07:34am EST 27-Jan-99 Bear Stearns (Ehrens,Scott 212/272-9382) AMZN
AMZN: Reports Terrific Fourth Quarter:ROIC Is Key (Not Gross Margin)(Part 1 / 2
Scott Ehrens (212) 272-9382 sehrens@bear.com 1/27/99
Matthew Esh (212) 272-9043 mesh@bear.com
Matthew Adams (212) 272-6905 madams@bear.com
Subject: Analysis of Sales/Earnings
Industry: Internet / New Media
BEAR, STEARNS & CO. INC.
Amazon.com, Inc.* (AMZN- $115.09) Buy
Amazon.com Reports Terrific Fourth Quarter: ROIC Is Key (Not Gross Margin)
(Part 1 / 2)
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*** Blowout Quarter on Top and Bottom Line. Amazon.com
reported strong fourth quarter earnings yesterday with a narrower
than expected loss of ($0.14) per share versus our estimate of
($0.19) and consensus of ($0.18) per share. Earlier in January,
the company had pre-announced fourth quarter revenues of $252.8
million (vs. $185 million estimated), an increase of 65%
sequentially and 313% from a year ago. International sales
accounted for 19% of revenues, aided by the addition of local
sites in Germany and the U.K in October. Revenue growth was
driven by the addition of 1.7 million customers in quarter,
reaching 6.2 million cumulative, as well as by a 64% repeat order
rate, which is impressive given the large number of new
subscribers.
*** ROIC Is Key (Not Gross Margin). Gross margin is typically a
good indicator of a traditional offline retailer's return on
invested capital. However, given the highly scalable nature of
the online retail model (i.e. exceptionally high revenue
potential per dollar of capital invested), it becomes gross
profit dollars, and not gross margin, that drive the online
retailer's return on invested capital. We therefore estimate
that Amazon.com's return on invested capital has the potential to
be substantially higher than that of traditional offline
retailers (see ROIC analysis).
*** 1999: The Year of Expansion. Amazon.com's strategy of
investing for long-term value creation will continue as the
company undertakes several initiatives in 1999 designed to
improve customer service and capture a significant share of the
expected growth of new online shoppers. The company will expand
its distribution capacity with a new facility in Nevada, expand
its product lines in music and videos, and hire additional
technical staff to improve its systems and increase customer
service.
*** Raising Revenue Estimates. The stronger than expected
growth in revenues leads us to raise our revenue estimates for
the first quarter to $255 million (was $200 million) and for the
full year 1999 to $1.24 billion (was $930 million.). We are
increasing our expected EPS loss for 1999 from ($0.58) to ($0.93)
reflecting the new initiatives mentioned above and the resulting
increases in product development costs. We are also establishing
our 2000 estimates of $1.7 billion in revenue and a net loss of
($0.27) per share.
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MARKET CAPITALIZATION $17,768 (MM)
EARNINGS Q1 Q2 Q3 Q4
Mar Jun Sep Dec Year P/E
Current 1997 $(0.03)A $(0.06)A $(0.07)A $(0.08)A $(0.24)A NM
Current 1998 $(0.07)A $(0.12)A $(0.16)A $(0.14)A $(0.50)A NM
Previous 1998 $(0.07)A $(0.12)A $(0.16)A $(0.19)E $(0.55)E NM
Current 1999 $(0.27)E $(0.26)E $(0.22)E $(0.19)E $(0.93)E NM
Previous 1999 $(0.18)E $(0.16)E $(0.14)E $(0.11)E $(0.58)E NM
Current 2000 $(0.27)E NM
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ROIC Is Key (Not Gross Margin)
In traditional offline retail, gross margin is a very important
metric to watch. While a successful bricks and mortar retailer
can drive sales per square foot higher, there is a limitation to
the traffic (and therefore revenue) that a store can accommodate
before expansion or relocation is necessary. Therefore, gross
profit dollars are limited by the gross margin of the
merchandise. This means that gross margin is directly correlated
to the offline retailer's return on invested capital.
