I promised the thread that I would present a case for Amazon.com as a Gorilla-King (Godzilla that is) eWorld investment as well. We know that Amazon is in the new chapter of the revised edition of The Gorilla Game. Again, I want to run some numbers on Amazon - not simply just using the Icarus scoring system that Moore/Kippola/Johnson have used, but on the tight criteria for choosing a good quality growth stock using five basic fundamentals. As I mentioned before, it comes from The Fool's starting point method at The Motley Fool. I don't take any credit for these 5 fundamentals. They can and should be used to apply to any growth stock for first viewing pleasure. Repeat - first viewing pleasure. One has to sometimes go beyond a list of 5 considerations. Then, certain rules or criteria sometimes have exceptions. Amazon and AOL fit into the exception category. Keep in mind, in the world of Godzilla - it is a winner take all zero sum game. The lack of earnings at Amazon in the short term will be more than compensated in the end of the game is won.
Much of the below information is a repeat of the format I used when evaluating eBay. However, for comparison's sake, I think it is best that I try to stay within the same framework. (Besides, that way I don't have to type so much. <g>)
So here goes. Here are the five criteria we should look for in a growth stock:
1. Sales growth in excess of 15% over the previous year.
2. Gross margins holding steady or rising and above 50%.
3. Cash savings that amount to 5 times more than long-term debt.
4. Inventory that is growing no faster than sales over the past year.
5. Receivables that are not growing faster than sales over the past year.
I think it is safe to assume we all know what Amazon.com is all about. If not, buzz on over to amazon.com and please - do get up to date. Unlike eBay - where I didn't see any reason to invest in this stock until my summer trip to the states and reminder that people like to buy and sell junk - I have been a long time customer of Amazon.com. You could call me lazy for not seeking out other online stores to order my books, music and videos that might offer a better price. However, the stickiness, brand and service of Amazon.com have this 38 year old hooked. I don't know if I am a typical Amazon customer, but I figure my annual Amazon.com orders total well over $500. Nevertheless, I became attracted to Amazon as an investment in 1998. I guess that means this post will be a little more lengthy than the eBay post. <g>
Now, let's apply those standard tough, Foolish criteria to Amazon.com and see what the Fools say about Amazon.
Amazon (10-Q, 8/16/99)
Sales growth: 312.8%
Gross margins: 78.2%
Cash-to-debt: 1.2x
Inventory growth: 101.3%
Receivables growth: na
Here's a company that meets most of our fundamental criteria on the list. Sales have been extremely strong; gross margins are, like eBay, in the stratosphere. Amazon has much more debt than we would like to see, but unlike eBay, they had huge start-up costs and have financed it through debt and will continue to spend to grow at this point. I couldn't find any any formation on receivables at the following locations (they all listed them at 0):
quote.fool.com
siliconinvestor.com
siliconinvestor.com
siliconinvestor.com
What do our manual authors say about Amazon?
*The retail store model: Currently the darling of the industry, thanks to Amazon.com, this model raises concerns when we look toward a future of agent-driven price comparisons driving down commodity margins to an effective rate of zero. Already some sites are losing money on product sales in order to gain a customer relationship they plan to extract profits from by other means. (revised manual page 325)
......."and so it goes. No one knows what models - or, more likely, what combination of models - will thrive in a mature Internet sector, and so we see the current public companies and a host of private ones leaping like frogs from pad to pad, looking for a sustainable home. This is a temporary phenomenon. Sooner or later, business models must settle down. But in the meantime it has a curious impact on valuations that we are calling the option effect. (revised manual pages 326-7)
Books, Music, Video, Toys & Games, Electronics, e-Cards, Auctions, zShops (new) - and the list (or option effect) is growing. Toss in the partnerships and alliances to the fold as well. The option effect - in a nutshell - is that what the company is today will be much different in the future. Already, since the revised edition was penned in the second quarter of 1999, Amazon has grown into a different beast via the option effect than it was in April - June. Likewise, it is fairly safe to assume that a few months from now it will have grown and added portions via the option effect as well. Nonetheless, let's run the Icarus Scores via the author's suggestion.
As I mentioned before, running the Icarus Scorecard on AOL, Yahoo!, Amazon.com and eBay ranked AOL first, eBay second, Amazon third followed by Yahoo! in the second quarter of 1999. The criteria used in the Icarus scoring for the Godzilla includes these items:
Switchboard/exchange
Brand
Value chain position
Specialization
Stickiness
Low-cost business design
Experience curve
Each are weighted with High Medium and Low (5,3,1) as it pertains to GAP and CAP for a total weighting score for each item. Then the total weighting is added together for the total score based on the Icarus scoring method. It's not a fool proof method, but in conjunction with the Fool method above of matching the five tight criteria (which many companies fail - believe me), I think we have a good working basis to at least attempt to make sense of this crazy eWorld Godzilla game.
A few more rules from our authors:
It's not a gorilla game. Don't confuse the two.
Take a buy-and-hold approach.
Pick individual stocks based on Icarus scores.
Don't buy baskets of stocks.
Icarus Scores for Amazon.com are:
I have given a brief summary below of the scoring. Under each section the score is multiplied by the weight to come up with the weighted score for that section. Then you tally all the weighted scores to get the total score.
