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MORGAN STANLEY DEAN WITTER
This memorandum is based on information available to the public. No representation is made that it is accurate or complete. This memorandum is not an offer to buy or sell or a
solicitation of an offer to buy or sell the securities mentioned. Please refer to the notes at the end of this report.
August 4, 1998
Technology: Mary Meeker (212) 761-8042
Internet mmeeker@ms.com
Amazon.com (AMZN):
AOL ? Part Deux! OUTPERFORM
Price 52-Wk Rng Div Yld Shs(MM) EPS 97A EPS 98E P/E EPS 99E P/E
$134 $147 - 12 -- -- 48 $(0.64) $(1.42) NM $(0.86) NM
KEY POINTS:
ú C2Q financial results better than plan ?On July 22,
AMZN reported a C2Q operating loss (EBITA) of $12MM
or EPS of a loss of $0.33. The EPS loss was better than our
estimated loss of $0.40 and First Call estimated loss of
$0.43.
ú Upside driven by revenue of $116MM, up 316% Y/Y
and 33% Q/Q vs. C2Q:97 revenue of $28MM and C1Q:98
revenue of $87MM. Revenue was nicely above our
$102MM estimate.
ú Cumulative customer accounts grew to an impressive
3.1MM, up 415% Y/Y and 39% Q/Q, above our 2.8MM
estimate. Repeat purchases constituted 63% of sales in
C2Q:98, up from 60% in C1Q. Note as always that each of
AMZN?s customers has handed over his/her credit card
number, entered his/her email and home addresses, and
made a purchase, all of which adds up to a very large, valu-able,
and growing asset for the company.
ú In a move reminiscent of our days of America Online
analyst masochism (a function of being a longtime
bruised/battered/triumphant AOL bull), we are in-creasing
our loss estimates for Amazon.com. Why? The
team from Seattle is ?swinging for the fences.? Their/our
view? Online retailing is going to be huge (already, Ama-zon,
based on this quarter?s financial results, by our math, is
the second fastest growing retailer in the history of the
planet), and no company is as well positioned to take ad-vantage
of the market opportunity, in part by spending to
grab share (in multiple markets) early, as Amazon.com is.
Translation? They are going for it. Remember, yikes,
Amazon.com
Stock Price Analysis
2 MORGAN STANLEY DEAN WITTER
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solicitation of an offer to buy or sell the securities mentioned. Please refer to the notes at the end of this report.
America Online spent $1B over ten years to nab 10MM
customers and it now carries a market value of $33B.
ú The more success AMZN has, the more it wants ?
expect an incremental 10?25% to be added to opex for ef-forts
related to customer acquisition, music, video and inter-national
expansion. Specifically, for AMZN, we are in-creasing
our EBITA loss for C1998E from $36MM to
$55MM and increasing our loss for C1999E from $6MM to
$25MM (and if the company has its way, it could be
greater). Our C2000E profit goes from $54MM to $41MM
while our C2001E profit is unchanged at $87MM.
ú As with AOL in the early days, it?s tough to determine
exactly where ?critical mass? is, and as long as customer
addition/repeat buying/revenue generation trends remain
especially positive, ongoing expense stoking is advised,
because when we turn to profitability, thanks in part to eco-nomics
of increasing returns, a captive customer base and
scale, profit growth can be especially positive.
ú We maintain our Outperform rating on AMZN
shares. AMZN is the leading retailer/merchandiser on the
Internet, and it carries first mover advantages, along with
the leading mind share, market share, and e-commerce ex-perience
skill set. Near term, valuation remains a concern,
but long term, we maintain that the stock, if the company
executes to its vast potential (60MM current Web users
worldwide), still has lots of running room. Shorting and
short covering will continue to be an issue ? most recent
short interest was 8.7MM shares, and the estimated float of
AMZN?s stock was 11MM shares.
ú In this note, we also detail the key points made by
AMZN management during the company?s 2 nd annual
analyst meeting, conducted on July 24, 1998.
