Gary: the beat goes on with loyal followings like David Gardner of MF:
fool.com
____________________________________________________________
Questioning Amazon
Amazon.com has created a great brand and a loyal customer base.
No company is better positioned to lead online commerce, which,
despite media reports, is not dead. Amazon has made some good partnerships lately that will allow
it to manage inventory better. Still, some think that Amazon.com expanded its product offerings too
quickly and thereby reduced its profit potential. If it can maintain its focus and curtail capital
expenditures, it should continue to outperform. In any case, it is still a Rule Breaker.
By The Breaker Team
September 6, 2000
[Note: Today's column is the transcript of a discussion the Rule Breaker Portfolio
managers held recently about Excite@Home and Amazon.com, the portfolio's worst
performers year-to-date. Yesterday's column dealt with Excite@Home; today's column
discusses NOW 50 component Amazon.com. Let us know what you think of this format in
the poll at the end of the article.]
Brian Lund: What was the thinking behind the purchase of Amazon.com (Nasdaq: AMZN)
in 1997?
Jeff Fischer: Amazon.com was the first-mover in creating a book-buying experience
tailored and optimized for an online audience. The thinking at the time of the purchase
was that Amazon.com would move in a like fashion into various portions of consumer
e-commerce -- and do so first. As we bought it, we saw how the company was utilizing its
community to make bookselling much more than normal bookselling. And, we saw the
potential to expand into all kinds of product and sales platforms.
David Gardner: Exactly. And, we saw it building a lasting brand and business, with
incredible customer info. Overall, by its positioning as a leader square in the middle of a
tsunami, it could become a publishing company, or a delivery service like Webvan
(Nasdaq: WBVN) -- it owns 30% of HomeGrocer.com (Nasdaq: HOMG) -- etc.
Jeff: And, it always had the buzz, Amazon. It has had that magic branding buzz since the
beginning. (Explaining why or how that happens is not easy.)
Brian: Has anything changed?
David: It's gotten bigger, perhaps even over-expanded in product categories. The most
profitable and easiest to do are consumer information and entertainment products, stuff
that could eventually be digitized.
Jeff: Just in the past week, Amazon has made interesting moves in new directions. It is
beginning to leverage its strength: customer traffic and retention. I don't believe that
we'll see Amazon add much more inventory (or new "physical" product categories) anytime
soon. Instead, it is partnering to provide inventory and acting as the higher-margin
customer attractor and deal-maker.
Brian: The Toys "R" Us deal seems good to me. It allows Amazon to use its strengths
and lets "Toys" use theirs.
Jeff: Amazon's car-selling partnership is another example. And, management is thinking
about how to best utilize its strengths and leverage its electronic medium in its Microsoft
book deal (again, no real inventory to carry). Amazon's URL has incredible value, with
some 25 million registered customers. Amazon can pull and push the necessary levers to
turn that traffic into profits, long-term. So, these recent decisions by management are
encouraging to me.
David: Yes, Jeff. And, most of those 25 million customers are purchasers, not just
lurkers.
Paul Commins: Amazon should abandon lawn tractor inventory and return to the "ruthless
ringmaster" model. Hold the core user base, partner for non-core products, and expand
only when they have a good chance to dominate quickly and completely.
David: I want to say one thing about this whole "business-to-consumer (B2C) is dead"
thing. This is speaking from the standpoint of sentiment. I can't believe what overkill the
media (and markets) have done to these companies, Amazon included. Sentiment is such
today that we're almost being led to believe that consumers aren't going to use the
Internet anymore to buy stuff or pay anything to anybody. Sorry, but consumers are
continuing to flock in increasing numbers to use the Internet in increasingly relevant and
numerous ways. I think Amazon down in the $30s will prove, long-term, to have been a
great deal. Same with eBay (Nasdaq: EBAY) right now. In fact, I think both make
excellent long-term investments from their prices right now.
Paul: The overkill was present on both sides. The same irresponsible media has led us to
a choice between Al Gore and George W. Bush. The whole "e-commerce is everything"
followed by "e-commerce is dead" thing is entirely a media creation. Meanwhile,
e-commerce continues to be what it has always been, regardless of how much promo it
gets.
David: E-commerce is much closer to "everything," though, than it ever will be to "dead."
Anyway, I just wanted to put in a quick word of support for "B2C," which is an idiotic
phrase. Because no one was using that phrase until the business-to-business (B2B) hype
and buzz, then all of a sudden people start saying "B2C" as if it's this new but old thing.
Most great investments you and I make over time have always been in "B2C," whether it
was Sara Lee (NYSE: SLE), Wal-Mart (NYSE: WMT), Coca-Cola (NYSE: KO), what have
you.
Brian: True. The question is, can Amazon make a good return on invested capital (ROIC)
in online commerce? The company has a lot of debt -- high-cost debt.
Jeff: I can't believe how often the media has ignored (from one side of their mouths) the
fact that Amazon is still building, building, building. Amazon plans to earn three to four
times the ROIC of a traditional retailer. It has been sinking all its costs in the past five
years, building for a large sales base. Eventually, the costs dwindle as the sales fill the
facilities to capacity, and then you'll begin to see ROIC rise as the inventory turns.
