From BW
>BUSINESS WEEK ONLINE
August 3, 2000
STREET WISE By Amey Stone
Will Amazon Become a Takeover Target?
Unless it turns profitable soon, many analysts believe it's only a matter of time before the e-tailer is bought out or sold for parts
The writing is on the wall. Growth is slowing at Amazon.com (AMZN), whose business model (yes, there is one) depends on continued surges in sales volume if it's ever to reach a profit. For its second quarter, reported July 26, sales grew just 1% over the prior quarter, to $578 million (up 84% over the same quarter a year before, but less than analysts were predicting). In this context, the company's massive losses -- $116 million, or 33 cents per share, in the latest quarter -- are the most obvious symptom of a bigger problem.
Many retail veterans believe Amazon will never turn a profit for the simple reason that it doesn't make enough money on each item sold to cover its costs. "Jeff Bezos never understood the concept of a retail gross margin," says Thomas Friedman, president of Retail Systems Alert Group, a Newton, Mass., firm that provides retailers with information-technology research and advice. "Every retailer in the world from biblical times has understood that concept. For some reason, when he created his business model, he ignored it."
But Amazon's inability to turn a profit now -- or maybe ever -- doesn't mean the online giant will necessarily close up shop and disappear. Another end game for Amazon.com is to be acquired. No deals are currently in the works (that we know of), but potential pairings are provoking speculation among industry consultants and analysts. For any of them to take place, the company's share price would probably have to fall considerably. With a current $11 billion market cap, "Only the largest buyers would be able to afford it," says James Vogtle, e-commerce-research director at Boston Consulting Group (BCG).
VALUABLE ASSETS. The actual price a buyer would be willing to pay depends on the costs it could take out from the deal, as well as the strategic value it could assign to Amazon. That value would be different for every buyer, says Eric Kintz, head of the American e-commerce practice at management consulting firm Roland Berger & Partners. One of Amazon's most valuable parts is its list of 22 million customers. How valuable? Consider: For e-commerce companies, customer-acquisition costs (Wall Street lingo for how much a company spends on advertising and marketing to gain each new customer) were pegged in the first quarter at $45 per customer, up from $38 in 1999, according to BCG and www.Shop.org, an online retail trade association. Amazon's order-fulfillment structure (including its new network of distribution centers) also has value.
Potentially the most valuable asset is its online store, comprising the front-end customer interface, one-click shopping, personalization, and other features. "The true value is what they bring in the software package, which is very much underestimated by the Old Economy retail world," says Kintz.
Wal-Mart is tops on any list of potential Amazon acquirers. It has the most to gain strategically, since it's still struggling to come up with a Web site that appeals to customers. With its $243 billion market cap, Wal-Mart could just take Amazon's technology and scrap the independent site, essentially removing a competitor, Friedman believes. Drawbacks for Wal-Mart include the difficulty of melding Amazon's back end (distribution and accounting) with its own and the fact that Amazon deals only in a handful of product categories compared to Wal-Mart, says Kintz.
The next most likely scenario is for a large foreign buyer to nab Amazon to make a big splash in the U.S. Several industry participants point to France's Carrefour, which is the second-largest retailer in the world and is eager to expand into the U.S. But Carrefour is in the process of integrating its merger with Promodes and for now has enough on its plate, Kintz believes.
STREET HASSLE. To widen the field beyond the world's No. 1 and 2 retailers, Amazon's market cap would have to fall significantly -- probably to around $2 billion (or more than an 80% drop, to about $5.50 a share), say consultants. At that severely depressed level, the largest bricks-and-mortar booksellers become candidates. Barnes & Noble could buy Amazon, spin off its other businesses, and take the bookstore piece. Borders, which is having financial problems of its own, could do the same -- although most analysts expect such a combination would go the other way, with Amazon buying Borders. Amazon is probably not in the market for acquisitions, but it's not unheard of for a company to acquire rather than face the risk of being acquired.
A down-and-out retailer is the final scenario. Friedman points to Sears or J.C. Penney as "traditional organizations looking for a spark." Since Penney has a pretty good Web site of its own, Sears seems a more likely candidate.
Wall Street, which can be said to have created the Amazon phenomenon as much as CEO Jeff Bezos (who is, after all, a product of the Street himself) is losing faith. A third of the 30 analysts who cover the company downgraded it to a hold (read sell) due to its second-quarter results, according to First Call Corp. A Lehman analyst titled her report on the downgrade "Throwing in the Towel on Amazon."
COOKED GOOSE. The stock, which hit a high of $113 last December, is now at around $31 -- a figure that once seemed unthinkably low for the e-commerce superstar (see BW Online, 6/26/00, "Is Amazon Really a $30 Stock?"). "The problem is that the market is demanding both growth and profitability, and all the rats are leaving the boat," says Kintz. Investors got a shock on July 25, when Joe Galli, Amazon's president and operating chief, resigned unexpectedly to become CEO of business-to-business e-commerce company VerticalNet. "For Amazon, that is a very bad sign," Kintz says.
Some retail-industry experts think the end of Amazon's grand experiment is in sight. "My assessment is extremely gloomy," says Kurt Barnard, president of Barnard's Retail Trend Report newsletter. If by the fourth quarter of this year, a booming holiday season doesn't lift it into the black, "then I think Amazon's goose is cooked," he says.
But in some quarters, it's still premature to envision a time when Amazon is on the auction block. E-commerce experts say it doesn't need to sell, and they still have faith that its business model will work. "It seems way too early to be talking about something like that," says Steve Weinstein, an analyst with Pacific Crest Securities who downgraded Amazon to a market-perform rating after its latest quarterly report. "I'm very comfortable with their cash position." Amazon still had $900 million in cash at the end of June -- enough to last until it can generate some positive cash flow. Weinstein expects the company to be cash-flow positive on a full-year basis in 2002.
CHOP IT UP? Meanwhile, those with a base in traditional retailing say no one would want to buy Amazon at this price even if it were for sale. "As an independent entity, it's worth nothing," says Barnard. "There are component parts which may be valuable for those who have use for those parts."
If Amazon stays independent, it would have to go through a massive restructuring, many observers believe. Friedman thinks it would have to become a group of very focused companies. For example, it could break down into a fiction bookstore, a college bookstore, and a B2B-tools company. "It would need to become highly specialized in a narrow marketplace where it would not have to discount merchandise," he says.
Amazon isn't at that stage yet -- mainly because analysts are hoping the recent slow growth in the second quarter was just due to seasonal factors. "What surprised me is how quickly e-commerce plateaued," says Weinstein. "That doesn't mean it won't surge again." Wall Street clearly has its doubts, but for now, some hope for Amazon endures. |
