10:18am EST 29-Mar-99 Merrill Lynch (H.Blodget/T.Pankopf) AMZN
AMAZON.COM:Announces Auction Similar to eBay's
ML++ML++ML Merrill Lynch Global Securities Research ML++ML++ML
AMAZON.COM (AMZN/OTC)
Announces Auction Similar to eBay's
Henry Blodget (1) 212 449-0773
Tonia Pankopf (1) 212-449-1011
ACCUMULATE*
Long Term
BUY
Reason for Report: Company Update
Price: $139 1/16
Estimates (Dec) 1998A 1999E 2000E
EPS: d$0.50 d$.90 d$0.28
P/E: NM NM NM
EPS Change (YoY): NM NM
Consensus EPS: d$0.91 d$0.29
(First Call: 24-Mar-1999)
Q1 EPS (Mar): d$0.07 d$0.29
Dividend Rate: Nil Nil Nil
Dividend Yield: Nil Nil Nil
Opinion & Financial Data
Investment Opinion: D-2-1-9
Mkt. Value / Shares Outstanding (mn): $2,085.9 / 154
Book Value/Share (Dec-1998): $0.90
Price/Book Ratio: 154.5x
LT Liability % of Capital: 53.6%
Stock Data
52-Week Range: $199 1/8-$12 7/8
Symbol / Exchange: AMZN / OTC
Options: Phila
Institutional Ownership-Spectrum: 35.3%
Brokers Covering (First Call): 20
ML Industry Weightings & Ratings**
Strategy; Weighting Rel. to Mkt.:
Income: Underweight (07-Mar-1995)
Growth: Overweight (07-Mar-1995)
Income & Growth: Overweight (07-Mar-1995)
Capital Appreciation: In Line (28-Jan-1999)
Market Analysis; Technical Rating: Below Average (28-Dec-1998)
*Intermediate term opinion last changed on 09-Mar-1999.
**The views expressed are those of the macro department and do not necessarily
coincide with those of the Fundamental analyst.
For full investment opinion definitions, see footnotes.
Investment Highlights:
o On March 29, Amazon.com announced the launch of a consumer-to-consumer
(C2C) auction service similar to eBay's. We regard this as excellent news for
the company and the stock.
o In our opinion, C2C auctions is a potentially enormous market opportunity-
one that could ultimately generate revenue from not only the trading of
collectibles but the exchange of goods and services that are currently sold
through classified advertising. Reflecting this potential, the leader in the
business, eBay, currently has a $20B market capitalization (4/5 of
Amazon.com's).
o We believe Amazon.com stands a good chance of becoming a leader in C2C
auctions (note its impressive track record in books, music, and videos, as well
as the competitive advantage provided by its large customer base and its
ability to integrate auctions into its other product offerings). This would
have very positive implications for the company's long-term franchise and
business model.
Online auctions is a high margin, highly scaleable business. The leading C2C
auction company, eBay, has been profitable since inception and is currently
cruising along with a 20%-plus operating margin. We believe that Amazon.com's
auction service could help the company increase its gross margin (eBay's gross
margin is 80% versus Amazon.com's 20%). To offer C2C auctions, moreover,
companies do not need to build additional fulfillment capabilities (C2C
participants mail checks and items directly to one another; the auction company
only facilitates the matching of buyer and seller). Amazon.com should be able
to quickly scale its auctions without stressing its existing fulfillment
capabilities
Auctions help create a "network-effect" that locks in customers. If you want
to get a good price for something you want to sell, it helps to sell it into a
marketplace in which there is the most possible demand. Similarly, if you want
to find something you want to buy, it helps to go to the marketplace that has
the largest available selection. One of the reasons eBay has been so
successful in what would otherwise be a business with very low barriers to
entry is that 1) it has a critical mass of both buyers and sellers and that 2)
this critical mass acts as a draw, luring ever more buyers and sellers to the
site. In December 1998, eBay had approximately 2 million registered users. In
our opinion, Amazon.com's 6 million customers represent a strong foundation
from which to build its auction community.
Auctions will allow Amazon.com to diversify its product offerings and more
easily scale its business. Amazon.com's currently offers books, music, videos,
and other products, all of which it sells and ships directly to its customers
from its distribution centers. The company's mission, however, is to help its
customers find and acquire anything they might want to buy online-a much larger
ambition than the current offerings suggest. The trouble with building out
product categories one at a time is that it takes time (it has taken Amazon.com
four years to roll out the three stores currently open on its site). If
successful, the new auction service will allow Amazon.com to increase its
product breadth quickly and efficiently, which should help attract additional
customer.
In our opinion, Amazon.com has a good chance of becoming a major player in
online auctions: 1) it has already proven its ability to move into new
categories and quickly become the dominant vendor (music and videos), 2) it has
an enormous customer base (6 million at the end of December versus 2 million
registered users at eBay and less than 1 million at Onsale), and 3) it will be
able to integrate its live auctions into its existing product offerings,
helping to boost demand in each individual auction. On this last point, the
paying customers in online auctions are sellers, not buyers. To attract the
most valuable paying customers, therefore, it helps to offer sellers more value
than they will find elsewhere. Although eBay's large community of buyers
currently offers sellers the most value in the market, we believe that
Amazon.com's ability to integrate the auctions into existing merchandise will
be very attractive.
Impact on Business Model. We believe Amazon.com's auction service could
improve the company's profitability. To analyze the impact the auction service
might have, we looked at eBay's performance last year. EBay ended 1998 with
2.1 million registered users, $47 million in revenue, and $40 million in gross
profit. If Amazon.com were to match eBay's 1998 success in 1999 (a seemingly
reasonable assumption, given Amazon.com's historical success in moving into new
markets and its large customer base), this would likely have the most visible
impact on the company's gross profit ($50 million in incremental revenue on a
$1.2 billion estimate is chicken feed; because of the profitability of that
revenue, however, the impact on gross profit is more significant). Our current
1999 gross profit projection for Amazon.com is $270 million. If the company
were to add the equivalent of eBay's 1998 $40 million of gross profit
performance in 1999, our gross profit number would increase 15%, to $310
million. We expect Amazon.com to spend heavily to ensure the success of the
auction business, so we do not expect to see any near-term improvement in the
company's operating loss. Long-term, however, we believe it could improve the
company's profitability.
Another point in the "fulfillment versus 'zero-gravity'" debate. One of the
big questions in the electronic commerce industry is whether companies should
own or outsource fulfillment (in other words, take inventory and manage
fulfillment or be purely "virtual" and outsource everything). In our opinion,
Amazon.com's move into the auction business suggests that the "shopping
portals" of the future will be hybrids: offering some services in which they
act as the direct fulfillment agent (taking inventory, shipping out of
warehouses, etc.) and others in which they simply facilitate the matching of
buyer and seller and take a small commission for doing so.
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