C2Q:98 Financial Details
Revenue was $116MM, up 316% Y/Y and 33% Q/Q,? well
above our $102MM estimate. International sales ac-counted
for 22% of AMZN?s 2Q:98 revenue. The two in-ternational
online bookstore acquisitions announced April
27 th (details below) should increase AMZN?s percentage of
sales from foreign markets in future quarters. And with
two-thirds of worldwide book market revenue coming from
overseas, we continue to see international sales being a big
boost to AMZN?s top line.
AMZN maintained its big lead as the #1 online book
shopping site (75%+ market share) and in fact was again
the #2 online-specific shopping site (behind BlueMoun-tainArts)
based on reach (8.1% in June - Media Metrix).
AMZN?s reach was significantly higher than both of its di-rect
competitors, BarnesandNoble.com (which printed
$9MM in revenue in its April quarter) and Books.com. In
addition, AMZN announced ongoing growth in the number
of "associates" (Web sites that sell its products), with ap-proximately
90K associates currently, up from 40K at the
end of C1Q:98.
Gross Margin of 22.6% was up from 22.1% in C1Q. We
continue to believe that as AMZN?s buying power increases,
it will be able to reach higher gross margins ? the com-pany?s
target is 23?27%. Remember that traditional book
sellers like Barnes & Noble support gross margins near 36%
due to purchasing power and, in part, due to their ability to
charge higher prices in their retail locations.
Operating expenses were up 207% Y/Y and 34% Q/Q.
Operating expenses for the quarter reached $38MM. Ama-
Table 1
AMZN: C2Q:98 at a Glance
C2Q:98A C2Q:98E C2Q:97A
Revenue ($MM) $116 $102 $27.9
Q/Q Growth 33% 17% 74%
Gross Margin 22.6% 22.1% 18.7%
Op. Expenses ($MM) $37.8 $35 $12.3
Net Loss ($MM) $15.8 $19.1 $6.7
Oper. EPS ($0.33) ($0.40) ($0.16)
Shs. Out. (MM) 48.0 48.3 42.6
E = Morgan Stanley Dean Witter Research Estimates
Figure 1
Consumer Reach of Online Booksellers
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
Sep-
97
Oct-
97
Nov-
97
Dec-
97
Jan-
98
Feb-
98
Mar-
98
Apr-
98
May-
98
Jun-
98
Amazon.com
BarnesandNoble.com
Books.com
Source: Media Metrix
MORGAN STANLEY DEAN WITTER 3
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solicitation of an offer to buy or sell the securities mentioned. Please refer to the notes at the end of this report.
zon?s strategy continues to be to invest aggressively for the
long term, particularly in the area of sales and marketing.
Sales and marketing rose to $27MM, up 240% Y/Y and
36% Q/Q. As a percentage of revenue, sales and marketing
increased slightly from 22% to 23% Q/Q. Product devel-opment
rose to $8MM, up 187% Y/Y and 20% Q/Q. As a
percentage of sales, product development declined slightly
from 8% to 7%. G&A increased to $3MM, up 91% Y/Y
and 66% Q/Q. As a percentage of sales, G&A rose from
2% to 3%. Headcount during the quarter rose from 796 to
1,130.
Balance sheet fundamentals are healthy. Cash and cash
equivalents rose from $117MM in C1Q:98 to $340MM in
C2Q:98, due in large part to proceeds from the May 5 th
$326MM offering of 10-year, 10% senior discount notes.
Note that the company also reduced long-term debt by
$77MM in the quarter. With current liabilities of only
$72MM, AMZN?s liquidity ratios are strong (at the end of
C2Q:98, current ratio was 5.1)
Amazon?s working capital needs benefit from two factors
? almost all of its transactions are credit card based (so
accounts receivable are negligible) and the company?s busi-ness
model has so far required very little inventory. As
we?ve pointed out before, this is a company with a negative
cash conversion cycle ? it gets cash from customers be-fore
it gives cash to suppliers. Here are the details ? at the
end of 2Q:98, inventory days were 17, accounts payable
days were 48, and receivables days were 1, due to essen-tially
100% credit card purchases. That translates into a
negative cash conversion cycle of 30 days.
