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Barron's..ouch..
What has Wall Street so lathered up about certain Internet stocks
-- especially portal companies like Yahoo, Netscape, Lycos,
Infoseek and Excite -- is that they have business models rather like
software companies. These are "destination" sites, in tech-talk,
gateways to the World Wide Web. And as more and more
"eyeballs" pass through the portal, the ad rates the gatekeeper
charges can rise dramatically. Margins are potentially terrific. Thus,
while the stocks may be nuttily overvalued -- and in our view, they
are -- the businesses themselves are rich in potential profits.
In sharp contrast, Amazon.com, even on its jillionth sale, still has to
pay the wholesaler or publisher for the book and also the costs of
handling, warehousing, wrapping, addressing and mailing.
Eventually, Amazon may achieve operating margins in the high
single digits -- that, anyway, is what it has told Wall Street. Which
translates into net profits of, at most, a nickel a share on every dollar
of sales.
And even that modest figure is a target, mind you, and given
Amazon's ballooning losses, arguably an optimistic one. Barnes &
Noble and Borders, the nation's two top booksellers -- the
Wal-Marts of the industry -- manage to net only two to
three-and-a-half cents of every sales dollar.
Right now, of course, Amazon isn't remotely close to 5% margins --
or, for that matter, to any margins at all, except negative ones. The
company is losing money hand over fist, and that, it concedes in its
financials, won't change in "the foreseeable future." In the
nine months ended September, for example, on revenues of $357
million, Amazon lost $78 million, or $1.60 a share. Last quarter's
losses, moreover, if you include the amortization of goodwill, are
actually accelerating faster than sales.
In short, the more books Amazon sells, the more money it loses. The
"business model," at least for now, is aptly described by the hog
farmer who lost $50 on every pig he sold -- but hoped to make it up
on volume.
To build its brand name, to grow its sales and its subscriber base,
Amazon is shelling out big bucks. More than a few of those bucks
end up in the coffers of the aforementioned portal companies.
Nearly 25 cents of every sales dollar Amazon takes in is spent on
marketing and sales.
At the same time, price-cutting is rampant in the business. Already a
deep discounter, Amazon slashed book prices again in June and
noted in its September 10Q that it was offering "everyday discounts
of up to 40% on hundreds of thousands of titles and certain 'special
value' editions discounted up to 85%." In the future, it predicted, it
may "increase the discounts."
At first blush, you might think Amazon's gross margins would top
those of the traditional booksellers, since it does not have the
expenses of running bookstores.
But the reverse is true. Gross margins of Barnes & Noble and
Borders -- after deducting both the cost of the merchandise and
occupancy costs -- are 27-28 cents of every sales dollar. Amazon's
gross margins -- after deducting the cost of merchandise and
shipping -- are less than 23 cents.
The critical question of whether Amazon will ever make money
hinges on this: Do the customers keep buying if ad spending slows
and discounts moderate? Put us down as doubtful.
For all we admire Amazon's ingenious Website -- in our view, it's a
bit better than Barnes & Noble's and a darn site better than Borders'
-- when we shop for a book, price is what counts. If Borders has the
book $2 cheaper, Borders gets our order.
Nor are we alone: "Saving money/lower prices" was, by far, the
most important reason for shopping on the Internet, according to a
recent survey of 1,363 consumers by Ernst & Young.
Amazon is drawing a host of new customers, not so much because
its Website is cool (though it is), but because of its rock-bottom
prices. If the discounts begin to disappear, so, we suspect, will the
customers. After all, it's the same book, whether you buy it over the
Internet or across the street.
Though also committed to an expensive foray into online selling,
Borders chief exec Robert DiRomualdo has no illusions about the
business.
"This is not Yahoo, where the feeding frenzy allows me to triple my
rates for search-engine space and which all drops to the bottom
line," he is quoted as telling a retailing conference. "This is a
low-margin retail business."
Internet retailing may actually work best as an adjunct to
old-fashioned peddling of the brick-and-mortar variety. Indeed, over
a third of consumers in the Ernst & Young Internet study said they
had researched books on the 'Net and then bought them
somewhere else. There are fairly stiff shipping charges to pay for
online orders, and then there's the inevitable wait.
Okay, books are low-margin. But can't Amazon use its franchise to
sell other stuff? Of course it can, and it has. Amazon added music to
its offerings and overnight became the largest online seller of CDs.
However, CDs have far worse margins than books. So the only thing
Amazon has proved so far is that it can lose money selling books
and lose still more money selling CDs.
The stocks of Barnes & Noble and Borders -- with sales of $3 billion
and $2.5 billion, respectively -- are selling at about 90% and 60% of
revenues. In contrast, at Friday's close, Amazon was valued at $19
billion, or 31 times sales.
If you valued Amazon at, say, twice forward sales -- and assumed
that revenues handily triple -- the stock, instead of trading at 123,
would sell under 25. And, at one times sales, under 12. |
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