Amazon's worth? Don't ask the pros
Musical chairs at Merrill Lynch highlight vagaries of research
OPINION
By Christopher Byron
MSNBC CONTRIBUTOR
March 16 — Dedicated Merrill Lynch clients surely had grown accustomed to hearing consistently bearish pronouncements on Amazon.com from Merrill's Internet analyst, Jonathan Cohen. So what are they to think now that Cohen has jumped to online investment bank Wit Capital, and sitting in his old Merrill seat is one of Amazon's wildest bulls?
Christopher Byron BBS
Merrill Lynch analyst Henry Blodget tells CNBC he holds a long-term positive outlook for Internet stocks.
Amazon seeks to issue more shares
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THE NEWS that Mr. Jonathan Cohen has left his perch at Merrill Lynch & Co. to become the head of research at the online investing operation calling itself Wit Capital invites some thoughts on the current state of stock analysis on Wall Street.
That is partly because Mr. Cohen — long viewed as one of Wall Street's most respected and outspoken bears regarding the prospects for Amazon.com — will now head the research effort at an Internet-based firm whose own future depends on many of the same forces that Cohen is worried about regarding Amazon: most notably, the continuation of its wildly excessive valuation.
But there is something else at work in this situation as well: Cohen's replacement at Merrill Lynch.
That person has turned out to be none other than Henry Blodget, a research analyst at CIBC Oppenheimer & Co. who is widely regarded as Cohen's polar opposite when it comes to Internet retailer Amazon.com.
With the current bull market nearly a decade old now, major retail investment firms like Merrill still make a big deal about the quality of their sell-side stock research — and typically like to brag about who got the most slots on the Institutional Investor all-star team in various industry sectors. But no firm wants to alienate a potential client by knocking its stock.
Jonathan Cohen, now at Wit Capital, has said that Amazon.com was probably the most expensive stock in the history of Wall Street.
That in turn leads to the current state of Wall Street investment research, in which no analyst who wants to keep his job issues a “sell” recommendation on a hot stock. The safer choice is to opt for such meaningless euphemisms as “hold,” “accumulate” or “long-term accumulate.” Then, only after the stock has fallen nearly to zero, does the firm issue the dreaded “sell” — witness, for example, how Merrill Lynch & Co., the underwriter of Boston Chicken Inc., rode the stock down from $40 to nearly $3 before telling its investors to bail out.
Yet rarely does one encounter a more craven flip-flop — or more unconvincing rhetorical waltzing to justify it — than that put on by Merrill on behalf of Amazon.com … a company for which Merrill has now hired back-to-back analysts with diametrically opposed opinions about the stock while all the while insisting that Merrill, as a firm, has no opinion on Amazon.com one way or the other.
THE GREAT DIVIDE
Merrill Lynch's new Internet analyst Henry Blodget talks to CNBC Tuesday about the sector's volatility.
In case you've forgotten just how far apart Messrs. Blodget and Cohen are to each other regarding Amazon.com, here's a quick refresher. It was only last December when Mr. Blodget — then at CIBC Oppenheimer — stunned Wall Street by predicting that Amazon (then selling, split-adjusted, for barely $300) would rise to $400 within a year … which it promptly did within days.
Whereupon Mr. Cohen was asked by reporters what he thought of all that, and shot back that Amazon should in fact be selling for $50 per share and was, on any reasonable valuation, probably the most expensive stock in the history of Wall Street.
Now, I have no idea what caused Mr. Cohen to pack his bags at Merrill Lynch and head for Wit Capital — though I can report, based on conversations with various insiders at Wit, that Mr. Cohen has not in fact altered the view he held at Merrill Lynch at all, and still regards Amazon as grossly overpriced. Cohen himself declined to comment on the matter.
Amazon.com, Inc. (AMZN)
price change
$135.06 -3.375
Be that as it may, his replacement, Mr. Blodget, has probably done more to boost the value of Amazon.com on Wall Street than any other analyst around. And there's nothing in his research output since joining Merrill to suggest that he's changed his view, either. His latest note, dated March 10, describes Amazon.com as “one of the fastest growing companies in history,” and claims that the real “risk” in the stock is in not owning it — though he acknowledges that its worth cannot be pinned down more precisely than somewhere between “$1 and $200.”