Inventory turns slipped a tad to 25 in C2Q:98 from 26 in
C1Q:98. We?ve been predicting that as the company in-creases
its on-hand inventory to stay ahead of demand, its
inventory turns would fall and likely settle in the 15-40
range. We?ve also pointed out that this is still more than an
order of magnitude better than traditional retailers.
C2Q:98 Metric Details
Cumulative customer accounts grew to 3.14MM, up
415% Y/Y and 39% Q/Q, well above our 2.8MM estimate.
The number of new customer adds rose to 880K from 750K
in 1Q:98. We estimate that Amazon?s customer accounts
now constitute around 5% of total worldwide Internet users
? you gotta ask why this can?t be a lot higher. Repeat pur-
chases constituted 63% of sales in C2Q:98, up from 60% in
C1Q.
The estimated number of visits per day continued to
grow strongly, ramping to 715K in 2Q:98, up 360% Y/Y
and 33% Q/Q. We also estimate that the number of books
sold rose to over 6.8MM in the quarter, from 5.1MM in
1Q:98.
Three Small Acquisitions Completed
AMZN also announced three acquisitions on April 27 th .
The aim of these acquisitions is to expand AMZN?s reach
into International and Video markets. The three acquisi-tions,
paid for with 540,000 shares plus some cash, lead to
$58MM in goodwill to be amortized over two years.
AMZN purchased:
1) ABC Telebook (www.telebuch.de) ? #1 online book
retailer in Germany.
2) Bookpages (www.bookpages.co.uk) ? #2 online book
retailer in UK.
3) The Internet Movie Database (www.imdb.com) ? #1
provider of online movie-related content.
High-Yield Debt Offering Completed
On May 5, AMZN received $326 million from the sale of
10-year 10% senior discount notes (zero coupon for the
first five years). The company will use approximately $75
million of the proceeds to retire a $75MM credit facility and
expects to use the remainder for general corporate purposes,
including working capital, expansion into sales of music
products and international markets, and capital expendi-tures.
The notes are noncallable for five years and callable
thereafter at a premium declining to par in year eight.
Table 2
Basic Growth Metrics for AMZN, C3Q:97 ? C2Q:98
C3Q:97 C4Q:97 C1Q:98 C2Q:98
Revenue ($MM) $37.9 $66.0 $87.4 $116.0
Q/Q Growth 36% 74% 32% 33%
Customers Accounts at
Quarter End (000s) 940 1,510 2,260 3,140
Q/Q Growth 54% 61% 50% 39%
Customer Adds (000s) 330 570 750 880
4 MORGAN STANLEY DEAN WITTER
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solicitation of an offer to buy or sell the securities mentioned. Please refer to the notes at the end of this report.
Competitive Dynamics
Barnes & Noble (BKS) reported its April quarter results
on May 21, 1998. It announced $9.4MM in online book
revenues, up 14% Q/Q. The C1Q:98 operating loss for the
online book segment was $13.6MM. The company is re-porting
that through May 2, 1998, its Internet segment had
more than 500,000 customers and over 6,500 affiliate sites.
For the year 1998, Barnes & Noble is forecasting $100MM
in sales through its barnesandnoble.com site. Borders
(BGP) told analysts before it launched its Web site on May
8, 1998, that it expected to generate $25MM in online sales
in FY99, which ends January 1999.
As for AMZN?s budding music presence, we note with in-terest
that leading Internet music retailer CDNow (CNWK)
stated during its C2Q:98 earnings release conference call
that it viewed Amazon.com as one of its two major com-petitors,
the other being N2K, the other current leading
Internet music retailer. Pretty impressive given that until
this quarter, Amazon.com hadn?t sold a single CD or cas-sette.
Outlook
C3Q should see total revenue of $133MM. Gross margin
should hold at 22.6%, and operating expenses should rise to
$49MM. Operating net income should come in at a loss of
$23MM or a loss of $0.47 EPS. We continue to estimate
breakeven in C2000.
For C1998, we estimate total revenue of $519MM, gross
margin of 22.7%, and operating expense of $173MM. We
see operating net income coming in at a loss of $68MM ?
