Respectfully submitted to the judges as to why it happened: Alan Abelson's view-
Bubble Trouble By Alan Abelson and Rhonda Brammer
Sizing up the state of the market. The book on Amazon.com. and why it's no Microsoft -- or, for that matter, no Yahoo.
What ails the Internet stocks?
In the space of two weeks, eBay, Amazon.com and Yahoo are down
35%-40%. Their values -- even after Friday's bounce -- have been sliced by a tidy $5 billion, $12 billion and $16 billion, respectively.
The most pedestrian explanation of why the group has taken such gas is that the stocks were, and are, wildly overpriced. That's a theory obviously bruited about by the sour-grapes types who never bought them. eBay, Amazon and Yahoo -- with sales of $50 million, $600 million and $200 million,respectively -- are valued at $8 billion, $19 billion and $28 billion. But,
remember, as any computer geek trading the shares will tell you, these
companies may be the Microsofts of the future or even the Microsofts
squared of the future.
Another plausible cause of the spectacular plunge by the erstwhile Internet
favorites is that the supply of the things has finally begun to sate the seemingly
insatiable demand. In which case, the pipeline of new offerings,
chock-a-block with Web-thises and .com-thats (WebTrends, ZDNet,
pcOrder.com, Priceline.com and MiningCo.com, to name only a few), could
well bury the group.
But besides the proliferation of stocks, with the newcomers drawing cash out
of the existing issues; the stratospheric valuations; the burst of new issues that
threatens to swamp demand, another generally unremarked but sinister factor
may be puncturing the Internet balloon -- the happy campers who trade the
stocks are starting to succumb to an outburst of sanity.
And if Wall Street ever casts a coldly rational eye on the Internet bunch, as it
began to do last week, chances are that shares of Amazon, the largest online
bookseller, could be among the prime casualties, in spite of the heavy damage
already inflicted on the stock.
For strip away the buzz and hype and what's left is a money-losing retailer
fighting a no-holds-barred battle for market share in a slow-growing, cutthroat
business. What Amazon does, essentially, is take orders for books over the
Internet and ship them, mostly by snail mail.
The beauty of Microsoft -- as anyone will attest who watched last week as
the company blew past analysts' estimates once again -- is not simply
30%-plus growth in revenues (38% last quarter). Rather, it's the company's
astonishing profitability. For every $1 of sales, an awesome 30 cents-plus falls
to the bottom line (40 cents last quarter).
No secret that these margins are the result of a formidable franchise -- a
monopoly, in the government's view. The "business model," as the jargon
goes, is great: Microsoft sells its jillionth package of software and the
revenues are virtually pure profit.
What has Wall Street so lathered up about certain Internet stocks --
especially portal companies like Yahoo, Netscape, Lycos, Infoseek and
Excite -- is that they have business models rather like software companies.
These are "destination" sites, in tech-talk, gateways to the World Wide Web.
And as more and more "eyeballs" pass through the portal, the ad rates the
gatekeeper charges can rise dramatically. Margins are potentially terrific.
Thus, while the stocks may be nuttily overvalued -- and in our view, they are
-- the businesses themselves are rich in potential profits.
In sharp contrast, Amazon.com, even on its jillionth sale, still has to pay the
wholesaler or publisher for the book and also the costs of handling,
warehousing, wrapping, addressing and mailing. Eventually, Amazon may
achieve operating margins in the high single digits -- that, anyway, is what it
has told Wall Street. Which translates into net profits of, at most, a nickel a
share on every dollar of sales.
And even that modest figure is a target, mind you, and given Amazon's
ballooning losses, arguably an optimistic one. Barnes & Noble and Borders,
the nation's two top booksellers -- the Wal-Marts of the industry -- manage
to net only two to three-and-a-half cents of every sales dollar.
Right now, of course, Amazon isn't remotely close to 5% margins -- or, for
that matter, to any margins at all, except negative ones. The company is losing
money hand over fist, and that, it concedes in its financials, won't change in
"the foreseeable future." In the
nine months ended September, for example, on revenues of $357 million,
Amazon lost $78 million, or $1.60 a share. Last quarter's losses, moreover, if
you include the amortization of goodwill, are actually accelerating faster than
sales.
In short, the more books Amazon sells, the more money it loses. The
"business model," at least for now, is aptly described by the hog farmer who
lost $50 on every pig he sold -- but hoped to make it up on volume.
To build its brand name, to grow its sales and its subscriber base, Amazon is
shelling out big bucks. More than a few of those bucks end up in the coffers
of the aforementioned portal companies. Nearly 25 cents of every sales dollar
Amazon takes in is spent on marketing and sales.
At the same time, price-cutting is rampant in the business. Already a deep
discounter, Amazon slashed book prices again in June and noted in its
September 10Q that it was offering "everyday discounts of up to 40% on
hundreds of thousands of titles and certain 'special value' editions discounted
up to 85%." In the future, it predicted, it may "increase the discounts."
At first blush, you might think Amazon's gross margins would top those of the
traditional booksellers, since it does not have the expenses of running
bookstores.
But the reverse is true. Gross margins of Barnes & Noble and Borders --
after deducting both the cost of the merchandise and occupancy costs -- are
27-28 cents of every sales dollar. Amazon's gross margins -- after deducting
the cost of merchandise and shipping -- are less than 23 cents.
