Crystal ball, Part 1 of AMAZON/AOL BARRON'S article
Barron's OnLine, May 31, 1999
Amazon.bomb
Investors are beginning to realize that this storybook stock
has problems
By JACQUELINE DOHERTY
Cover story ,Part 1
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.
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