That article on Amazon.com was right on. The entire edition is big-time bearish. Especially that Abelson article.
I sure hope Asia and Europe drop nicely on Monday while the US is closed. Should make for a fun Tuesday morning...Amazon should drop 20 points alone. <g>
Here's Amazon.bomb article...
interactive.wsj.com
Amazon.bomb
Investors are beginning to realize that this storybook stock has
problems
By Jacqueline Doherty
Until a few weeks ago, investors couldn't get enough of Amazon.com.
Perhaps it was because Amazon's story is so easy to like. Founder Jeff Bezos
did what many people only dream of: He chucked a high-paying, stable job to
become his own boss and seek his fortune as an Internet pioneer. Just over a
month ago, the stock market was indicating that Amazon was worth a
remarkable $36 billion and that Bezos' own stake was worth $13 billion.
But since early May, a lot of investors have been
learning that a good story does not always make
a good stock. From an April high of 221 1/4, Amazon shares have been
sliced nearly in half, to 118 3/4, cutting the company's worth to about $19
billion and reducing Bezos' fortune to $7 billion. The stock could fall a lot
further. Remember, adjusted for stock splits, these shares were worth just $3
apiece when they were first issued to the public two years ago. Several
analyses, including two in this magazine, have indicated that the shares could
be worth less than $10 apiece.
Unfortunately for Bezos, Amazon is now entering a stage in which investors
will be less willing to rely on his charisma and more demanding of answers to
tough questions like, when will this company actually turn a profit? And how
will Amazon triumph over a slew of new competitors who have deep pockets
and new technologies?
We tried to ask Bezos, but he declined to make himself or any other
executives of the company available. He can ignore Barron's, but he can't
ignore the questions.
Amazon last year posted a loss of $125 million on revenues of $610 million.
And in this year's first quarter it got even worse, as the company posted a loss
of $61.7 million on revenues of $293.6 million.
So far Bezos has been able to mollify most investors by telling them that his
company is not just an online bookseller, but instead a retailer of many things.
He has, in fact, moved into selling music CDs and drugs online. But these
products can have even lower profit margins than books.
More important, the addition of entirely new product lines such as CDs and
drugs has masked the slowing growth in Amazon's basic book business. In
1997, Amazon's book sales grew by 825%. Last year growth slowed to
260%. This year, Amazon stopped reporting its revenues by category. But
analysts have concluded that the growth in book revenues will drop to 90% in
1999, and it will be even lower next year. A slowdown by any measure.
Despite all the hoopla surrounding Amazon, Bezos has not really
revolutionized the book industry at all. In essence, he is a middleman, and he
will likely be outflanked by companies that sell their wares directly to
consumers. To begin with, publishing houses themselves could sell their books
online. And new technologies promise to cut costs even further by allowing
consumers to download books via the Internet. Books can be printed out on
traditional computer printers or put into a new notebook-sized computer
device that displays books on its screen a page at a time.
One such device is the Rocket eBook, sold for $499 each by NuvoMedia.
It's true that the retail price will have to fall further before Americans buy
eBooks en masse. But it will happen. Right now eBook users can download
the digitized content of a book from several Internet sites. There are 550 titles
available, with Stephen King's novels and Monica's Story among the most
notable.
Who owns NuvoMedia? The company is private, but Barnes & Noble's
Internet unit and the German publishing giant Bertelsmann each own a 17%
stake, which they bought at the beginning of last year.
Such new publishing technologies have incited a battle over who has the rights
to the electronic versions of books and what the royalty structure of electronic
books should be. Essentially, the fighting is about how the profits should be
divided. "It's an extraordinarily touchy issue in the industry right now," says
William Black, a consultant to the publishing industry through his own firm,
Black & Co.
Here's another potential threat to Amazon: What's to stop famous authors
from establishing their own Websites to sell their books? If Madonna can
have her own record label, the theory goes, why can't Stephen King or
Danielle Steel have their own book imprint?
Perhaps the premier company in selling its wares directly over the 'Net is Dell
Computer, which takes in $14 million a day by peddling its goods online. You
can bet that this has put a big dent in computer sales at traditional retail stores.
Likewise, it can't be lost on Bezos that Bertelsmann has taken a 41% stake in
Barnes & Noble's online venture, barnesandnoble.com. Bertelsmann, which
owns such high-profile publishing houses as Random House and Bantam
Doubleday Dell, "is going to try to take the market away from Amazon,"
predicts Stephanie Oda, publisher of Subtext, a newsletter about the
publishing industry.
Bertelsmann Chief Executive Officer Thomas Middelhoff concedes this much:
"We will sell books more like Michael Dell sells computers."
