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To: Marco Polo who wrote (2)	9/19/1997 9:06:00 PM
From: Marco Polo	Respond to of 67

FOOL ON THE HILL An Investment Opinion by Randy Befumo Web Companies Warm to Media Attention Online retailers like AMAZON.COM (NYSE:AMZN) and ONSALE (Nasdaq:ONSL) have surged in recent days as investors begin to become overheated about prospects for the World Wide Web. Not since the Growth Stock Spring of Love in 1996 have companies associated with the Internet enjoyed such share appreciation. Stock of the online bookseller Amazon.com has almost doubled since last month while online auctioneer Onsale has nearly tripled since the beginning of September. The reason? Buzz. Both companies have received significant media attention in the last few weeks due to high-profile agreements with Internet search engines and online services and influential recommendations from analysts, both online and offline. Although Amazon.com and Onsale are the most recent beneficiaries, the trend is in fact a little older. The renaissance began a few weeks ago with shares of the search engines like YAHOO! (Nasdaq:YHOO) , EXCITE (Nasdaq:XCIT) , LYCOS (Nasdaq:LCOS) , and INFOSEEK (Nasdaq:SEEK) , and has continued without interruption. Even much-maligned AMERICA ONLINE (NYSE:AOL) has joined in the fun over the past couple months as it has shucked its access business to focus exclusively on content and commerce. America Online only finalized this transformation last week by swapping its ANS/Core Networks subsidiary with WorldCom for CompuServe's subscriber service. Investors who were around in early 1996 and who saw Spyglass enter the year at $55 and go as low as $12 by July, know that enthusiasm absent a real economic model or attractive valuation can cause problems. One particular phenomenon of increasing concern is the large disparities in valuation between pure-play Internet vendors of goods and services and larger companies with significant Internet operations who provide the same stuff. If the Internet-oriented subsidiaries were separately traded and valued at the same level as the pure-plays, they would be worth a significant portion of the parent corporation's current valuation. This is presents a situation where you have a huge gap left open for arbitrage that needs to close. Take the thrilling business of bookselling. Much of Amazon.com's promise is that it can sell a book more efficiently, generating more dollars by turning over its inventory very quickly. By setting up a business where a sale is converted into cash before the product is delivered, it sets up an operating model that looks an awful lot like Dell Computer's PC business. Almost everyone agrees that if Amazon.com can create the same kind of operating efficiencies that Dell has relative to indirect vendors of PCs, the company certainly could pump out a lot of cash. The question is what price should you pay for that potential in today's dollars? With $27.9 million in book sales for the second quarter ended June 30, Amazon.com was generating $310,000 in revenues per day. Right now if you annualize its quarterly revenues, the company has a $111.6 million run-rate. With 23.7 million shares outstanding valued at $47 3/8 per share, the company's market capitalization is $1.1 billion. This implicitly means that investors are paying $10.06 for every dollar of Amazon.com's sales right now. Certainly one can argue that you should net out the company's $56.4 million in cash that was on the balance sheet as of the end of last quarter, but given that the net operating loss last quarter was $6.7 million and the company is projecting losses through the rest of the year, between the money it spent setting up deals with the America Online's of the world and the money it lost doing business, we'll assume that cash is going to be used up. Keep in mind that bookselling is traditionally a low-margin business. While Amazon.com has room to increase those margins by cutting out the middleman, achieving operating efficiencies, and selling specialized books, a lot of this is eaten up by having to price its products lower in order to still be competitive with non-online store prices after including shipping costs. The direct PC vendors like Dell have shown that while Dell can underprice the competition even including shipping and handling, it does so because the basic prices of its machines are pretty high relative to those costs. Amazon.com has difficulty selling a regular paperback book in the $5 to $6 range significantly below a book store's price, although for oversized trade paperbacks and hardbacks the company has plenty of room. While Amazon.com can ultimately squeeze out a percentage point or two more than Barnes & Noble or Borders, the vast majority of the excess returns to shareholders will come from its asset turnover. This is the factor that will allow them to have a higher return on invested capital with similar net margins. This is why I was willing to compare Amazon.com with Dell Computer when the company came public back in May. However, the comparison to Dell cuts both ways, and investors willing to pay $10.06 per dollar of Amazon.com sales should keep this in mind. While bookselling is an $84 billion global market, PC vending is of a similar scope. With Dell generating in excess of $2 million of sales a day in its last quarter from the Internet compared to around $1 million in the prior quarter, the company is already generating more than six times the sales from the Internet that Amazon.com is -- and at a profit. If the market were to value Dell's Internet business alone at the same rate as Amazon.com, it would be worth $1.8 billion. Net Dell's cash hoard (which it will probably not consume), this accounts for nearly 7% of the company's valuation. Assume that the market might pay a higher price for Dell's sales given that they are (1) at a profit and (2) at a time when Compaq has yet to do a single dollar of Internet-based revenue, and you could push that value higher. Today's run in Amazon.com was the result of Morgan Stanley Dean Witter analyst Mary Meeker's positive coverage of the company at "outperform." Meeker stated succinctly, "We don't want to miss this one." However, also a long-time Dell bull, Meeker would be the first to point out to the investors engaged in the Amazon.com frenzy that the potential the Internet provides to companies selling products online is equal, or perhaps even greater, for things other than books. Dell's Internet business is not even discussed very much by Dell proponents, indicating that these sales are being lumped in with the company's other sales and are being valued at around 3 times its revenue run-rate. Amazon.com is being valued at 10 times the revenue run-rate. Dell already has in place many of the operational benefits that Amazon.com promises. Either Dell and companies like Dell with established and viable Internet-based businesses that are part of a larger business need to increase in valuation or Amazon.com and companies like it are overvalued. Investors cannot have it both ways... forever.