Kathman on Words of Wisdom from Omaha 03-19-99
Dorsey on the Marriage of Broadband and Content 03-17-99
McDevitt on REITs and Irrational Pessimism 03-15-99
Nettrends: The Great Internet Price War 3-16-99
David Kathman on Amazon's Latest Rise 12-18-98
Pat Dorsey on Sauces and Shorts 12-14-98
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Faithless in Seattle with Amazon.com
by Pat Dorsey | According to Internet mega-bull Henry Blodget, the real risk with online bookseller Amazon.com AMZN is not owning it.
Really--I'm not making this up. Blodget, you may recall, was the gent who gained wide acclaim last December for predicting that Amazon would be worth $400 within a year (well above the split-adjusted $300 it was then trading for), and subsequently watching the stock run past his price target in less than a week. The latter-day Nostradamus has since left CIBC Oppenheimer for Merrill Lynch MER, where he recently penned the following words: "The real risk with open-ended growth stories [Amazon] is not so much losing money but missing multi-baggers."
Ah. So, according to Mr. Blodget, the opportunity cost of not investing in Amazon is so immense that it outweighs the risk of losing 50%-75% if the stock tanks. (The downside figures are his, not mine, from a separate report on the Internet sector as a whole.) A bold thesis, to say the least, and I have to say that I'd be much more inclined to believe it if it hadn't been put forth in a piece that reads more like a love note than a research report.
The same analysis, for example, closes with "We love the opportunity, the company, and the management, so we are recommending the stock for strong-stomached investors with similar faith."
Faith? What does faith have do with security analysis? Am I supposed to build a shrine to Amazon CEO Jeff Bezos and pray nightly that the stock continues climbing ever-upward, despite its ever-increasing losses? Perhaps Blodget should commission some devotional candles with a portrait of St. Bezos on them to pass out to his clients--maybe with a built-in compass so the faithful can always be sure to face the Mecca of e-commerce, Seattle.
I suppose I shouldn't single out Mr. Blodget for his reliance on faith, since Amazon seems to be asking the same thing of its investors. Amazon, let us not forget, has urged investors to focus on the company's "long-term franchise value rather than a perceived bottom-line trend." Let's think about what that means for a moment: Amazon is essentially telling investors that the huge losses it's incurring are just the cost of building a powerhouse brand, and that brand will eventually be worth the price the company is paying to create it. On the face of it, this makes some degree of sense--after all, what is Coca-Cola without its brand but sugar water in a red can?
The problem with Amazon's "brand at any price" strategy, however, comes in the nature of the goods that Amazon is selling. Brands are valuable because (among other reasons) they lower consumers' search costs. In other words, if experience (or advertising) has convinced me that the Gap GPS consistently sells khaki pants that I like, I might be willing to pay somewhat more for Gap khakis than for a similar pair of pants at, say, Wal-Mart WMT. The key to this example, however, is that pants are an easily differentiated product--their quality, style, and other attributes can vary substantially from one retailer to another. So, I might be willing to pay the Gap a little bit more because its brand assures me that my pants will be stylish and well-made.
Books, CD's , and videos, on the other hand, are commodity products--a copy of Monica's Story is going to be the same piece of tell-all trash whether I order it from Amazon, Borders, or a lesser-known bookseller like 1bookstreet.com. In general, sellers of commodity products compete by trying to offer consumers the lowest price possible, because there's no other way to differentiate the goods they're selling. Since competing on the basis of price is a tough game to win (lower prices mean less profits), it's a mystery to me why Amazon's brand is worth as much as investors are paying for it--especially when Amazon doesn't even have the lowest prices. (I used four separate shopping engines: mySimon, Acses, eCompare, and bestbookbuys to compare a basket of six different books. On average, Amazon was about 14% more expensive than the cheapest bookseller, including shipping.)
For its part, Amazon claims that it's trying to differentiate the overall online shopping experience through personalized services, better customer relations, and other sorts of value-added services that engender loyalty to the Amazon brand. If online shoppers were browsers at heart, and were primarily looking for web sites to recommend books appropriate to the their interests, this might be a good strategy. However, a study by Internet researchers Jupiter Communications last year found that a whopping 77% of online shoppers went to the Web with a specific purchase in mind.
Hmm. If most folks already know what they're going to buy, and it's going to be the same thing no matter where they buy it from, what's the incentive to buy it from Amazon as opposed to anywhere else? Sounds like a pretty fragile foundation upon which to build a brand, if you ask me.
Speaking of fragile foundations, did I mention that Amazon recently sold $1.25 billion dollars in convertible bonds, describes itself as "highly leveraged," and will be paying well over $60 million in interest this year? These and many other interesting nuggets can be found in the company's recently filed full-year financial report--a fascinating read, even for the not-so-financially inclined. (The risk factors alone take up about six pages.)
Sorry, Mr. Blodget, but the risk of not owning Amazon is one that I'm more than willing to take--I guess I just don't have enough faith. Maybe I'll reconsider if you send me one of those St. Bezos candles.
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Pat Dorsey is an Editorial Analyst for Morningstar StockInvestor. If you've got thoughts or questions about this column, you can send him an e-mail at pdorsey@mstar.com
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