The direct-sales principle is changing the
music industry as well, and that could mean
trouble for Amazon's effort to sell CDs.
Just last week Universal Music, a division
of Seagram, and BMG Entertainment,
Bertelsmann's music arm, teamed up with
AT&T and Matsushita Electric of Japan to
create technology to sell music over the
Internet.
Against this backdrop, Amazon is looking
more and more like a traditional retailer,
complete with an expensive network of
warehouses loaded down with inventory.
So far this year, Amazon has bought two
warehouses in Kentucky and signed leases for facilities in Nevada and
Kansas, adding to its two existing sites in Seattle and Delaware. In other
words, Amazon is buying a lot of costly bricks and mortar, the very stuff that
is supposedly bloating costs at traditional retailers.
Those traditional retailers, meanwhile, are moving onto Amazon's turf. Just
last week, Barnes & Noble's online arm, barnesandnoble.com, raised $421.6
million on the stock market, suggesting the unit has an overall value of $2.5
billion. Even Borders, the bookstore chain that has been the farthest behind in
the race to capture online eyeballs on the 'Net, just announced a
cross-marketing agreement with Internet upstart About.com.
In the retail drug area, traditional players such as CVS and Walgreen are
boosting their online efforts. Earlier this month CVS, the country's largest
drugstore chain, announced it will purchase the Internet's first online
drugstore, Seattle-based Soma.com, for $30 million. Walgreen plans to launch
its Website in August. All manner of other retailers can be expected to follow
suit.
"Once Wal-Mart decides to go after Amazon, there's no contest," declares
Kurt Barnard, president of Barnard's Retail Trend Report. "Wal-Mart has
resources Amazon can't even dream about."
Soon Amazon will be encountering competition on the Internet from even the
nation's mom-and-pop bookstores. By August, the American Booksellers
Association will launch BookSense.com, a program that will let local stores
launch individual Websites with their own logos, designs and book reviews.
The association will provide back-office support, including credit-card
processing for Internet sales and an online catalogue of 1.6 million book titles.
The association estimates that only about 2% of adult books purchased in the
U.S. last year were sold via the Internet. That means it's still early enough for
smaller bookstores to take a shot at grabbing 'Net customers.
"The first mover does not always win. The importance of being first is a
mantra in the Internet world, but it's wrong. The ones that are the most
efficient will be successful," says one retail analyst. "In retailing, anyone can
build a great-looking store. The hard part is building a great-looking store that
makes money."
Figuring out how to make a profit won't be easy. Publishers usually sell books
to retailers at 44%-48% of the book's suggested list price. Similarly,
wholesalers sell books to retailers at 40%-42% of the list price. Either way,
when retailers offer customers a 50% discount, there's a good chance that
they're losing money on the deal. Yet just recently Amazon decided to offer
50% off on the books on the New York Times' best sellers list, and
barnesandnoble.com and Borders.com quickly followed Amazon's lead.
Adding to the cutthroat competition are various Websites with search
engines that track down whatever book you want at the lowest price. On top
of all that, there's the site called Buybooks.com, which has a stated business
plan of undercutting Amazon's prices by at least 10%.
In this tough environment, it probably shouldn't be surprising that Amazon is
losing so much money. In fact, the company had negative operating margins of
about 10% in the first quarter, meaning it spent $1.10 to bring in each $1 of
revenues. And results are expected to get worse in the second quarter, when
operating margins should be a negative 23% as the company raises its
spending on advertising and warehouses dramatically, says Sara Zeilstra,
consumer e-commerce analyst at Warburg Dillon Read. She has a "hold"
rating on the stock.
Bulls on Amazon stock prefer to look at Amazon's gross margin, positive
22.1%. But that takes into account only the actual cost of the books and not
the company's other operating costs, like advertising. If Amazon stopped
spending on advertising to build its brand name, the company could turn a
profit, the bulls contend.
It's a convenient theory, because Amazon doesn't disclose exactly how much
it spends on advertising and some of the costs of filling orders. The company
breaks out only "marketing and sales expense," which last year totaled $133
million. However, this number is somewhat misleading because it also includes
some of the costs Amazon incurs to fill orders for its customers. It can be
argued that the company's heavy spending on advertising is being used to
build a brand name, a long-lasting asset, but that's not true of fulfillment costs,
which won't go away. In fact, they will only get larger as Amazon grows.
Adding to the bloat at Amazon is its recent hiring binge. In the first quarter of
this year alone, the company increased its payroll by about a third, to 3,000.