EPS of a loss of $1.42.
For C1999, we are looking for $857MM in total revenues,
gross margin of 24.5%, and operating expenses of
$235MM. Operating net income should be a loss of
$44MM, with EPS of a loss of $0.86.
Highlights of C2Q:98
July 21, 1998 ? AMZN and Intuit announce a multi-year,
multi-million dollar agreement naming AMZN as
Quicken.com?s exclusive bookseller in the United States,
and the preferred provider of books in the United Kingdom
and Germany.
July 21, 1998 ? AMZN confirms a tentative agreement
with Compaq whereby Amazon.com will be included in
new shipments of Compaq Presario personal computers.
June 11, 1998 ? AMZN opens its online music store, of-fering
more than 125,000 music titles ? 10 times the number
the average music store offers ? at savings of up to 40%.
June 8, 1998 ? AMZN announces that enrollment in its
Associates program has doubled in four months to more
than 60,000 members.
May 8, 1998 ? Borders opens its Web store, offering books,
music, and videos.
May 5, 1998 ? AMZN receives $326 million from the sale
of 10-year 10% senior discount notes (zero coupon for
the first five years).
April 27, 1998 ? AMZN announces that it has acquired
three leading Internet companies: Bookpages, Ltd; Tele-book,
Inc.; and Internet Movie Database Ltd.
April 27, 1998 ? AMZN announces two-for-one stock split,
effective June 1, 1998.
April 23, 1998 ? AMZN announces that it is seeking cus-tomer
input into the construction of its virtual music
store. Note that the worldwide retail music market is esti-mated
at $40B in revenue (compared with $85B for books).
Also note that Forrester predicts online music sales to reach
$4.2BB by 2002. Already, CDNow and N2K, two leading
online music retailers, have reached a combined annual
revenue run rate of $75MM+. While non-book revenues are
likely to be almost negligible for AMZN in FY98, we esti-mate
that they could reach 15% by 2001.
April 7, 1998 ? AMZN announces that it has formed an ex-clusive
Associates relationship with iVillage: The
Women?s Network. AMZN and iVillage will offer book-related
features and content across all nine iVillage.com
channels.
Analyst Conference Highlights:
ú Amazon.com?s 2 nd annual analyst meeting, conducted
on July 24, 1998, was positive and upbeat.
ú Key management presentations included: Jeff Bezos
(Founder and Chief Executive Officer), Joy Covey (Chief
MORGAN STANLEY DEAN WITTER 5
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Financial Officer), Rick Dalzell (Chief Information Officer),
Jimmy Wright (Chief Logistics Officer), Mary Engstrom
(Vice President, Merchandising), David Risher (Senior Vice
President, Product Development), Jennifer Cast (General
Manager, Music), and Joel Spiegel (Vice President, Engi-neering).
ú What follows are the key points made by AMZN man-agement
during the analyst meeting.
Jeff Bezos, (Founder and Chief Executive Officer):
ú CQ2 results were great: $116MM in revenue (up 33%
Q/Q), 3.1MM customer accounts at quarter-end, with
880,000 customer adds in the quarter.
ú Total market opportunity remains large: $82B book mar-ket
worldwide, $40B music market worldwide, and $16B
video market worldwide.
ú In the last year, AMZN has executed effectively against
its five goals: superior customer value, brand building, im-proved
customer acquisition and retention, product exten-sion,
and international expansion.
ú Superior customer value: AMZN introduced its One-Click
feature, revised and upgraded its site three times, and
shortened the order-to-mailbox process time by, among
other things, increasing its inventory.
ú Brand building: AMZN has seen success in its print,
online, radio, and TV advertising efforts and has signed up
over 90,000 Associates to sell AMZN books from their Web
sites.
ú Customer acquisition and retention: 880K new cus-tomers
added in the latest quarter with 63% of orders now
coming from repeat customers.
ú Product extension: AMZN?s new music site was for-mally
rolled out in June.
ú International expansion: Acquisitions of two of the
leading online book retailers in Germany and the UK will
help it penetrate those markets.
