More on the Bear Case for
Amazon
By Herb Greenberg
Senior Columnist
4/27/00 9:15 PM ET
Jim Cramer's recent dispatch on the "Bull Case for Amazon"
(AMZN:Nasdaq - news - boards) assumes the company will win
because it will be the last e-company standing. And as the last
company standing, it raises prices, and so much for the
gross-margin issue I raised last night. Or so it would seem.
But that assumes that consumers will sit idly by and accept high
prices, and that the failure of others won't create new competitors
(a la the airline industry), and that assumes that Wal-Mart
(WMT:NYSE - news - boards), Barnes & Noble (BKS:NYSE -
news - boards) and other well-capitalized brick-and-clickers won't
make it. (Check out my recent Fortune article on how the
brick-and-clickers are doing much better than most folks realize.)
The last-man-standing defense, as
Cramer calls it, is just another way to
justify a high multiple for a company
that isn't yet making any money and,
despite what the company says,
shows little promise of making money anytime soon.
While Wall Street was busy looking at the company's booming
revenues and its narrower-than-expected loss, some analysts
were looking at other, less obvious details, which raise serious
questions about whether Amazon can ever make much money
regardless of whether it's the last man standing.
For example, the year-over-year revenue growth in Amazon's
core U.S. biz -- books, music and DVD/video -- was just 50% in the
first quarter, down from 98% the quarter before. "That's
staggering," says longtime Amazon bear Jeff Matthews of Ram
Partners in Connecticut. "If the Gap Stores division of Gap
(GPS:NYSE - news - boards) or the core division of any
high-growth retailer reported that its sales growth had dropped in
half," Matthews adds, "it would be, 'Game over, let me out of
here.'"
Then there's the issue of gross margins, which I mentioned in last
night's column on Amazon. If you include fulfillment (the cost of
filling orders) and exclude revenues from companies in which it
has an investment, gross margins are really more like a paltry 1%
or 2%, rather than the 22.3% that Amazon reported.
Fulfillment, the big-ticket item, accounts for a whopping 17
percentage points of those margins. Amazon and other Internet
companies may be forced by changes in accounting rules to
include their fulfillment costs as "cost of goods sold" -- a key
component of gross margin -- rather than as normal operating
expenses. (Gross margin is calculated by subtracting cost of
goods from revenues and dividing the remainder, or gross profit,
by revenues.)
That prompted one reader to wonder what the
difference was, because either way, the
fulfillment costs take their toll on earnings.
Good point: From a bottom-line, profit
standpoint, it doesn't really matter whether
those fulfillment costs are included as a cost of
goods or as a regular expense. The results are
the same: They all go into the same pool and, in
the end, the company either swims (turning a
profit) or it doesn't.
What does matter, though, is the psychological impact of a
company that has been touting its rising gross margins -- which it
says are 22.3% -- now having to say that it has a gross margin of
1% or 2%. A concept stock with a 1% or 2% gross margin, even if
you're merely juggling where an item appears on the income
statement, simply ain't the same as one with a 22.3% margin!
That's not all. The issue of whether to include revenues from
affiliates as revenues for Amazon is a crucial one -- at least from
the standpoint of short-sellers. As this column pointed out a few
months ago, that's one reason short-sellers are comparing
Amazon with Boston Chicken (BOSTQ:Nasdaq - news -
boards), which included revenues, but not losses, from its
franchisees.
Remember, Amazon is an investor in those companies, and it
included $19 million in advertising revenues from them last quarter.
It then pretty much told Wall Street to ignore $88 million in its share
of losses from those same companies. That's up considerably from
the $60 million some analysts had been expecting, but the size of
the losses was viewed as a nonevent on Wall Street because
Amazon was focusing on results without those losses and
several other items.
"What Amazon is telling people is, 'Lets look at the loss from
operations, which includes the good stuff, but let's exclude the bad
stuff,' " says one short-seller.
"For an apples-to-apples comparison," adds another, "they should
put the fee payments below the line, too."
Or they should steer analysts to include the losses as part of
income. But doing so would've added 26 cents per share to the
company's loss. And besides, bullish analysts claim Amazon is
accounting for the losses the right way because the revenues in
question are merely advertising fees -- not a share of operating
revenues.
According to short-sellers, however, when those companies pay
to advertise on Amazon, they increase the size of their own
losses. As their losses go up, so does Amazon's proportionate
share of those losses, based on its investment in those
companies. (Tricky, I know, but the short-sellers are adamant
about this issue.)
Just as important, however, is whether those revenues are
sustainable. "Investors should not be overlooking the risk Amazon
has by taking stakes in all of these companies," says
PaineWebber analyst Sara Farley, who has a neutral rating on
the stock. When Amazon closed on its investment in
Ashford.com (ASFD:Nasdaq - news - boards) in January, for
example, Ashford was an $11 stock; now it's $3. "What's the
likelihood that future cash payments from Ashford will be made?"
Matthews asks.
In the end, stock investors may not care about any of this, but
bond investors -- who have first claim on the company's assets --
do. Amazon's $2 billion in bonds, which have been a longtime thorn
in the company's side, currently yield around 12.5% and trade at
around 62 cents on the dollar, suggesting that bondholders remain
concerned about Amazon's viability. "That's the same yield we're
paying Colombia," cracks one short-seller. "And they're sufficiently
concerned that they're paying twice the rate of Treasuries for first
claim on the assets."
That's because the bond investors are playing the
last-man-standing defense, too. Only the last one left standing,
they worry, will be them! |