Unfortunately, because of the way Amazon reports its results, there is no way
to figure out how much of the increase in Amazon's operating costs are
coming from its added employees and how much from advertising expenses.
None of these concerns have stopped Wall Street analysts from remaining
bullish on the stock. Morgan Stanley Dean Witter's Mary Meeker, dubbed
"Queen of the 'Net" in a Barron's cover story in December, still has an
"outperform" rating on the stock. In April, Donaldson Lufkin & Jenrette's
analyst, Jamie Kiggen, increased his price target for Amazon to $280 from
$190 and upped his rating to "top pick" from "buy." At Citigroup's Salomon
Smith Barney unit, Richard Zandi isn't far behind with a $220 target and a
"buy" recommendation.
Then, of course, there's Henry Blodget, the man who captured headlines by
calling for Amazon shares to rise sharply in December of last year. He has
since moved from CIBC Oppenheimer to Merrill Lynch, but continues to
have a "long-term buy" recommendation on the shares and predicts the price
will rebound to $150.
Such analysts have kindly gone along with the company's method of using
"proforma net income" numbers to judge Amazon's performance instead of
using the measure of net income prescribed under Generally Accepted
Accounting Principles. The pro-forma numbers make Amazon look much
more attractive because they exclude merger and acquisition costs. Chief
among these is goodwill, the difference between what assets are valued at on
the books and what the acquiring company pays for those assets. Goodwill
must be deducted from earnings over the assets' useful lifetime.
Analysts have so uniformly embraced
Amazon's pro forma method of
reporting earnings that even earnings
services First Call and I/B/E/S have
gone along.
The pro-forma numbers make a
substantial difference. Amazon reported
a first-quarter net loss of $36.3 million,
or 23 cents a share, on a pro-forma
basis. That is far better than the net loss
of $61.7 million, or 39 cents a share,
the company would have reported if it
kept its books as almost all other U.S.
firms do. Making matters worse, as the number of Amazon's acquisitions
increase, and its goodwill levels climb, the gap between pro-forma net income
and actual net income will grow larger. At some point, it will become too big
for investors and analysts to ignore.
The situation is made worse in Amazon's case because the company
amortizes its goodwill over two or three years instead of the 20- or 30-year
periods used by most industrial companies. The reason? In the fast-paced
Internet world, most assets are not seen as longlasting.
Despite the use of pro-forma gimmickry, the first cracks in Amazon's shares
appeared in April after the release of the firm's first-quarter earnings. The
company surprised its shareholders by indicating its losses would be much
greater than expected and would last for far longer than expected. Prior to the
announcement, analysts were expecting a pro-forma loss of 91 cents a share
for this year. Now that number has been almost doubled, to a loss of $1.70,
or $274 million, according to First Call. Likewise, for the year 2000, the loss
estimates ballooned from 29 cents to $1.27, or $204 million. The company is
expected to reach $1 billion in revenues this year, and could surpass $2 billion
next year.
Adding to Amazon's woes is its decision to build warehouses. In the past,
Amazon very of ten would simply take an order and turn to a wholesaler such
as Ingram Book Group to buy the book. It meant that Amazon didn't have to
keep huge inventories of books on hand. Now that Barnes & Noble is
attempting to acquire Ingram, there is some question whether Amazon will be
able to rely on the wholesaler as it has in the past.
Traditional booksellers like Barnes & Noble and Borders already have
warehouses around the country. Taken together, Ingram and Barnes & Noble
have enough distribution sites to offer overnight delivery at no extra cost to
about 80% of the U.S., says Zeilstra at Warburg Dillon Read. The best
Amazon can offer right now is delivery in three to seven business days, and
that's if it has the book in stock.
Amazon, which had distribution facilities in Seattle and Delaware, earlier this
year announced that it leased additional warehouse space in Nevada and
Kansas. And last week Amazon bought two distribution facilities in Kentucky.
The firm is also leasing office space in what used to be a hospital in Seattle,
and it has added distribution sites in Regensburg, Germany, and Slough,
England.
Zeilstra estimates that Amazon's latest moves have increased its U.S.
warehouse space from a little under 300,000 square feet at the end of last
year to 2.7 million square feet. So it shouldn't be surprising that Amazon's
lease expenses have surged. In 1997, the company estimated that its minimum
lease and marketing spending for 1998 would be $13.9 million. About two
thirds of that was for lease payments. For this year, Amazon estimates that
minimum lease and marketing commitments will be $47.6 million. That's a
substantial expense for a company that's expected to lose $274 million on a
pro-forma basis this year.
