James,
I archived a variet of research reports regarding the internet stocks when I was short AMZN. I am going to post some here this evening because I believe some people will find what happened compared to what was expected to happen interesting.
Price: $83 3/4
Estimates (Dec) 1997A 1998E 1999E
EPS: $d0.64 d$1.64 d$1.68
P/E: NM NM NM
EPS Change (YoY): NM NM
Q3 EPS (Sept): $d0.19 $d0.55
Cash Flow/Share: NA NA NA
Price/Cash Flow: NM NM NM
Dividend Rate: Nil Nil Nil
Dividend Yield: Nil Nil Nil
Opinion & Financial Data
Investment Opinion: D-4-3-9
Mkt. Value / Shares Outstanding (mn): $4,018.1 / 48
Book Value/Share (June-98): $0.82
Price/Book Ratio: NM
ROE 1998E Average: NM
LT Liability % of Capital: 74.9%
Est. 5 Year EPS Growth: NM
Stock Data
52-Week Range: $137 1/2 - $130 ?
Symbol / Exchange: AMZN / OTC
Options: Phila
Institutional Ownership-Spectrum: 22.9%
ML Industry Weightings & Ratings**
Strategy; Weighting Rel. to Mkt.:
Income: Underweight (07-Mar-95)
Growth: Overweight (07-Mar-95)
Income & Growth: Overweight (07-Mar-95)
Capital Appreciation: Overweight (28-May-93)
Market Analysis; Technical Rating: Average (27-Jul-98)
**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:
ú Our enthusiasm for the growth of Internet
connectivity and commerce remains
undiminished by the persistent inefficiencies
that frustrate the equity market?s ability to
attach values to individual Internet
companies.
ú Independent of its valuation, we are generally
optimistic about Amazon.com?s longer-term
opportunity. We can not, however, reconcile
the value of that opportunity with the
company?s current market capitalization.
ú We rate Amazon.com?s shares D-4-3-9
(Reduce/Neutral), and recommend that
investors exercise significant caution towards
them.
Fundamental Highlights:
ú Bookselling is an inherently competitive and
low-margin business.
ú Because the intellectual property value
contained in published works typically
represents only a small portion of the price to
end-users, we do not expect that moving that
business to an online environment will
meaningfully change those characteristics.
Comment
United States
Information Processing - Internet Software & Svc
1 September 1998
Jonathan Cohen
First Vice President
Tonia Pankopf
Assistant Vice President
Amazon.com Inc
The World?s Leading Internet Commerce
Company Is Too Expensive
REDUCE
Long Term
NEUTRAL Reason for Report: Initial Opinion
Merrill Lynch & Co.
Global Securities Research & Economics Group
Global Fundamental Equity Research Department
248900/248897/248100/248000 RC#20124408
Stock Performance
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Amazon.com Inc Rel to S&P Composite Index (500) (Right S
Amazon.com Inc ? 1 September 1998
2
The World?s Leading Internet Commerce Company Is
Too Expensive
Amazon.com is the world?s leading online book and music
retailer and the single most widely identified company
with the growth of online commerce. Over the course of
its brief existence, the company has enjoyed an almost
unprecedented level of commercial success, even within
the rarefied context of public Internet companies. We
attribute that success (manifested in the form of revenue
growth) to a number of factors, including:
1) Management. Amazon.com has assembled one of the
highest-quality and best-regarded management teams
within the Internet space.
2) Business Segment. Online commerce in general and
online bookselling specifically continues to attract
enormous consumer interest.
3) Timing. Amazon.com was essentially first-to-market in
a business where first-mover position has come to define
competitive advantage.
4) Willingness to Spend. The company has been both
willing and (by the grace of the public equity market)
afforded the latitude to lose enough money to build a
substantial online retailing business.
