Amazon.com Inc – 7 October 1998
2
Bertelsmann AG announced yesterday that it has entered
into an agreement to form a joint venture with Barnes &
Noble. As part of the agreement, Bertelsmann will
purchase a 50% stake in barnesandnoble.com for $200
million. Each has additionally agreed to invest $100
million in the venture.
Bertelsmann is a global media company and one of the
world's largest publishers of English-language books. The
company owns publishers that include Random House Inc.
and Bantam Doubleday Dell. (Bertelsmann is the world's
third-largest media company after Time Warner Inc. and
Walt Disney Co.)
As a result of the transaction, Barnes & Noble announced
that it will postpone its planned initial public offering of
barnesandnoble.com for several months. Barnes & Noble
had planed to sell as much as 20% of barnesandnoble.com
in an offering to raise as much as $100 million.
This transaction is the largest within the Internet
commerce space thus far and represents a meaningful
commitment by a traditional media company to electronic
commerce. We believe that the transaction provides
barnesandnoble.com with not only a broad base of
proprietary content, but also the ability to leverage its
relationship with Bertelsmann over time. Together, we
believe that barnesandnoble.com and Bertelsmann have the
ability to build one of the leading electronic commerce
sites for both books and music that could threaten
Amazon.com's market leadership position.
In light this recent announcement, we would reiterate our
comments on Amazon.com's operating model.
We believe that the model for online retailing is becoming
split into two parts. Those companies with sufficient
operating scale and/or brand equity in the physical world
that can leverage themselves into the online space with
significant competitive advantages. Companies in this
group include pure-play retailers such as Barnes & Noble.
The other category of companies include those which have
embraced a virtual commerce model predicated on not
owning physical inventory or infrastructure. Companies in
this group will generally operate on an agency (as opposed
to principal) basis.
Our specific concern regarding Amazon.com (independent
of the valuation issues we have discussed previously) is
that it sits between those two models. The company is not
large enough (in terms of order volumes and distribution
infrastructure) to generate the economies of scale
necessary to compete effectively with large physical-world
retail chains. At the same time, Amazon.com is far too
large (in terms of the cost structure associated with its
proprietary inventory and distribution systems) to compete
effectively with companies which forego that structure and
provide a linkage with existing distributors.
We believe that the notion that Amazon.com will be able
to profitably leverage its (diminishing) market share in
online book sales into other, largely unrelated business
lines may prove overly optimistic.
More critically, we do not believe that online commodity
product sales produce the sort of brand equity generated by
the distribution of proprietary information or media
products.
Amazon.com's current valuation continues to lie
significantly above the regression that describes the
valuations of other Internet companies (that regression
correlates price/revenue valuation multiples to expected
long-term corporate operating margins). Given both the
concerns we have outlined above and the magnitude of the
company's valuation premium, we continue to recommend
that investors exercise significant caution towards
Amazon.com shares.
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Opinion Key [X-a-b-c]: Investment Risk Rating(X): A - Low, B - Average, C - Above Average, D - High. Appreciation Potential Rating (a: Int. Term - 0-12 mo.; b: Long Term - >1 yr.): 1 - Buy, 2 - Accumulate, 3 - Neutral, 4 -Reduce,
5 - Sell, 6 - No Rating. Income Rating(c): 7 - Same/Higher, 8 - Same/Lower, 9 - No Cash Dividend.
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