What's amazing is that the $47.6 million
probably doesn't include the company's
variable advertising costs, like the bills
for placing ads in magazines or on
television, explains Marie Menendez, a
senior analyst at Moody's Investment
Services. She believes the number
includes only the commitments for
banner ads on Internet sites. Amazon's
lease and marketing expenses "look a
lot like rent for bricks-and-mortar
retailers," she notes.
Indeed, traditional retailers normally
have lease expenses that run between 5% and 10% of their revenues. Despite
all Amazon's hollering about being a "virtual" company, its minimum lease and
marketing payments could easily exceed 5% of this year's revenues.
Another drawback of warehouses is that they are usually chock full of
inventory, and that costs money. "As they build these warehouses, they have
to fill them up with stuff, and all of a sudden Amazon isn't so virtual anymore,"
says Warburg's Zeilstra.
Bulging inventories will dramatically change Amazon's business model. No
longer can the company sell a book, receive payment for it on the same day
and then stuff the cash in interest-bearing securities for 30 days until it must
pay the wholesaler for that book. In short, Amazon will be joining the real
world, where bookstores place their orders months in advance, long before
they take in customers' cash.
Amazon's true believers refuse to see these factors as problems. They choose
to view Amazon as some new breed of retailer, impervious to the old rules of
profit and loss. These folks argue that although it costs Amazon a lot in
marketing dollars to attract new customers, getting repeat customers costs
little and generates much better margins. And it's true that an amazing 66% of
Amazon's first-quarter revenues came from repeat purchasers. But will that
traffic allow Amazon to rake in dollars from advertisers?
"When you command 10 million customers, then you become attractive to
advertisers," says Ravi Malik, a portfolio manager at Froley-Revy Investment
Co. "In the short run it's going to be volatile, but in the long run, I think
Amazon is using the right strategy."
This line of reasoning usually ends with Amazon being compared to America
Online. The idea is that Amazon can increase its customer traffic enough to
attract advertising dollars, just as AOL has. But there are some important
differences between AOL and Amazon. First of all, AOL provides a service
for which users get charged $20 a month. It also offers e-mail, which insures
steady traffic and is a pain to change once a client's friends and business
contacts have his or her address. Simply put, torpidity keeps a lot of
customers coming back to AOL.
AOL also has amassed what's considered to be the biggest audience of users
on the Internet, 16 million subscribers in all. Amazon has only half that many
clients, and most view the site as a retailer rather than as a source of
information or entertainment. That's why they don't tend to hang out on the
Amazon site for hours at a time the way they do at AOL.
It's hard to say when it will dawn on the masses that Amazon's growth is
slowing markedly. In 1997, the company's revenues grew 825%, admittedly
from a small base. This year that growth is expected to skid to 128%, and
next year it will topple to 58%. Within a few years, this company could be
increasing revenues at an annual rate of 10% or so.
To fight this relentless slowdown, Amazon has been adding new businesses at
a rapid pace. It launched online music offerings in June of last year and added
video and holiday gift offerings in November. The company bought a 46%
stake in drugstore.com in December, followed in March by the purchase of a
50% stake in Pets.com, an online pet-supply source. By April, Amazon
announced plans to acquire LiveBid.com to compete head-to-head with eBay
in the online-auction arena. Amazon's most recent acquisition occurred in
May, when Amazon purchased a 35% stake in HomeGrocer.com for $42.5
million.
Such diversification efforts allowed Amazon.com to reduce its book business
to 71% of total revenues in the first quarter of this year, down from 100% a
year earlier. But these new businesses haven't helped Amazon get any closer
to making a profit. Increasingly, Amazon's strategy is looking like the
dim-bulb businessman who loses money on every sale but tries to make it up
by making more sales.
But make no mistake, this could go on for quite a while. Despite Amazon's
mounting losses, the company has $1.4 billion in cash. That's enough to cover
a lot of losses and buy up a few more Internet companies, too. The cash is
not from the $50 million of net proceeds Amazon raised in its May 1997 initial
public stock offering but rather from the sale of $530 million of junk bonds in
May 1998 and $1.25 billion of convertible notes, which have junk-bond
ratings, sold in February. And don't be surprised to see Amazon try to raise
more funds. The company has registered with the Securities and Exchange
Commission to sell an additional $2 billion of debt, equity or preferred stock.
While Amazon's shareholders may be oblivious to considerations such as
profits, the credit-rating agencies have taken a wary attitude toward the
company, with Moody's Investors Service rating the bonds Caa1 and
Standard & Poor's rating them single-B. Nonetheless, investors stampeded
into the company's junk offering, perhaps because it sported an annual interest
rate of 10%.
Eventually, shareholders and bond buyers will wise up.
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