Certain Wealth in Uncertain Times  ®

We are having host server difficulties with Firefox and Opera...

 
TO BECOME A SUBSCRIBER and see all our articles, prices, and quotes before the public does, click here:

Give Me the Investors Edge!!

   “THE AMAZON (AMZN) FLOWS BETWEEN

 A ROCK AND A HARD SPOT”

December 1999

                 And here you thought that Scylla and Charybdis, the original rock and a hard spot (in the form of a whirlpool, according to Homer's Ulysses,) were in the Mediterranean, did you? No, they are on either side of an ever-constricted AMAZON.COM (AMZN).     

           Before you consign me forever to The Land of Fuddy-Duddy, let me point out that I love the Internet. Use it for just about everything these days in terms of research, purchasing, strategic alliances, etc. I embrace the Brave New World gleefully.  But if the Emperor has no clothes, somebody's got to step up and say so. There's a difference between liking a company's business plan and liking their valuation level. The former is an absolute necessity before I look further; the latter can cause me to wait and advise re-entry at a lower price.     

           In AMAZON's case, however, I'm actually concerned about the business model itself. It's my job to help you to know when to sell for huge gains and re-deploy those assets so you don't give it all back. I'm discussing my concerns with you because you don't want to own a Rambler just because the auto industry is The Next Big Thing (it was once, you know!) And ramble is what I see AMAZON doing. Early entrants aren't always the survivors -- and when they go down, they sometimes take your life savings with them. To avoid buying a Rambler when you could have a Jaguar, think about this...     

           AMAZON is not a case of garbage in/garbage out. It's a case of cash in/ashes out. They are burning through $100 million a year. At this rate, they have three or four years left in business without selling off assets to competitors.      Since AMAZON won't show a profit for at least several years (Chairman Jeff Bezos' affirmation, not mine), it desperately needs cash from Wall Street -- which really means from institutions like your company's pension plan and individuals like you and me. As long as they can get cash from us, they don't need to generate any money internally. But to keep this pump primed, it must keep investors excited about untold "future" growth in revenue, revenue per customer and customer base.    

           Uh-oh. Revenue per customer is stagnant right now and growth of the customer base is slowing considerably. If the economy goes into a tailspin anytime soon, total revenue will fall as well. If that happens, AMAZON's predilection to buy any service, any product, to add to its stable will look pretty dumb. If AMAZON hasn't been able to knock off BARNES & NOBLE (BKS) or BORDERS (BGP), what makes them think they can take on even savvier titans like WALGREENS (WAG) and WAL-MART (WMT)? Yet they fly, seemingly willy-nilly, into any business they can find that has a dot-com at the end of its name.     

           Most analysts excuse AMAZON's stock price by using a multiple of revenues (sales), rather than earnings (cash to the bottom line). They model the company out to 2004 or so like this: IF gross margins stay in the 20s, and selling and marketing expenses are cut back considerably (thanks to alleged economies of scale), pretax profit may reach 5% on a projected $10 billion or so in revenues. I don't buy it. AMAZON spends just under $20 to attract a new customer -- who then buys $100, plus or minus, of merchandise in a year. At their gross profit margin of 20%, the company makes $20 on its sales the first year -- exactly equaling the cost of acquisition, for a $0 profit for the year.     

           But, you protest, they make it up in following years, right? Not so far -- and that's what I find most troubling. AMAZON's model of low gross margins and high marketing expense is inferior to many other Internet firms and it takes more than time to fix a broken business model.
      But they have a "First Mover" advantage, you say? There is no such thing! If there were, you'd still be buying Duryea cars and Sperry computers and Altair PCs. While AMAZON dithers about trying to find itself, other retailers are gearing up to eat its lunch.     

           I see no moat around AMAZON. Instead, I see a herd of hungry lions like WAL-MART,WALGREENS, and BARNES & NOBLE about to say, "Thanks for establishing the market, kid. Now step aside. If there's anything left when we're done eating, you can have some of the bones."     

           Even if you can accept a business plan that seems long on Internet coattail-riding and short on business sense, now move on with me to the valuation models. AMAZON sells for 14 times year 2000's projected revenues of $3 billion. WAL-MART sells at one times revenues. AMAZON isn't likely to make a profit for years (Jeff Bezos.) WAL-MART has a pretax margin of 5% and brings $300 million to the bottom line every year. Earnings like that mean no visits to the capital markets to expand or grow.  AMAZON as a company that raised $1.25 billion at 4 3/4% -- less than the US government paid at the same time! Unlike most analysts, I don't see this as magic. Don't mistake good luck and media buzz for a solid business model and a fair price. To keep the buzz going, AMAZON has to announce major news every week. Chairman Bezos knows this. He is a former hedge fund manager -- he knows how Wall Street works. To keep the PR machine oiled, they are going to take bigger risks than they should and buy companies they shouldn't.  < >

 

           2007 Update: I am happy to say I was wrong about Amazon.  Oh, not in the short term.  We shorted the stock, it plummeted, and we made a bundle.  But longer-term it looks like AMAZON’S emphasis on stellar customer service and becoming a respected site for much, much more than just books has held them in good stead.  Further, Jeff Bezos has done a fine job of creating a sense of online community: their customer reviews are read by many to determine whether they should buy a product.  I buy a lot of things from AMAZON and have actually contributed to those reviews.  They give a fair deal at a fair price.  I’m pulling for them — and if their stock gets out of whack again, I’ll be delighted to short them until they come back to earth!

HEADLINE ARTICLES 

1999

COPYRIGHT © 2009  STANFORD WEALTH MANAGEMENT