February 3, 1999
Who's on Amazon's Shopping List?
By Paul R. La Monica
COMPANIES FOR SALE?IMAGINE THAT someone backed a tractor-trailer onto your front lawn and dumped a huge pile of brightly colored Monopoly money at your feet. The driver's parting words: "Hurry up and spend it before everybody finds out it's not real."
Such is the giddy predicament facing many Internet companies whose Daliesque stock valuations have made them all too eager to use their shares to buy the cyberspace equivalents of Boardwalk and Park Place. Sure there are compelling strategic reasons for At Home (ATHM) to buy Excite (XCIT), for America Online (AOL) to acquire Netscape (NSCP), for Yahoo! (YHOO) to absorb GeoCities (GCTY) and for Lycos (LCOS) to try to buy everything else. But do you see any real money changing hands? What's fueling this land grab is stock.
Well, fine. We're not here to moralize (anymore than we have already). But we would like to point out one company conspicuous by its absence from the above list -- Amazon.com (AMZN). The e-commerce leader has used its richly valued shares to purchase some privately held firms like the Internet Movie Database, Web-based calendar firm Planetall and online-shopping database company Junglee. But those deals combined barely broke $500 million. You've gotta believe those AMZN shares are burning a hole in CEO Jeff Bezos's pocket as he tries to figure out Amazon's strategy going forward.
Will Amazon Go Shopping?
Borders Group (BGP)
Beyond.com ( BYND)
Egghead.com ( EGGS)
Lycos ( LCOS)*
[financial info omitted]
Should Amazon enter the Web portal race and try to gain a larger audience? Should it try to acquire other premiere e-commerce sites and broaden its wares? Or should it, like some Mafia family going legit, try to buy a brick-and-mortar business that has something Amazon doesn't -- profits? As you might expect, we have a few ideas.
The Corner Bookstore
Here's a heretical thought: Amazon buys Borders Group (BGP). We know, we know. Amazon buying a traditional retailer would be akin to Ford deciding back in 1903 to acquire a company that made horse-drawn carriages. And all those investors who keep pounding the table that Internet stocks are different might dump the stock if Amazon began dabbling in the brick-and-mortar book biz.
Still, there could be some benefits to an Amazon deal for Borders -- and they go well beyond the soporific details of logistics and real estate costs involved in building a distribution structure. Above and beyond the Internet itself, Amazon is now about establishing and extending a brand. And what better way than to have a profitable presence in the real world. Imagine sipping your cappuccino curled up on a sofa at your local Amazon bookstore. Don't have the title you want at that location? Order it yourself at one of the Web kiosks scattered throughout the store. Then view a poetry reading or author's talk going on live at another Amazon store through the same in-store Web browser.
There's also the whole earnings thing. Borders is actually profitable, so a purchase by Amazon could give it more validity in the eyes of investors that are waiting for Amazon's explosive sales growth to fall to the bottom line. And Borders stock is cheap, selling at just 13 times estimated fiscal 2000 earnings, less than 0.5 times trailing sales and 2.1 times book value.
The problem is, Amazon may never buy Borders or any other brick-and-mortar business because such a move might cripple its highflying stock. Sara Zeilstra, an analyst with Warburg Dillon Read, says investors (not traders, investors) are buying the stock because they believe Amazon's meteoric revenue growth will someday lead to a high degree of profitability. But if Amazon were to make a brick-and-mortar deal, Zeilstra says investors probably would perceive that as an admission from the company that it might never make money online. "That would negate the whole reason people are willing to accept the losses in the first place," she says.
After all, there's a reason investors aren't willing to pay Internet prices for Borders and Barnes & Noble (BKS). The book business is notoriously low margin, online or in a 25,000 sq. ft. superstore. Barnes & Noble's operating margins are an anemic 1.9% and Borders isn't faring much better with operating margins of 3.4%. And Amazon's marketing expenses aside, the costs of running a wide-ranging retail chain are drastically higher than operating a Web-based retail franchise.
Still, some think Amazon could make a small foray into the brick-and-mortar world. Ken Cassar, an analyst with Jupiter Communications, says if Amazon were to try and establish any brick-and-mortar presence, it would likely set up a few large flagship stores in major urban markets, similar to the approach Nike (NKE) has taken with its Nike Town stores, and direct computer marketer Gateway (GTW) has with its Gateway Country stores. Cassar says Amazon wouldn't be doing this in order to make money, but to increase the awareness of its brand name.
The Wal-Mart of the Web?
Before Amazon starts buying or building stores, however, it may first want to expand its already formidable e-commerce presence. And of all the areas it could branch into, analysts see the software business as the most logical extension. Egghead.com (EGGS) or Beyond.com (BYND) could make sense as an acquisition. A deal for either company would mark Amazon's biggest transaction to date, but each company trades at a market cap of less than $1 billion. In other words, Amazon could eat either one for breakfast and not even feel full.
