.
Which side are you on? Is Jeff Bezos your idol -- or just another overly ambitious retailer? Here are the opposing arguments -- on Bezos, the profitability issue, and more -- for investors to consider:
JEFF BEZOS
Doubters say he is spending way beyond his means: In its most recent quarter, Amazon lost nearly four times as much as it did in the same quarter last year. Third-quarter revenue was up only 13% from the second quarter, and profit margins are slipping. Yet in statements to Wall Street and the press, Bezos seems unfazed by the higher losses. Amazon plans to spend even more on marketing and distribution to ramp up for holiday sales -- and that could well crimp profit margins further.
For the fourth quarter, Morgan Stanley analyst Mary Meeker now expects Amazon to lose $154 million, for a total 1999 net operating loss of $360 million. In 2000, Amazon's losses may rise again, and analysts don't expect a profit until 2002. Amazon already has the strongest brand name in e-commerce. Is all this spending necessary, or is Bezos expanding this fast to cover up Amazon's basic inability to earn money from its core businesses?
Believers say he is the king of e-commerce: He understands it better than anyone else and has the biggest e-commerce brand name and a huge customer base to prove it. He's well on his way to achieving his mission of selling everybody everything on the Web but needs to keep investing in the business to take advantage of new opportunities.
This holiday season in particular, it would be a mistake for Amazon to try to make money and put off its brand-building efforts. With consumers expected to spend $6 billion online in the next two months, Amazon has a huge opportunity to turn holiday shoppers into long-term customers. Bezos' master plan is still on track, even if some investors are getting impatient.
PROFITABILITY
Doubters say it's a distant dream: If its business model worked, Amazon would be turning a profit by now -- or would at least be getting closer. Instead, its gross profit margins are declining. In the third quarter, gross margins were 19.8%, down from 21.5% in the second quarter. Even worse, the company now says that gross profit margins could fall by two to three percentage points in the fourth quarter, vs. the third quarter, because of higher costs associated with vibrant holiday sales.
Believers say it isn't really that far off: First of all, Amazon expects its book business to make money in the fourth quarter. Secondly, Amazon's new "zShops" initiative, where it allows other e-tailers to sell to its customers, should create a high-margin revenue stream. More important, it's hardly surprising that Amazon's gross margins should suffer as it builds out infrastructure in anticipation of higher demand. As its sales grow, its efficiency and profit margins will improve. "We're in a very special time right now," says Christopher Vroom, an analyst with Thomas Weisel Partners. While Vroom agrees that profits have been pushed back a bit, he argues that "it isn't a material change."
COMPETITION
Doubters say it will eventually catch up with Amazon: After all, traditional retailers are just figuring out e-commerce, and companies like Wal-Mart (WMT) are already masters at managing inventory and keeping profit margins up. Meantime, Amazon is basically turning into a traditional retailer as it invests more in distribution centers and takes on more inventory. Worse, its revenue growth is slowing, and the amount each customer spends on its products is declining. It isn't enough to get and hold onto customers if they don't spend much.
Believers say rivals will be crushed by Amazon: It is one of the few e-commerce players that has built out infrastructure enough to meet the incredible customer demand that's coming over the holidays. "We believe winners will be determined by who delivers the best overall shopping experiences," wrote BancBoston Robertson Stephens analyst Lauren Cooks Levitan recently. Online and offline retailers won't be able to match Amazon's customer service. That will bring it more customer loyalty. In the recent quarter, 72% of orders came from repeat buyers, up from 70% in the second quarter.
INVESTORS
Doubters say that investors have had enough: Wall Street is finally losing faith in Amazon, and that means the Street may not fund future expansion. Five analysts lowered their ratings on the stock after third-quarter earnings were announced. When Blodget, the biggest Amazon proponent on Wall Street, downgraded the stock, he wrote: "We believe investors will become as tired as we are of endless postponement of gratification."
Speculators are still keeping the stock price afloat. But once they leave, it will fall to a more reasonable valuation, such as five times revenues, or $20 a share, predicts Rick Berry, a technical analyst with J.P. Turner & Co.
Believers say that investors always sell off Internet stocks after earnings reports: The recent stock price decline is nothing more than a typical post-earnings letdown. For all of Wall Street's hand-wringing, the company actually reported a smaller-than-expected third-quarter loss of $86 million, or 26 cents a share, instead of the projected 28 cents. Just because Wall Street is putting pressure on Bezos to show some progress toward profitability doesn't mean it doesn't still love him. Besides, even if Wall Street decides not to help Amazon raise millions more in debt and stock offerings, "they've got ample capital for the next couple of years to fund growth," says Vroom.
MY THOUGHTS:
It wouldn't be fair to lay out these arguments without giving my own opinion on whether Bezos will turn out to be a genius or the goat who let Amazon fall to $20. My gut tells me that Bezos knows what he is doing and that this year's holiday shopping season will be big. While I wouldn't recommend that investors bet their Christmas savings on Amazon, and while I recognize that the competitive landscape could change as brick-and-mortar retailers learn the ins and outs of e-commerce, if I had some shares -- which I don't -- I certainly wouldn't bail out now.
YOUR THOUGHTS?
Which side of the debate do you come down on? Is Amazon worth buying now? Or are you getting out while the getting's good? Send your comments to Amey Stone
Stone is an associate editor at Business Week Online |