ú AMZN?s approach to acquisitions is to look for compa-nies
that are customer focused, have strong management,
and offer AMZN ways to leverage its own customer base,
brand, and competencies.
ú Looking at the online book retail competitive landscape,
Barnes & Noble has made impressive inroads to date, effec-tively
using in-store promotions. Borders has been less ag-gressive.
And Bertlesman should be a very strong com-petitor
in Europe, because of its publishing assets, its Euro-pean
book clubs, and its AOL relationship.
ú Looking at the online music retail competitive landscape,
AMZN considers traditional storefront music retailers ?
MusicLand, Best Buy, Blockbuster, Circuit City, etc? ?
as its primary competitors. CDNow and N2K are also com-petitors,
but Mr. Bezos noted that the Internet music retail
segment has grown much more slowly than the Internet
book retail segment.
ú Asked whether AMZN would seek to generate advertis-ing
revenue off its site, Mr. Bezos said that the company had
no plans to do so in the near future. AMZN is not philo-sophically
opposed to advertising on its site; it is just more
concerned currently about generating customer satisfaction
and retail revenue.
ú Overall, Mr. Bezos sees the biggest risk as managing the
twin challenges of super growth and evolving customer
needs. He sees success as hinging on brand awareness and
effective customer acquisition.
Joy Covey, (Chief Financial Officer):
ú Ms. Covey reviewed AMZN?s economic model, which is
focused on growth, revenue leverage, profitability, and
capital management.
ú Growth: Ms. Covey noted that with AMZN?s $116MM
quarter, Amazon.com became the second fastest retailer in
history to reach a $100MM quarter. She also contrasted
AMZN?s rapid revenue run rate to the slower rates of
CDNow and N2K.
ú Revenue leverage: Ms. Covey stated that this is based on
the high customer value AMZN provides to its customers,
as evidenced by the high and growing percentage of orders
placed by repeat customers.
ú Profitability: Operating losses as a percentage of reve-nues
have consistently declined. Scale has allowed
6 MORGAN STANLEY DEAN WITTER
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solicitation of an offer to buy or sell the securities mentioned. Please refer to the notes at the end of this report.
AMZN?s costs to decline as a percentage of sales. AMZN?s
sales and marketing expenses (23% of sales) are signifi-cantly
lower than the sales and marketing expenses of
smaller online retailers ? CDNow (77%) and N2K (107%).
ú Capital management: AMZN?s negative cash conver-sion
cycle is a significant advantage over traditional book-sellers,
and Covey expects this cycle to continue. Inventory
days will increase in the near term as the company expands
its inventory to meet customer demands but will decrease in
the long term due to scale. Scale should also allow AMZN
to further stretch out its accounts payable days.
Rick Dalzell, (Chief Information Officer):
ú Mr. Dalzell reviewed the company?s infrastructure devel-opments,
corporate business systems, and supply chain is-sues.
ú Infrastructure: AMZN?s goal is 99.9% system avail-ability.
Over a 12-week average, the company has managed
99.73% availability. Mr. Dalzell?s team is constantly look-ing
to eliminate potential points of failure.
ú Corporate business systems: Mr. Dalzell stated that his
team is busy working to convert the UK (Bookpages) and
German (ABC Telebook) acquirees? systems.
ú Supply chain issues: Mr. Dalzell is focusing on IS sys-tems
that will allow improved direct purchasing from book
vendors.
Jimmy Wright, (Chief Logistics Officer):
ú Mr. Wright, who just joined the AMZN team from Wal-Mart,
where he was vice president of Distribution, described
his primary goal as focusing the company?s operations on
execution of the ?pipeline.? His team will look to expand
distribution capacity, improve operating efficiency, reduce
order-to-mailbox time, increase same-day shipping, and
improve customer service quality.
ú Mr. Wright stated with the Delaware distribution center
up and running, AMZN now has 285,000 square feet of do-mestic
distribution capacity.
ú Mr. Wright said that shipments per total labor hour have
been rising and that fixed, variable, and total costs per
shipment have declined this year.
