As many investors are aware, the book industry is fairly inefficient,
very fragmented, and as a result, a
pretty low margin business. Barnes & Noble, the nation's biggest
retailer, has only a 12% share.
Couple this reality with the fact that the Internet has the power to
disintermediate middlemen (that
is: consolidate parts of an industry value chain and thereby
consolidate industry margin), and what
you have is no less than the possibility for a new industry
participant, leveraging the Internet's
disintermediating power, to change the face of the industry value
chain.
Let's be more specific. We're suggesting that, faced with the prospect
that their industry value chain
was being re-aligned fundamentally (by the introduction of a new
channel, the Web, and a new
vendor, AMZN, exploiting that channel beautifully), Barnes & Noble took
the only step it could have
to protect it's margin structure: backward integration. By buying
Ingram, BKS theoretically should
benefit from the efficiencies inherent in owning a large horizontal
chunk of an industry value chain.
That is, owning both the distribution and the retailing assets within
the book industry should allow
BKS to capture more margin than the book industry cold possibly provide
them on a stand-alone
basis. And since Amazon.com was the catalyst that caused the original
re-alignment of the book
industry, we believe it's safe to suggest that tiny little Amazon has
caused the latest book industry
value chain re-shuffling.
In and of itself, this observation is intellectually stimulating and
fairly novel, but how can we
determine how shareholder value will be re-allocated? Since The
Capitalist believes that the only real
gains in life are capital gains, we are pressed to ask the question:
How can we apply these lessons for
profit? To this end, we think that the Internet will, and in some cases
already has, changed whole
segments of the economy, causing shareholder value growth as well as
decline. We will highlight two
that are most obvious to us: the newspaper business and general retail
businesses.
Newspapers derive only about 20% of their revenue from classified
advertising but it accounts for
more than 60% of a typical newspaper's net income. What happens when
this revenue goes over to
the Internet in its entirety? Newspapers will still be stuck with the
majority of their fixed cost
structure, but will have lost, if not the entirety of their classified
advertising revenue, then certainly a
substantial chunk of it to the Yahoo!'s, and AOL's of the world. Of
course, they could always partner
with these on-line players, but that still means a revenue sharing
arrangement, and unless the
newspaper company is able to cut costs drastically (remember the
20%/60% rule above), they will
become a negative equity entity.
As for retailers in general, they are most certainly a fixed cost
business that depends on driving
enough foot traffic to cover their overhead. What happens when 10-15%
of their foot traffic goes to
the Internet, to Amazon.com, to AOL, to Yahoo!? Well, like newspapers,
they either must partner
with the new on-line retailers, establish a site of their own and pay
the cost of driving Internet foot
traffic (not to mention the costs of the site itself), or lower their
cost structure drastically in order to
remain profitable (remember that retailing is a tough, low margin
business). Which of these options
they choose will absolutely determine how they will be able to grow
shareholder value over time,
which presents an opportunity for being on one side or the other of
this trend.
We encourage Internet investors to think broadly about how the Internet
will change the shape and
dynamics of large and important parts of our economy. As the Internet
cuts a swath across each
industry it comes into contact with, there will be winners, like
Amazon.com and AOL, and there
most certainly will be losers. Maximizing your Internet knowledge for
the greatest return means
being able to identify both.
Company Watch
America Online (AOL)
AOL Reaches 14mm Subscribers
Continuing their strong growth in subscribers, AOL announced on
November 12th that they had
reached 14 million worldwide subscribers for the service
(ex-CompuServe). Recall that AOL
announced that they had reached 13.5 million subscribers at the end of
September, suggesting that,
according to our admittedly simple calculations, AOL has added, in the
43 days between 9/30 and
11/12, something like 11,600 new subscribers per day. Assuming that
that pace holds (which is
actually lower than the pace AOL experienced going from 13 million to
13.5 million in 34 days),
AOL would be at 14.56 million subs at the end of the December quarter
(an addition of 1.05 million
new subs in the quarter, against our 1mm new subs estimate).
We're hard pressed to imagine a scenario in which AOL subscriber growth
doesn't quicken as we
approach the holiday season, as the weeks after Thanksgiving are AOL's
strongest of the year in terms
of gross registrations. So, unless this year turns out to be a bust
from a PC unit growth standpoint
(and no evidence suggests that will be the case), it's very likely that
we'll be seeing, once again,
higher-than-expected subscriber growth for AOL in Q4. Will it beat
AOL's previous all-time record
net adds of 1.2 million last December? Sure looks that way. |
