TCS Daily


Another Journey on the Amazon

By James K. Glassman - September 5, 2001 12:00 AM

For the past year, Amazon.com has faced a chorus of Wall Street critics who say that the company is running out of money. In January, Amazon responded to the critics by forecasting a pro-forma operating profit for the fourth quarter of this year. The company also announced a series of cost-cutting moves designed to show that the allegedly profligate dot-com was getting serious, being responsible with its cash and becoming a real company headed for real profits in the near future. That's when I became a critic.

I believed then that Amazon should continue to accept losses in pursuit of market share. With a slowing economy and dot-com competitors dropping like flies, an ambitious Amazon had a shot at becoming America's dominant retailer - online or off. Cutting staff and expenses in a frenzied dash toward profitability meant a scaling back of such ambitions.

So where does that leave Amazon today? The company is still in business, growth has slowed dramatically in recent quarters, and I'm still wishing that Amazon had continued full speed ahead toward mega-market share. However, that doesn't mean I'm down on the stock now. In fact, I think AMZN shares represent an interesting opportunity at recent valuations. And I don't think it's too late for CEO Jeff Bezos and company to re-ignite his growth machine.

Let's first talk about value. At a recent $8.59 per share, Amazon's market capitalization - or value according to shareholders - is just $3 billion, almost precisely the company's revenues over the past 12 months. That's not a crazy dot-com valuation. Wal-Mart is similarly valued, relative to its annual revenues. Of course, Wal-Mart is very profitable, while Amazon loses money. But Amazon's losses are shrinking, in fact the company is almost running a positive cash flow. And even though growth has slowed, revenues still increased 16 percent in the second quarter of this year versus the same quarter a year ago, while the economy as a whole was tanking.

Amazon is still the dominant online retailer and has a great chance to strengthen its hand and become the blowout success story of the upcoming Christmas shopping season. Dot-com competitors continue to wither and die and bricks-and-clicks companies will probably continue to suffer from what you might call the Economic Fear Factor. In a down market, nobody wants to take risks, expand operations or try something new. Corporations continue to slash information technology budgets. One executive at a Fortune 100 corporation tells us that not only have budgets for new computer systems been eliminated, but IT spending has fallen below the level needed simply to maintain existing systems.

This suggests that traditional retailers will not be jumping into Amazon's online market with both feet. So the company probably has some breathing room to consolidate its grip on the online shopping market and win over new customers. That breathing, however, could be constricted by a lack of liquidity. As of its last report, on June 30, Amazon had $600 million in cash, down from $1.1 billion at the end of last year. In a sense, Amazon is in a race, not against traditional competitors, but against its own bank account.

It's a race that Amazon just might win. New customers keep showing up, even with Amazon's reduced marketing expenses. Last quarter, the firm welcomed 2.6 million first-time shoppers worldwide. Across its various online properties, the company claims 35 million cumulative customer accounts, and reports that 21 million of its customers have bought something within the past year. How many companies in America have more than 20 million direct customer relationships, with a stored credit card number, contact information and purchasing history for each?

This is a massive customer base, and it should become more profitable, as Amazon moves further into auctions and sales of used items, with huge profit margins. Furthermore, the lack of online competitors means that Amazon won't have to discount as much as in the past to entice customers to buy new products, which will continue to be its bread-and-butter.

A word of caution: Amazon's balance sheet still looks ugly. Not only is cash dwindling, but long-term debt stands at $2.1 billion. While I believe that there's compelling upside potential here, there's also a great deal of risk. Still, ask yourself this question: Would a smart buyer want to own the world's biggest online retailer for a price of $6 billion? (I am assuming here a premium of one-third over the current stock price, plus an assumption of the debt.) That sounds reasonable to me - a much better buy than a little less than two years ago, when the market cap was about $40 billion.

I like AMZN right now, but for stocks in general and for Amazon in particular, it's worth remembering the words of Thoreau: "Goodness is the only investment that never fails."
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