AMZN raised estimate - reiterate STRONG BUY !!!
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08:33am EST 27-Jan-99 SG Cowen Securities Inc. (REAMER, SCOTT 617-946-3749) AMZ
AMZN/AMAZON'S HUGE Q4:98 SURPASSED ONLY BY A BETTER.../STRONG BUY/PT 1 0F 2
SG COWEN
Scott Reamer
(212.495.7769)
January 27, 1999
Amazon.com (AMZN - $115)
Amazon's Huge Q4:98 Surpassed Only By A Better Q1:99: Strong Buy, Increased
Target
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EPS (FY Dec) Quarterly EPS
EPS Revision P/E Q1 Q2 Q3 Q4
1998E ($0.50) NM ($0.07) ($0.12) ($0.16) ($0.14)
1999E ($0.87)E -$0.26 NM ($0.29)E ($0.26)E ($0.22)E ($0.12)E
2000E $0.16E NM
Market Cap: $17.7 billion
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Key Points:
1. Amazon.com's Q4 was even stronger than we'd thought; customers, new
categories, international
2. January sales trends, remarkably, continue to exceed December's;
guidance for Q1 was for Q/Q increase
3. Raising our numbers aggressively (yet again) on the top line;
profitability remains distant on purpose
4. Avoid all eye contact with the trees.stay focused on the forest.
5. New price target is $195 based on discounted revenue and discounted
earnings.
6. Aggressively reiterating our Strong Buy (1) rating, we'd be all over
this name on the open.
Thesis:
Amazon.com is the Internet's leading retailer, the market's single purest
proxy for consumer online commerce, and the most compelling consumer
retailing experience on the Net. In our view, this stock has all the
elements of a great performer, including an enormous and fragmented market
opportunity, a superb management team, first mover advantage, a great brand
and product, and, of course, an Internet pedigree. Though there are plenty
of secular reasons why we view this company and this stock so favorably, we
gain most of our comfort from, in Bob Pittman's words, "having seen this
movie before" in the form of that other great Internet stock: America
Online. Though the analogy to AOL is sometimes loose fitting, we see many
of the same characteristics in this stock and this company that we saw in
AOL back in 1995; a great management team, a huge market opportunity, an
obsessive focus on customers, and dysfunctional competitors. Of course, the
valuation debate will continue, but we're of the mind that, if Amazon can
execute half as well against the myriad (and enormous) retailing
opportunities before them as they have to date, the space is theirs to own,
which suggests that Amazon will be a much bigger company tomorrow than it
is today. Our Strong Buy (1) rating and $195 price target reflect this
optimism.
Discussion:
And You Thought You Already Knew What A Great Q4 Amazon Had?.Think Again
Amazon reported a December quarter that, despite the pre-release of the top-
line, provided as much jaw-dropping material as any quarter in their short
history. Without question, Q4:98 provided the most compelling sets of data
points yet that Amazon's commerce portal thesis is becoming a near term
reality; the question has gone from "Can they become a commerce portal?" to
"How big can they be as a commerce portal?" (For a more complete
dissertation of this thesis, please see our 12/18/98 Internet Capitalist
piece "A Web Retailer Does Not Equal A Commerce Portal".)
AMZN posted a loss of ($0.14) per share and beat our consensus-matching
($0.18) estimate by $0.04 on phenomenal revenue growth and some nice,
somewhat unexpected leverage in the cost structure. All the key drivers of
the model were exceptional; revenue growth, customer acquisition, music
sales, video/international sales, and sales and marketing expenditures,
with gross margins, the only out layer, declining Q/Q thanks to the mix
shift to music and videos. We detail each below:
Revenue: At $253 million, total revenue beat our $192 million estimate
handily (disturbingly, really) and represented 65% sequential top line
growth. Music sales surged 130% q/q, to $33 million (vs $14mm in Q3) to
account for 13% of total, versus our mere $21 million estimate. Overall,
videos, the gift center, the German store, and the UK operations generated
something like $30 million in revenue (12% of total), which is impressive
given the age of each of those efforts (less than two months). Like last
quarter, fully 63% of orders (on a blended basis with the new products
included) were repeat orders, a figure that should increase with time as
the customer set matures.
Customers: AMZN added more than 1.7 million new customers in the quarter,
bringing the total to 6.2 million customers. Some perspective is in order
here, given the enormity of this number: last December Amazon had only
1.5mm customers, having taken them a bit over 2 years to get to that
figure; this quarter they added more customers than they were able to for 8
quarters running in 1997. Amazon, like AOL and Yahoo! before it, is
providing yet another great set of data that proves that increasing returns
is real and is powerful.