Each item is related high, medium or low, scored 5, 3 and 1 respectively. Focus stands for strategic focus and success stands for marketplace success to date. These scores come from the second quarter of 1999 by the authors of the revised edition. It is important to remember that we are now a quarter beyond that and have entered into the fourth quarter. More adjustment might have to be given to Amazon since they have added things to their site since the authors did this scoring earlier this year.
The authors go on to say this:
"Finally, we should note that this analytical framework ranks the combined GAPs and CAPs of the four investments in the following order: AOL, eBay, Amazon and Yahoo!. Again, whether this ranking is 'correct' or not is not the primary issue. What it does force is a discussion about why this sequence. In our case, this leads us to draw attention to AOL's first-mover advantage in terms of its market mass, eBay's ability to leverage the one business model we think is truly gorilla-like, and Amazon's and Yahoo!'s lower switching costs, which give them exposure to long-term brand erosion and commoditization."
Are Amazon's lower switching costs really exposing them to long-term brand erosion and commoditization. As I mentioned above, they've got me hook, line and sinker. I'm a happy customer who has no desire to look elsewhere. This Godzilla Game may be segmented in terms of a winner take all. Amazon is now a combined Internet stock business model (retail, auction, etc...). Could it win the books and video market, yet play second fiddle in the auction market or another portion of there portfolio? Sure. It's all open for speculation and discussion.
Amazon
Switchboard/exchange
Focus - L
Success - M
Score - 4
Weight - 10
Weighted Score - 40
Brand
Focus - H
Success - H
Score - 10
Weight - 8
Weighted Score - 80
Value Chain Position
Weight - 8
Specialization
Weight - 8
Stickiness
Focus - H
Success - M
Score - 8
Weight - 6
Weighted Score - 48
Low-cost business design
Focus - H
Success - M
Score - 8
Weight - 4
Weighted Score - 32
Experience Curve
Focus - H
Success - M
Score - 8
Weight - 4
Weighted Score - 32
Total Score - 232
How could we adjust some of these scores considering so many things have been added to Amazon since the author's applied the above Icarus scores to it in the second quarter 1999?
Then again, there is the whole issue of cash flow as it pertains to trying to value Amazon. I'm not a cash flow expert, but maybe somebody else would like to take a stab at that. I know Henry Blodget(t) talks about Amazon's cash flow as well as Dale Wettlaufer over at the Fool.com.
Let's go back to a Recap of 1998, courtesy of the Amazon.com Investor Relations site.
Heads-down focus on customers helped us make substantial progress in 1998:
Sales grew from $148 million in 1997 to $610 million - a 313% increase. Cumulative customer accounts grew from 1.5 million at the end of 1997 to 6.2 million at the end of 1998 - an increase of over 300%. Despite this strong new customer growth, the percentage of orders placed on the Amazon.com Web site by repeat customers grew from over 58% in the fourth quarter of 1997 to over 64% in the same period in 1998. Our first major product expansion, the Amazon.com music store, became the leading online music retailer in its first full quarter.
Following their October launch under the Amazon brand and with Amazon.com technology, the combined fourth-quarter sales in the U.K. and German stores nearly quadrupled over the third quarter, establishing Amazon.co.uk and Amazon.de as the leading online booksellers in their markets.
The addition of music was followed by the addition of video and gifts in November, and we became the leading online video retailer in only 6 weeks. 25% of our fourth-quarter 1998 sales was derived from Amazon.co.uk, Amazon.de, and music, video, and gift sales on Amazon.com, all very new businesses.
We significantly improved the customer experience, with innovations like 1-Click(SM) shopping, Gift Click, store-wide sales rank, and instant recommendations. 1998's revenue and customer growth and achievement of continued growth in 1999 were and are dependent on expansion of our infrastructure.
Some highlights:
*In 1998 our employee base grew from approximately 600 to over 2,100, and we significantly strengthened our management team.
*We opened distribution and customer service centers in the U.K. and Germany, and in early 1999, announced the lease of a highly-mechanized distribution center of approximately 323,000 square feet in Fernley, Nevada. This latest addition will more than double our total distribution capacity and allows us to even further improve time-to-mailbox for customers.
*Inventories rose from $9 million at the beginning of the year to $30 million by year end, enabling us to improve product availability for our customers and improve product costs through direct purchasing from manufacturers.
*Our cash and investment balances, following our May 1998 high yield debt offering and early 1999 convertible debt offering, now stand at well over $1.5 billion (on a pro forma basis), affording us substantial financial strength and strategic flexibility.
*We're fortunate to benefit from a business model that is cash-favored and capital efficient. As we do not need to build physical stores or stock those stores with inventory, our centralized distribution model has allowed us to build our business to a billion-dollar sales rate with just $30 million in inventory and $30 million in net plant and equipment. In 1998, we generated $31 million in operating cash flow which more than offset net fixed asset additions of $28 million.
I'm sorry I didn't get this completed on time. My six year old son just got sick all over his bed, MSFT reported, Judge Jackson announced he will rule on any Friday at 6:30PM in the trial (what the heck does that mean), Siebel is about to report and I've had three beers to consider my beloved Dell stock.
BB
Next up in the Godzilla winner take all look - DoubleClick.
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