Mary Engstrom, (Vice President, Merchandising):
ú Ms. Engstrom described progress in AMZN?s relation-ship
with book suppliers ? ?they now know us,? ?they get
it.?
ú Ms. Engstrom reviewed the online channel benefits to
book vendors: low return rates, sales of backlist, centralized
distribution, and demand creation.
ú Low return rates: Average return rates in the book in-dustry
range between 20% and 30%. With AMZN, they are
consistently below 5%, in part because AMZN has not sig-nificantly
pre-ordered books.
ú Sales of backlist: AMZN helps publishers sell books that
have been published for over a year ? these books are more
profitable for publishers who generally amortize major costs
over the first year of sales.
ú Centralized distribution: AMZN?s centralized distribu-tion
reduces suppliers? distribution costs.
ú Demand creation: AMZN helps generate primary de-mand
for books and does not simply cannibalize sales from
other channels. Ms. Engstrom noted that 43% of people
who have bought a book through Amazon.com have bought
a book in a bookstore after first seeing it on Amazon.com.
And 74% of Amazon customers report that they have in-creased
their overall book purchases because of the experi-ence.
ú Ms. Engstrom stated that AMZN continues to seek to
reduce its dependency on wholesalers and increase the per-centage
of the books it purchases directly from publishers,
which should improve its gross margin given the steeper
discounts of this channel (44?55%) versus the wholesale
channel (40?42%).
ú Ms. Engstrom noted that the online channel dynamics for
music are similar to those for books: online retailers offer
low return rates for suppliers, sales of backlist, centralized
distribution, and demand creation. However, gross margins
for music online retailing are lower than for book online
retailing.
MORGAN STANLEY DEAN WITTER 7
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solicitation of an offer to buy or sell the securities mentioned. Please refer to the notes at the end of this report.
David Risher, (Senior Vice President, Product Devel-opment):
ú Mr. Risher stated that Amazon?s penetration of the po-tential
U.S. book market is approximately 2.5%. AMZN
estimates that there are 100MM book-buying adults in the
U.S. (half of whom buy several books a year), and AMZN?s
current U.S. customer accounts total approximately 2.5MM.
ú Mr. Risher reviewed AMZN?s advertising programs ?
AMZN began radio advertising last year and began TV ad-vertising
earlier this year. Amazon.com?s brand awareness
is up across the U.S., although it still lags behind that of
Barnes & Noble.
ú The number of AMZN Associates has surpassed 90K,
although sales through these channels combined with sales
through AMZN?s aggregator partnerships (Yahoo!, AOL,
Excite) still account for a minority of the company?s visitors
and customers.
ú Mr. Risher stressed the importance of turning visitors into
customers and of maintaining customer loyalty. He cited as
two loyalty drivers ? ecstasy (a tremendous customer expe-rience)
and stickiness. Again, Mr. Risher noted that 63% of
AMZN?s orders are from repeat customers.
ú Mr. Risher listed four key success factors: attracting
visitors, turning visitors into customers, getting customers to
return often, and getting customers to buy more during each
visit.
ú Asked about the performance of AMZN?s partnership
deals with the major portals (Yahoo!, AOL, Excite), Mr.
Risher said that the company was very pleased.
Jennifer Cast, (General Manager, Music):
ú Ms. Cast did not detail progress to date at AMZN?s music
site ? opened in June ? but did review Amazon?s rationale
for entering the music market.
ú Ms. Cast stated that the online music market was poten-tially
very large and that it provided AMZN an opportunity
to leverage its assets.
ú Online music retail: The U.S. music retail market is
approximately $12B, while the worldwide market is $40B.
In the U.S., 14.6MM adults who use the Internet have pur-chased
4+ CDs over the last 12 months. This is AMZN?s
target market.
Leveraging of assets: Ms. Cast stated that the demograph-ics
of online music retailing are similar to online book re-tailing
in terms of age, income, education, geography, and
race. Further, the lifestyles and media habits of online book
and music consumers are similar. Thus, music retailing
allows AMZN to leverage its existing customer base. Music
also allows AMZN to leverage its brand and distribution
system. |