Software would fit with Amazon's strategy of hawking relatively inexpensive products. And Cassar says even though software retailing, like books, is low margin, Amazon has shown so far that high margins are not a major criteria behind a decision to enter a new product line. So which of the two companies is a more likely target for Amazon?
Egghead, which has transformed itself from a mall-based retailer to a purely e-commerce company, is bigger than Beyond in terms of sales. Egghead had $106.5 million in revenue in its first three quarters of its fiscal year (ending March). Beyond sold $36.65 million in all of 1998. And according to Media Matrix, Egghead had 762,000 more unique visitors in the month of December than Beyond. But Beyond is growing faster, hence the disparity between the market cap of the two (see table). Beyond's sales increased 35% from the third quarter and were up 118% from the fourth quarter of 1997. Egghead's revenue grew just 19% from its fiscal second quarter and increased 77% from the prior year. So Amazon could spend more for a company that has greater momentum on its side. But then again, Amazon could buy Egghead at a discount to Beyond and hope that its retailing savvy leads to a higher level of growth at Egghead.
Analysts think Amazon might want to increase its presence in toy retailing as well. The company has already started to sell some toys over its site but if it truly wanted to gain a category-killer foothold in this market, it could look no further than privately held Etoys.com. Etoys was the fifth-most frequented shopping site in December, according to Media Metrix.
Et Tu, Yahoo?
Could Amazon be a portal? "It's all about traffic building," says Scott Appleby, an analyst with ABN Amro. Amazon obviously has a major Internet presence but it lacks any form of advertising revenue, which is where portals make most of their money. Amazon is first and foremost a retailer. But other online retailers, At Cost, a subsidiary of Onsale (ONSL), and privately held Buy.com, have adopted a strategy of selling goods at incredibly low prices and hope to make money off advertising. So you have to wonder if Amazon wouldn't be interested in some advertising-generated revenue of its own. By buying a portal, Amazon could get ad revenue without having to resort to the deep-discount tactics of some of its retail competitors.
Who could Amazon buy? With Yahoo too big (and having its own retailing aspirations) and Excite now off the block, some analysts say Lycos (LCOS) may be the only one left. And why not? Even though a Lycos deal could be expensive -- its market cap is approximately $5.8 billion compared to Amazon's market value of nearly $20 billion -- Lycos' network of Web sites, including Tripod, Hot Bot and WhoWhere, had 26.4 million visitors in December, nearly three times as many visitors as Amazon. Lycos will also probably earn a profit before Amazon. The company is predicted to earn 34 cents a share in fiscal 2000 (ending June). And if, as Appleby says, the endgame is getting as much traffic as you possibly can, then you would think it would behoove Amazon to move beyond commerce into content.
But most analysts doubt Amazon is looking to enter the portal business, at least not the way Lycos and Yahoo do it now. "Amazon wants to be the place where you find something to buy," says Zeilstra. "They don't want to be responsible for giving people email addresses and weather forecasts."
And Cassar says Amazon already has some portal-like capabilities on its site; they are just clearly geared toward retail. Amazon has a Shop the Web feature that allows consumers to look for products Amazon doesn't sell, like hardware and apparel from retailers such as Cyberian Outpost (COOL) and Bluefly (BFLY). And even this service is viewed as more of a test for what products Amazon could eventually sell on its site. For example, if the company finds many customers using Shop the Web to buy clothing, Amazon would probably decide to set up its own apparel shop, Cassar says.
Amazon on the Amazon?
Finally, there's the possibility that Amazon could stick to its current roster of products but continue to expand geographically. That's exactly what Mitch Bartlett, an analyst with Dain Rauscher Wessels, expects. The company already operates Amazon sites for sales in the United Kingdom and Germany. And Amazon entered both markets through acquisitions, purchasing British online retailer Bookpages and German online bookseller Telebook in April.
Amazon did not break down international revenues in its financial results but the company did say that fourth-quarter sales from England and Germany more than quadrupled from the third quarter. Zeilstra estimates that 25% of Amazon's fourth-quarter sales come from its international sites.
Regardless of what Amazon decides to do, it appears that 1999 is shaping up as a year of rationalization and consolidation in the online world. If Amazon intends to remain the king of e-commerce, it would be wise for Bezos & Co. to make some more acquisitions. After all, Amazon's stock, while up more than 1000% since the beginning of 1997, is down nearly 40% from the all-time intra-day high of 199 1/8 it hit in early January. The stock is, of course, still valuable currency. But there's always the danger that one day it will have about as much value as the pile of Monopoly money we dumped on your lawn. |
