From Barrons.
Amazon's Filing Gets Clearer, but Questions
Linger
By Mark Veverka
It's oddly funny how a call from federal securities regulators can have an
inspirational effect on the reporting practices of a public corporation. After
revealing that the Securities and Exchange Commission had made an informal
inquiry into its accounting and disclosure practices, Amazon.com filed a
quarterly financial report last week that was noticeably more specific about its
marketing and investment revenues.
We couldn't help but notice that the customary 10-Q for the company's fiscal
third quarter was explicitly more detailed and less hazy than some of the
online retailer's previous submissions, especially when it came to explaining
how Amazon gets paid for its "commerce network" partner deals with other
electronic commerce companies.
As reported in this space last week, ("What Might the SEC Be Probing at
Amazon?" Oct. 30) such detail about the form of payment by commerce
partners was largely absent from earlier Amazon press releases and federal
filings. What's more, we learned that Amazon officials specifically told
Morgan Stanley's chief Internet analyst, Mary Meeker, that marketing
payments from commerce partners would be paid in cash, which she
reported in a February 3 research note.
Trouble is, most of the payments have been made in stock. In addition, other
financial analysts have since told Barron's that they were also informed by
Amazon executives early this year that most commerce partner marketing
fees collected in 2000 were to be paid in cash.
"We felt comfortable with our understanding that it would be payments in
cash," says Marie Menendez, a financial analyst with Moody's Investor
Service in New York, referring to her conversations with Amazon executives.
To Menendez' credit, the debt analyst opted not to build the
commerce-partner revenues into her model earlier this year because she
wasn't clear as to how they would generate enough cash to make the
payments. Moody's has assigned its third-lowest credit rating -- Caa3 -- to
Amazon's convertibles. The upshot: Amazon apparently was willing to let
Wall Street analysts and European bond investors think that some
commerce-partner marketing fees would be paid in cash. Why? We can't say
for certain, but cash on the books is more impressive than shares of equity in
nascent dot.com companies. Asked about this, Amazon officials responded
only by issuing a statement saying they stood by what they had disclosed.
The prospects of high-margin marketing fees were sure to bolster Amazon's
shrinking gross profit margins, a key concern as the company prepared to
float a major debt offering. The convertible eurobond offering raised about
$650 million (690 million euros) for Amazon and was completed by February
11, according to federal filings. Nonetheless, the offering was far from
automatic as Amazon's mounting losses cast doubts overseas.
More than 20 U.S. brokerage analysts filed research notes on February 3,
the day after Amazon reported its fiscal 1999 financial results, including
Morgan Stanley's Meeker. And at that time, most of the analysts reported
that Amazon expected to collect as much as $130 million in
commerce-partner revenues during this year and more than $450 million over
five years. For the most part, brokerage analysts did not stipulate whether
Amazon would be paid in cash or stock, although they implied in their
research reports that the bulk of the payments would be in cash. Only
Morgan's Meeker specifically stated that Amazon would receive cash, a
declaration based on her conversations with Amazon management, Morgan
spokesman Ray O'Rourke said.
Last week, we pointed out that Meeker's firm, Morgan Stanley, was the lead
underwriter for the eurobond offering. Under widely accepted SEC practices,
a quiet period generally doesn't begin until after the client and the investment
bank agree to float an offering. In this case, Amazon agreed to hire Morgan
to lead-manage the eurobond deal in the afternoon of February 3 after
Meeker's report was published, O'Rourke said.
Meeker released her bullish research report on the morning of February 3.
Meeker, through O'Rourke, insists she had no knowledge that her firm had
been hired to manage a bond deal until the analyst was "brought over the
[Chinese] wall" later that afternoon. (Meeker herself wouldn't speak with
Barron's on the record.)
It isn't uncommon for sell-side research analysts to be asked by their
investment-banking colleagues to weigh in on particular companies that they
cover without knowing the specific nature of the business being sought by the
bankers. At least one other research analyst at a firm that competed with
Morgan Stanley on the Amazon eurobond deal was approached by
investment bankers.
Every analyst covering Amazon "had an incentive to write positive things
about the company to get the deal," asserts a person familiar with the
situation.
However, O'Rourke says, Meeker contends she neither consulted with
Morgan Stanley bankers about Amazon in general nor knew that her firm was
in contention to win the e-tailer's eurobond underwriting business. What's
more, Meeker claims she wasn't even aware that Amazon was looking to
raise additional capital in any form, the spokesman said.
But Amazon's plans to raise capital weren't a well-kept secret. For his part,
Merrill Lynch Internet analyst Henry Blodget hinted that he was aware of the
online retailer's general plans. "We do not think the company 'needs' cash;
[however], we do think it is likely that the company will raise additional cash
soon," stated Blodget in a February 3 research note. Of course, we now
know that Morgan Stanley won the bake-off for a bond offering later that
day.
Meeker seems to be downplaying the relevance of what a $450 million cash
infusion might have meant to Amazon, much less the foreign institutions that
now hold the e-tailer's underperforming euroconvertibles. The "key point is
that the Amazon Commerce Network revenue we have modeled is in the
nice-to-have, not the must-to-have [sic] category," stated Meeker in her most
recent research note dated November 1.
But that wasn't the story last winter and spring, when Amazon CEO Jeff
Bezos was actively positioning his company as an Internet portal, not unlike
America Online, that would ultimately realize high-margin revenue growth
through its Internet investments, namely the Amazon commerce partners.
On a live national cable television program in April, The Summit in Silicon
Valley, produced by NBC News for its MSNBC outlet, Bezos explained to
the nation and host Tom Brokaw that commerce-partner investment was
integral to the company's business model.
A woman in the audience at Stanford University, who said she held 100
Amazon shares, asked Bezos: "I wonder if you can tell me what it is exactly
that I own?"
Much to everyone's surprise, Bezos didn't respond by telling the woman that
she owned a stake in the world's top online retailer. Instead, he said: "What
you own is what we like to think of as an incubator for e-commerce
companies that can start e-commerce companies at lower costs and more
quickly than any other company in the world.
"And so, if you think that e-commerce is going to be a big deal over the long
term, then what you own should be very valuable," he added.
In the short term, Amazon hasn't created a valuable incubator.
Amazon has invested roughly $520 million in its commerce
network-incubator portfolio. Through the first nine months, the return on that
investment is about $17 million in recognized cash revenues and a benefit of
about $225 million in stock. That suggests a haircut of nearly 50% on a
strategy that was supposed to build long-term value for shareholders.
Investors may want to heed the advice of Merrill Lynch's Blodget when it
comes to assessing the value of Amazon's commerce-partner revenues. "We
disapprove of booking equity as revenue, even as we agree with Amazon's
logic in this case," Blodget stated in an October 30 release.
"In the current market environment, however, we do not place a high value on
the equity component of the deals. A dollar of equity-based revenue in many
of the transactions is now worth anywhere from zero to 20 cents," Blodget
added.
Sounds like Amazon should stick to its knitting, and stay out of the incubator
business. |