I wrote this summer that Amazon's prospects look better now than ever, at least from a
competitive standpoint. I ask you all now: Can you name a single online retailer that
today is posing a real threat to Amazon's online retailing platform? If you can't name a
company now, then how will a new company come along and upset Amazon in the next
few years? This is why I think the company is poised to dominate a good portion of online
retail.
David: They are poised to dominate, come the holiday season. There has been a
shakeout -- third- and second-tier companies that were jamming the airwaves last
Christmas season. Many of those will not be around. Amazon's need-for-speed strategy
has worked.
Brian: Hasn't the shakeout hurt Amazon, too? Partners like Living.com are falling, taking
Amazon's partnership revenue -- which is mostly in the form of rapidly depreciating equity
-- with them.
Jeff: I'm surprised the stock didn't react to the Living.com news more, actually. It is a
blow to Amazon in the near-term, the loss of several million dollars from contractual
deals.
David: Only in a short-term sense can this hurt Amazon. The field of competitors has
fallen away like knights before Lancelot.
Paul: For Amazon to fulfill its destiny, though, margins are everything. I don't see how
they can ever grow revenues to $150 billion or more -- which they'd need to do to deliver
on the investment at traditional retailer margins -- so, they have to beat traditional
retailer spreads by a consistent point or three.
Jeff: I disagree that margins are everything. Volume and efficient fulfillment are more
important. Look at Wal-Mart's margins. They're low.
Brian: Amazon doesn't have Wal-Mart's asset turnover, though.
Paul: Nor are they likely to, if they get too heavily into the mix of warehoused goods that
Wal-Mart covers so well.
Jeff: Cash flow is the focus. Nobody expects Amazon to be a high-margin company. They
do expect ROIC of three to four times a traditional retailer, though, and very favorable
cash dynamics (cash comes in right away, bills are paid on the shipped product weeks
later).
Brian: But, can they profit from it? Look at the latest balance sheet and cash flow
statement. Float diminished and cash flow worsened as payables went way down. That's
a loss of leverage, possibly because of the recent unpleasantness.
Jeff: Looking at the past quarter, one of the weakest of the year, is not a good way to
judge where the company may be five years from now.
David: That was one quarter. Not a great one, admittedly. But, we'd need to see more
before calling it a trend.
Paul: Surely Amazon won't beat Wal-mart in supply chain planning?
Jeff: Is Wal-Mart unbeatable? How come?
Paul: Not unbeatable at all.
Jeff: You said "surely."
Paul: I just don't think the way to beat them is by attacking their core strength,
especially if inventory management hasn't been your strong suit. I think it all comes back
to re-trenching on high-margin digital products, leveraging the advantage they were
supposed to have from the beginning as an Internet retailer.
David: Wal-Mart is embarrassingly late to the e-commerce dance, but frankly I'm not sure
Wal-Mart ever would've been a big player online, since so much of its stores are stocked
with stuff people wouldn't want mailed.
Brian: I think Wal-Mart will be a big player online.
Jeff: Comparing Wal-Mart's offline operations to Amazon's online operations has limited
value. Amazon isn't attacking Wal-Mart's core strengths, if you believe Jeff Bezos. He
sees offline retail as a different business than online.
David: Remember, though, Amazon can be a publisher, where now it's just a retailer.
Amazon could be a broadcaster, etc.
Paul: OK, I'm confused. Can we start all over on ROIC? Unless I'm missing something
obvious (likely), there are three ways to improve ROIC -- better margins, better turnover,
and higher leverage. Now, let's assume that they continue to expand into the traditional
retail products that Wal-Mart also sells. Wal-Mart is the established king of turnover.
Amazon won't beat them at diapers. Leverage is covered, but due to debt, not due to any
business advantage. That leaves margins.
Jeff: Amazon will beat Wal-Mart handily in invested capital (the sheer amount it will
need to invest).
Paul: How? I'm still clueless.
Jeff: Amazon will turn over much more inventory on a much lower base of invested
capital.
Paul: Agreed, as long as this inventory is not diapers or lawn tractors.
Jeff: By selling online, Amazon's invested capital will begin to max out much sooner than
Wal-Mart's. Amazon's capital expenditure spending is on the decline now, even.
Brian: It's in their control, anyway, and they don't have to spend much to grow more.
Let's wrap up with one last thought each.
David: I continue to see great additional potential for the company beyond what we
consider its present business and business model to be, and they are a hell of a brand.
No one is taking my Amazon shares from me.
Paul: I agree that the potential is vast, as long as they get back to the clever stuff that
made them big in the first place, and get away from taking on traditional retailers in their
breadbasket. Focus on the markets that Amazon can make special. Amazon adds the
brand, the customers, and the Web-personalization technology.
Brian: I agree that the brand is great. It gives them great mobility. I believe Amazon will
remain the online merchant king, but considering the dilution, the debt, and the big early
stock price run-up, I'm not sure that it'll be a great long-term investment.
Jeff: The debt is another big issue, of course, that we all dislike. But, I believe the
working capital (and debt, I hope!) management will improve greatly in the next 18-24
months. And, I continue to believe that Amazon has more potential now, as a long-term
business (10 years or more), than it ever has, partly because a majority of its competition
is failing. |