This is analysis?
No, I think it is evidence of an investment firm looking to suck up to a company that is clearly going to need debt and equity underwriting support from Wall Street for as far into the future as the eye can see.
AMAZON.COM GROSSLY OVERVALUED
Whatever the motives at work here, this much is clear to anyone willing to see the obvious: Amazon.com simply does not warrant even a fraction of the price at which its stock is currently trading.
We may find support in abundance for that observation in the company's own most recent full-year financial report, filed with the Securities & Exchange Commission on March 5.
Data provided
by Microsoft Investor
What the filing reveals, among other things, is that the Web retailing business model, as practiced by Amazon.com, is troubled to say the least. True, the company's revenue base has been growing at an astonishing 32 percent sequential rate, quarter-upon quarter, and the rate actually doubled to 64 percent in the fourth quarter over the third.
This has been viewed by bulls on the stock (like Blodget) as evidence that the company's business strategy is working and that the proper way to value the company is on a multiple of its revenues, since acquiring those revenues is the goal of how the company is spending its money.
But Amazon.com is a retailing operation, and that means that more than 77 percent of its revenues disappear instantly in the cost of the goods it sells. Thus, although Amazon.com reported $610 million in net revenues for the year just ended, a better gauge of the company's inherent worth on a revenue basis would be its net-net revenues — that is, the gross proceeds from which it has to pay all costs except the cost of the merchandise itself. In 1998, that number totaled roughly $146 million, which would translate into a stock price somewhere in the low thirties.
More importantly, the difference between Amazon.com's revenues and gross profit — that is, its 23 percent “gross margin” — basically defines the outer limits of how deeply the company can discount its merchandise at retail before it begins selling at a loss on its own cost of goods.
As it happens, Barnes & Noble Inc., the nation's leading conventional retailer of books, has a gross margin that, averaged out over the year, is almost identical to Amazon.com's. Yet Barnes & Noble includes in its gross margin calculation the cost of occupancy it incurs on all those (presumably) outmoded, costly and basically dinosaur-like retail outlets in malls around the country.
In other words, if you were to back out the occupancy costs and put the two gross margin calculations on an apples-to-apples basis, you'd find that Amazon.com is gaining revenue growth by steeply discounting its prices — a tactic in which is it clearly outgunned.
Finally, it is out of that “net net” revenue number that Amazon.com has to make the nut on the whole rest of its business — and this is something it simply cannot do. Its marketing and sales costs alone are eating up virtually its entire gross profit, and when you throw in product development and corporate overhead the operating losses get huge: $62 million for 1998.
And this doesn't even include interest expenses that are likely to touch $100 million in 1999 through various debt offerings. Indeed, while no one was paying much attention, Amazon.com became, in its own words, a “highly leveraged operation,” with more than $1.5 billion of junk and convertible debt on its books.
As everyone knows, the whole premise of the Internet as a medium for commerce is that its costs are presumed to be lower than elsewhere, meaning that if you just spend enough in marketing outlays to establish yourself on the Web, you'll eventually make money.
Yet it has already become clear — not just for Amazon.com but for many Internet companies — that marketing and product development costs are inescapable and permanent features of doing business on the Web. And in the case of Amazon, the idea that the Web will enable businesses to hold down employee costs has also fallen by the wayside.
Thus, in its March 5 10K filing, Amazon.com reported that its employees total 2,100 workers as of Dec. 31, 1998. That works out to roughly $290,000 of revenue per employee, which is not a whole lot more than the number for Saks and other old-line department stores.
The theory justifying all this is, of course, that these front-loaded costs will translate into continued, ultra-fast revenue growth that will eventually turn the company profitable. But there is nothing so far to indicate that this will in fact happen. Instead, the record of ever-growing losses is itself keeps growing.
Meanwhile, Merrill Lynch & Co. has done its about-face on the stock, and after telling its clients it thinks the stock is worth $50 at most, now wants them to buy it at $138 — all the while maintaining that, hey, these are the opinions of the analysts, not the company that employs them.
In this particular house of ill repute, it would seem that the owner is just the piano player. |