Amazon.com's revenue potential, however, is not limited by the
same factors. Think of Amazon.com as a store with unlimited
shelf space and an unlimited customers base. Amazon.com can
generate significantly higher revenue per dollar of capital
invested, as we discuss in the next section. This means that
Amazon.com's ROIC is a function of gross profit (in absolute
dollars) and not gross margin (a percent of sales), and therefore
a higher mix of lower margin sales would increase the companies
ROIC as total gross profit dollars increase.
Amazon.com Vs. Bricks and Mortar
In the fourth quarter Amazon.com generated $250 million in
revenue, an annual run-rate of $1 billion, on total invested
capital since inception of $10 million ($37 million in total
fixed asset expenditures since inception and $27 million in cash
generated from operations since inception). Amazon.com's
management offered the following comparison. A traditional
bricks and mortar book company would have had to build 200
superstore outlets, each generating $5 million in annual sales,
to match Amazon.com's $1 billion annual run rate of revenue. The
capital expenditure required to build those stores and supply
them with inventory and working capital would run approximately
$650 million, even assuming they were leased. In other words,
Amazon.com was able to generate the same amount of sales on
1/65th the investment of a traditional retailer. This means that
at current revenue levels, Amazon.com could achieve a ROIC
comparable to that of a traditional offline book retailer by
generating an operating margin that is 1/65th that of the
traditional retailer. (Likewise, if Amazon.com could achieve a
similar operating margin, it would achieve a ROIC that is 65x
that of the traditional retailer.)
This disparity will widen as Amazon.com generates incremental
sales. Since the traditional retailer must open additional
stores to generate more revenue, it must continue to invest its
capital. Amazon.com, considering its shelf space is essentially
unlimited and it already has global distribution, does not
require (to the same degree as the offline retailer) additional
capital spending. It does require investment on the back-end in
technology infrastructure and fulfillment infrastructure (e.g.
warehouses). However, as demonstrated in the fourth quarter,
Amazon.com already has the infrastructure to run revenues at a $1
billion annual rate with only $37 billion invested to-date in
fixed assets. Therefore, Amazon.com's ROIC could continue to
expand efficiently while the offline retailer remains constrained
by the cost of its bricks and mortar.
But Can Amazon.com Achieve a Positive Operating Margin?
Books Already Profitable. The scale of the core businesses is
starting to pay off. The company stated that in December, the
books business was profitable. This shows that the revenue base
in the core business is becoming large enough to overcome large
spending on marketing while Amazon.com continues to heavily
market the newer businesses. As these newer businesses
(amazon.co.uk, amazon.de, PlanetAll, Junglee, shoptheweb, and
Internet Movie Database) grow and reach profitability, other
businesses will be created that will require a heavy marketing
spend that will continue to mask the company's ability to
generate profits. Then, as the newer businesses become a smaller
portion of the total business (once several of the currently new
businesses reach maturity), Amazom.com will begin to show a
profit. We expect this to occur in the 2001 to 2002 time frame.
1999: The Year of Expansion
Instead of striving for short term profitability, Amazon.com will
continue to plow its revenues back into several strategic
initiatives in order to improve customer service and build
operating leverage within the business model. First the company
will begin leasing a highly mechanized 322,000 sq. foot
distribution center in Fernley, Nevada in the first half of 1999.
This new facility will not only expand capacity for additional
product lines, but will also cut shipping times to Western cities
by a day and increase the automation of fulfillment. The company
also expects to announce the addition of one or more centers in
the coming months. Amazon.com will undergo a company-wide systems
upgrade which includes the hiring of additional technical
personnel and the purchase of additional servers and telecom
connections. The company plans to add more user features and
increase the functionality of its Website in the anticipation of
strong growth in new Internet shoppers that, according to Jupiter
Communications, will drive online commerce revenues up by 55% in
1999 to an estimated $12.1 billion. Due to these initiatives we
expect product development costs to increase sequentially by 50%
in the first quarter of 1999 before resuming more normal growth
in the second half.
Strong Customer Growth During Holidays
Customer additions of 1.7 million during the fourth quarter
demonstrates the continued ability of Amazon.com to draw
customers despite growing competitive presence. The new additions
represent 65% sequential growth in total customers. To put this
in perspective, Amazon.com acquired 13% more customers this
quarter than the size of its TOTAL customer base of a year ago
(1,510,000). Orders from repeat customers as a percent of total
orders increased to more than 64%, impressive given the strong
growth in new customers.
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