Gross Margin: At 21.1%, gross margins were down 160 basis points
sequentially, due to the rapid mix shift from books to lower margin videos,
music, and .uk (British) and .de (German) sales, as well as the increase in
hardcover book sales (which are subject to greater discounting) in the
holiday period. It should be noted, as investors digest these trends, that
book margins alone had increased 400 basis points in the last 1.5 years,
and though management suggested that lower gross margins for music and
videos may be structural element of that business (a debate we're glad to
take up with readers), we suspect that gross margin trends have probably
seen their worst days for the next handful of quarters. On the inventory
front, Amazon now holds about $29 million of inventory on the balance sheet
(up $9mm q/q) and inventory turns stand at 26 days (flat from last Q).
Sales and Marketing: Total S&M expenses in the quarter were $48 million
(19.2% of revenue), basically in-line with our $47 million estimate, but
much, much lower on a % of revenue basis, thanks to the higher-than-
expected top line and the leverage that AMZN achieves when the top line
explodes as it did in Q4. For the second quarter in a row, Amazon has been
able to spend a very small amount on actual customer acquisition;
management stated that the bulk of the increase in S&M dollars Q4/Q3 was
due to customer service and distribution center costs and not, in fact, on
branding and customer acquisition. This is significant for a variety of
reasons, not the least because (1) it illustrates the leverage AMZN has as
they grow the business and (2) lower customer acquisition costs suggest
that the company is benefiting significantly from the power of increasing
returns. Once again, Amazon stated that the majority of their traffic comes
directly to the URL and not from a third party traffic partner like Yahoo!
or AOL.
Given the great Q4, it is important for investors to remember that the
customer acquisition efforts that landed AMZN 1.7 million new customers is
a leading indicator of revenue growth. Because Amazon tends to do a
remarkable job at "monetizing" their customers once they get them to make
their first order (that is, generates greater and greater revenue from them
by increasing purchasing frequency and purchase size), we should be equally
optimistic that the top line will be strong for the next handful of
quarters. With 1.7 million new customers ready to purchase (and purchase
more) in 1H:99 and beyond, we're hard pressed to envision a scenario in
which Amazon doesn't have another awe-inspiring quarter in March.
We Are (Habitually) Increasing Our Revenue Estimates, Q1 Guidance Is For A
Q/Q Increase
It was difficult for us to imagine a scenario in which management would
suggest that Q1 revenue would likely be greater than what was an enormous
December quarter, but inexplicably, that's exactly what they did. The
early read on January sales and customer acquisition is that both are
chugging along heavier than the pre-holiday (that is, pre-Thanksgiving)
period. Despite the very positive long term implications for Amazon here,
this is the first real data point that investors have received that
suggests that the December quarter Web retailing trend was not secular
(that is, seasonal), but rather structural, and that, perhaps, Web
retailing may sustain itself at ever greater rates than any of the most
ardent bulls had believed. We'll wait to see other data points from other
companies, but for now, Internet investors should take note at the
potentially huge implications that such a trend could have.
Thanks not only to the great December quarter, but also to the very real
likelihood that the March quarter is going to be strong (and sequentially
higher), we are increasing our revenue estimates substantially. We are
going from $975 million in 1999 to $1.3 billion (up $341 million or 35%)
and from $1.4 billion in 2000 to $1.9 billion (up $494 million or 35%). On
the earnings front, we're heeding the company's call on their investment
strategy and lowering earnings a good bit thanks to the company's plan to
spend even more in the face of this phenomenal top-line growth. Major
investments in distribution centers (like the one recent addition in Nevada
which impact S&M), as well as increased spending on new product offerings
and better functionality (R&D) are bring our 1999 EPS numbers down from
($0.52) to ($0.87)
Now before we start to hear the shorts cry out that Amazon will always and
forever suffer from profitless prosperity, we'd encourage investors to
consider the logic and history of Amazon's approach to investing for
growth. The dynamics of online businesses being what they are (that is,
highly scaleable once a fixed cost infrastructure and customer acquisition
foundation have been laid), it makes lots of sense to us on an ROIC and
lifetime customer value basis to spend money today building capacity for
the sales growth they expect in the future. As well, a subtle but important
data point emerged from the conference call that Amazon's book business was
actually profitable in the December month, suggesting that, just as
management says, they could be managing the business toward profits today
if they wished (they could, for example, always sell advertising on their
site or sell higher margin items on a merchandise basis). Instead, they
believe, and we concur, that growing the top line is the most important
factor to consider in the near term.
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