Despite all of the above strengths, our investment rating on
Amazon.com?s shares reflects a significantly negative
view towards the stock?s prospects. Although our opinion
is principally based upon valuation (and our premise that
the company lacks the ability to justify that valuation on
an operating basis), it also takes into account our
concerns related to the long-term margin structure that
we believe will be associated with Amazon.com?s current
underlying model. The bottom line is that bookselling is
an inherently competitive and low-margin business.
Because the intellectual property value contained in
published works typically represents only a small portion
of the price to end-users, we do not expect that moving
that business to an online environment will meaningfully
change those characteristics.
Amazon.com has all the benefits that come from being
first-to-market in a high-growth industry. The company is
run by a truly brilliant management team with substantial
capital resources, but it shouldn?t matter: Amazon.com
must suffer substantial share price declines before there
exists any meaningful relationship between its market
capitalization and its operating prospects.
Why Books Are Not The Best Product To Sell Online
Selling books over the Internet has been one of the first
great successes of Internet commerce. Although we expect
that those sales will account for an increasingly
meaningful portion of total book sales (both in the U.S.
and worldwide), we also believe that it is important to
differentiate between the online transfer of content (which
Amazon.com does not provide) and the expediency of
taking orders for physical goods over the Internet (which
defines Amazon.com?s business). We continue to believe
that those products most adaptable to online distribution
are those that represent proprietary intellectual property.
Proprietary content which is both downloadable and able
to generate discrete revenues (as opposed to revenues
attached to whole bodies of content, such as advertising
sales) is almost perfectly suited to online distribution. The
sale of commodity physical products (such as books) can
be made more efficient and/or more compelling through
online-based order-taking systems, but that activity should
not be seen as either highly proprietary or high-margin.
Why The Stock Is Overvalued (by which we mean both
the measures of its overvaluation and how it came to
be that way)
Amazon.com?s initial public offering (in May 1997)
represented one of the defining moments within the
Internet space. The interrelationship between the
company?s IPO, its share price performance and its
operating success has led to a self-perpetuated circle of
reinforcement: the rising share price has generated
substantial ongoing publicity for the company, which has
in turn driven additional traffic (and book sales), which in
turn supports the rising share price. The problem with this
construct is that it can not sustain itself indefinitely: at
some point the net present value of the enterprise (which
simply can not grow as quickly as has the company?s
valuation) must necessarily constrain Amazon.com?s
ability to favorably position itself in the minds of potential
customers through a rising stock price.
Since the IPO, the company?s shares have benefited from
the continued support of the sell-side research community.
We have noted with concern that most recent Wall Street
research valuation analysis that we have read seem to rely
on tautological argument: ?the valuation is currently X-times
revenues, therefore as revenues increase, the share
price should rise proportionately (assuming the valuation
multiple stays the same).? Not only is the above analysis
logically corrupt, it has actually begun to gain some
credibility through its constant misuse. It appears that
Amazon.com has become both the beneficiary and the
victim of supporters eager to endorse its shares at almost
any valuation. The end result for the company might be
seen as a Gordian knot: the company may have to choose
between running its business in order to maximize its long-term
value or in a way more consistent with the near-term
expectations of the public equity market. An example of
the later would include growing revenues (at the expense
of profitability) more aggressively than a net present value
model would dictate.
Internet stocks are generally valued on the basis of price-to-
revenue multiples. Those multiples (which are usually
applied to projected calendar 1999 sales) are meant to
embody a more traditional discounted cash flow (DCF) or
forward price/earnings valuation analysis. In practice,
there exists a close relationship between expected
operating margins and the price/revenue multiples at which
Internet companies trade (projected operating margins
being a reasonable proxy for a DCF analysis).
Amazon.com Inc ? 1 September 1998
3
Amazon.com?s current valuation lies significantly outside
the statistical regression that describes the valuations of
other Internet companies.