The critical question of whether Amazon will ever make money hinges on this:
Do the customers keep buying if ad spending slows and discounts moderate?
Put us down as doubtful.
For all we admire Amazon's ingenious Website -- in our view, it's a bit better
than Barnes & Noble's and a darn site better than Borders' -- when we shop
for a book, price is what counts. If Borders has the book $2 cheaper,
Borders gets our order.
Nor are we alone: "Saving money/lower prices" was, by far, the most
important reason for shopping on the Internet, according to a recent survey of
1,363 consumers by Ernst & Young.
Amazon is drawing a host of new customers, not so much because its
Website is cool (though it is), but because of its rock-bottom prices. If the
discounts begin to disappear, so, we suspect, will the customers. After all, it's
the same book, whether you buy it over the Internet or across the street.
Though also committed to an expensive foray into online selling, Borders chief
exec Robert DiRomualdo has no illusions about the business.
"This is not Yahoo, where the feeding frenzy allows me to triple my rates for
search-engine space and which all drops to the bottom line," he is quoted as
telling a retailing conference. "This is a low-margin retail business."
Internet retailing may actually work best as an adjunct to old-fashioned
peddling of the brick-and-mortar variety. Indeed, over a third of consumers in
the Ernst & Young Internet study said they had researched books on the 'Net
and then bought them somewhere else. There are fairly stiff shipping charges
to pay for online orders, and then there's the inevitable wait.
Okay, books are low-margin. But can't Amazon use its franchise to sell other
stuff? Of course it can, and it has. Amazon added music to its offerings and
overnight became the largest online seller of CDs. However, CDs have far
worse margins than books. So the only thing Amazon has proved so far is that
it can lose money selling books and lose still more money selling CDs.
The stocks of Barnes & Noble and Borders -- with sales of $3 billion and
$2.5 billion, respectively -- are selling at about 90% and 60% of revenues. In
contrast, at Friday's close, Amazon was valued at $19 billion, or 31 times
sales.
If you valued Amazon at, say, twice forward sales -- and assumed that
revenues handily triple -- the stock, instead of trading at 123, would sell under
25. And, at one times sales, under 12.
INTRO TO ARTICLE (nothing to do w/ above, just an analsis of what Greenspan was saying, nothing very important LOL):
Life is full of disappointments.
Naive us, we tuned in to the President's State of the Union address because
we thought we'd get the lowdown on how the Clinton marriage was bearing
up under the weight of Monica and all (which, forget about all, is quite a lot of
weight). But just our luck -- he had another union in mind.
So we had to sit through what seemed like an eternity hearing about how
Americans are in a state of euphoria (which is near South Dakota but the
weather's a lot better) thanks to Bill and things couldn't be better, but will be if
we let him hang on to his job. He also pointed a couple of times to his wife
sitting in the balcony (we gather she's determined not to let him out of her
sight).
The Republicans politely sat on their hands during the length of the address
after exhaustive research demonstrated conclusively that Republican hands
have a mind of their own and sitting on them is the only way to keep them
from making obscene gestures. They did applaud when Mr. Clinton raised the
possibility of a woman President (they were afraid not to because they knew
Liddy was watching and the consequences would be doleful if they didn't).
The centerpiece of the speech was the President's recommendations on
Social Security, which, frankly, we found contradictory. On the one hand, he
vowed to keep the system solvent; on the other, he wants it to invest in the
stock market.
The very next day, Alan Greenspan, the famed bubble maker whose less
glamorous day job is Fed chairman, threw cold water on Mr. Clinton's
proposal that Uncle Sam pick the stocks for Social Security portfolios.
Speaking to an audience of financial simpletons -- the House Ways and
Means Committee -- he warned that the government might well decide to
invest in some low-return operation like Save the Whales, pointedly reminding
the attending politicos that whales rarely bother to show up at the polls.
Our own feeling is, why not allow people to invest part of their nest egg in the
stock market? They should be aware, though, that, as a smart fellow
observed in this space awhile back, life's bills and bull markets don't always
coincide. Moreover, with the market at such gross valuation -- even Mr.
Greenspan noted stocks were on the high side -- the timing seems a touch
problematic.
Mr. Greenspan's cool response to the Social Security proposal, his insistence
that the Fed doesn't and won't tailor policy to suit the needs of the stock
market (sure fooled us) and his cautious cautions on the level of equity prices
should have rattled the market, a savvy friend of ours contends. That it didn't
on Wednesday he takes as a very bearish sign, confirming, if further
confirmation be needed, this isn't a normal-functioning market.
Instead of the proverbial wall of worry, this market, he says, has been
climbing a wall of enthusiasm. He sees great similarities, especially in the
action of the Internet stuff, to dramatic tops in various commodities in the
'Seventies and early 'Eighties (tops that were invariably followed by crashes).
And he espies a scary parallel between the action of the Nasdaq 100 today
and the S&P 500 in August '87. Although not a technician, he's technically
knowledgeable. That the advance/decline line sank to a 50-day low so soon
after the indexes reached new highs, he views as the "kiss of death."
Our friend, besides having a keen investment feel, obviously is not averse to
indulging a flair for the flamboyant phrase. Since, like the rest of us, he puts his
pants on one leg at a time, he's not always right. But on major market calls, no
one ever got rich betting against him. |