Why Amazon.com Is Not (Yet) A Portal
It has recently been suggested that, because of its
popularity with consumers, Amazon.com may have the
ability to leverage its Web site(s) into the Internet portal
space, and that the company may be able to seize a broader
opportunity on that basis. While we believe that
Amazon.com deserves to be evaluated and valued
principally on the basis of its retail opportunities, we also
believe that the company has begun to move closer to a
community/context-based operating model (especially
with the company?s recent acquisitions of Planet All and
Junglee). At the same time, we also believe that it is
probably premature to apply an Internet portal-based
valuation construct to Amazon.com?s shares.
Competition From Physical Booksellers
After a very slow start, those companies that dominate the
physical bookselling market have turned their attention to
the online space. As the largest bookseller in the world
(and a leading direct mail competitor), Barnes & Noble,
we believe, has the ability to maintain a cost-based
competitive advantage over Internet-specific competitors.
In addition to its brand name, Barnes & Noble runs a state-of-
the-art distribution center and has relationships with
more than 20,000 publishers and distributors.
Additionally, the company has both vast mail order
experience and an existing budget of approximately $20
million annually for national advertising.
Very recently, Barnes & Noble announced that they would
sell approximately 20% of its Barnes&Noble.com
subsidiary (its online division) in an initial public equity
offering. We expect that, if that offering is successful, the
company will be much better positioned to compete more
aggressively (and to spend more freely) against
Amazon.com. Although Borders (the second largest
bookseller after Barnes & Noble) has only very recently
begun their online sales effort, the company seems highly
committed to an Internet-based sales model.
Amazon.com has noted that it believes that the four most
important parameters in the online bookselling market are
selection, convenience, price and service (in that order of
importance). We believe that, with the exception of
service, those factors could be seen as subject to rapid
commoditization in an online environment (selection
becomes a function of simply downloading a database,
convenience is a much more level playing field then in the
physical world and price is not an area where Amazon.com
has a great deal of flexibility).
Amazon.com does have the capital resources necessary to
re-engineer its business model (or to acquire other business
models). Thus far, the company has positioned its
acquisition program towards leveraging its customers and
brand name, and has essentially sought to build primary
demand generation (to increase sales through book
recommendations, online word-of-mouth, etc.) while
increasing consumer stickiness through its site. Looking at
those transactions announced thus far, we believe that the
company is effectively moving towards a more robust
online (community-based) consumer experience, and has
done a very good job of employing its public currencies in
paying for those acquisitions. In April, Amazon.com
acquired two international online booksellers (one in the
UK and one in Germany) and an online movie database.
More recently, the company announced the acquisitions of
Planet All (which will bring into the company?s network a
user population of approximately 1.5 million people, with
calendering functionality, community-based services, etc.).
Conclusion
Our enthusiasm for the growth of Internet connectivity and
commerce remains undiminished by the persistent
inefficiencies that frustrate the equity market?s ability to
attach values to individual Internet companies. In fact,
independent of its valuation, we are generally optimistic
about Amazon.com?s longer-term opportunity. We can
not, however, reconcile the value of that opportunity with
the company?s current market capitalization. We rate
Amazon.com?s shares D-4-3-9, and recommend that
investors exercise significant caution towards them.
[AMZN] The securities of the company are not listed but trade over-the-counter in the United States. In the US, retail sales and/or distribution of this report may be made only in states where these securities are exempt from
registration or have been qualified for sale. MLPF&S or its affiliates usually make a market in the securities of this company.
Opinion Key [X-a-b-c]: Investment Risk Rating(X): A - Low, B - Average, C - Above Average, D - High. Appreciation Potential Rating (a: Int. Term - 0-12 mo.; b: Long Term - >1 yr.): 1 - Buy, 2 - Accumulate, 3 - Neutral, 4 -Reduce,
5 - Sell, 6 - No Rating. Income Rating(c): 7 - Same/Higher, 8 - Same/Lower, 9 - No Cash Dividend.
Copyright 1998 Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S). This report has been issued and approved for publication in the United Kingdom by Merrill Lynch, Pierce, Fenner & Smith Limited, which is
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