A Holiday That Kept Amazon's Hopes Alive


By Margaret Popper For e-tailing dot-coms, 2000 was the year the Grinch stole Christmas. Those that haven't been forced to shut their doors are in imminent danger of doing so -- eToys' (ETYS) Christmas is rumored to have been disastrous -- or have watched their stock prices plummet to the lower depths.

Amid the carnage are some glimmers of hope. Amazon.com, (AMZN), like all Nasdaq companies, watched its stock price fall. But the mother of all e-tailers emerged from Christmas still breathing and is likely to survive for many quarters to come. Not only did it ship 31 million items from Nov. 2 to Dec. 23, according to the company, but it also, as promised, fulfilled by Christmas Day more than 99% of the orders it had received through midnight (West Coast time) Dec. 23. If that's true, the company has gone a long way toward erasing the bitter memories of Christmas past, when many Amazon shoppers didn't receive their orders in time to place them under the tree.

But customer service, while important, isn't everything. Now Amazon has to prove that its expensive growth strategy can eventually lead to profitability. With its current high distribution costs, analysts say there's no way the company can claw its way into the black. Amazon will have to maintain rapid revenue growth to achieve the economies of scale that warrant the giant distribution network it has created. Even if it gets its costs down, Amazon will never have margins that are much better than those of a direct-mail marketer. And while many analysts still love Amazon, its price will likely be stuck in low gear until it achieves those margins.

"BIG WIN." On the revenue side, Amazon's holiday story had a happy ending. "They held their own with market share. With all the competition from offline players like Wal-Mart, Target, and Kmart, that's a big win," says Jeffrey Fieler, consumer Internet analyst at Bear Stearns. "Amazon is the only [pure-play dot-com] winner."

Just a few days into the new year, analysts were betting that Amazon surpassed $1 billion in sales in the fourth quarter of 2000, with a strong holiday shopping spree boosting its numbers. That would have brought sales for the year to around $2.9 billion, according to Fieler. These numbers have the company repeating what founder Jeff Bezos has been saying since 1995: Revenue growth is what's important. "We're losing money because we continue to invest in new businesses," says Bill Curry, Amazon's director of public relations.

Analysts, however, are more likely to blame distribution than investing in new businesses. It's true that Amazon has been steadily whittling away at these costs, but it has to cut them aggressively to have a sustainable business for the long haul. And contributing to the distribution problem is too much capacity. The distribution centers Amazon built in 1999 and 2000 are operating at only about 30%. But that excess capacity could quickly evaporate. If the company's growth reaches 40% annually as predicted, in two more years it would have to build new distribution centers, points out Bear Stearns' Fieler.

Full utilization of its distribution capacity would go a long way toward getting costs in line. Amazon's distribution costs (including shipping) as a percentage of revenue are running 14% to 16%, Wall Street estimates. "They've got to get them in the high single digits," says Jeetil Patel, senior analyst at Deutsche Banc Alex. Brown. If distribution costs were running at 7% to 8% of sales, the company would have a shot at maintaining net-income margins of 7% to 10%, typical of a catalog merchandiser. That's not bad when you consider Wal-Mart's net-income margins are 1% to 2%.

Excess capacity and high distribution costs are dragging the stock price down

If the company can streamline distribution, it has a bright future. Amazon should continue to benefit from a continued increase in online shopping in 2001, even though the growth in e-commerce overall may be slower. A study by Goldman Sachs and PC Data shows that Internet purchases totaled $8.7 billion this Christmas season -- an increase of 108% above 1999. They should grow an additional 40% to 50% next holiday season.

Unless Amazon folds to competition from clicks-and-mortar retailers, it should get its fair share of those increased sales. "Amazon is in a better position at the end of [2000] than it was at the end of [1999] because so many of its competitors have gone belly-up," says Merrill Lynch Internet analyst Henry Blodget.

But it still has to contend with the Wal-Marts of the world. "It will defend itself by partnering with them -- as it did with Toys 'R' Us -- or beating them off," says Patel. The Toys 'R' Us partnership, in which Amazon takes care of fulfillment and Toys 'R' Us handles merchandising, was generally considered to be a success in 2000. While the final numbers aren't in yet, "we know that total toy sales volume on the Net went up, and we know that eToys didn't sell much, so it's likely it was the Toys 'R' Us site that did it," says Bear Stearns' Fieler.

Despite that success, Amazon is banking more on geographical expansion and product growth than partnerships. "We'll only do another partnership if it creates a win-win for our customers," says company spokesman Curry. The real growth will come from overseas, which now accounts for about 25% of Amazon's sales. "We'd expect international sales to be greater than 50% of the total more than five years from now," says Curry. In 2000, Amazon added virtual stores in France and Japan. It has had Web-based stores in Britain and Germany for two years.

MAYBE NEXT YEAR. Analysts must be buying the company's strategy for growth. Even with stiff competition from the bricks-and-mortar gang, analysts generally predict 2001 sales of around $4 billion, a 38% increase over last year. Of course, most analysts believe the company also will lose money this year. The company's books and music business was profitable to the tune of $25 million last quarter, but as Bear Stearns' Fieler points out, "that doesn't support the $6.2 billion valuation implied by its current stock price [of around $16 to $17 a share]." Losses for 2000 should be around $431 million, he says, tapering to $243 million in 2001.

Fieler predicts Amazon could actually make a profit of $90 million on $6.5 billion in sales in 2002, or 25 cents a share. Perhaps that's why he has a 12-month target price of $55 on the stock. Merrill's Blodget doesn't find this analysis farfetched. "If the rest of the Nasdaq recovers, Amazon could easily be back at $30 to $50 [a share] in 12 months," he says.

For investors who still want to bet on an e-commerce business model, Amazon is a pretty attractive buy. Just be cautious about the revenue-is-everything business model. Smart investors will keep a sharp eye on Amazon's cost structure in the coming months. Popper covers the markets for BW Online in our daily Street Wise column


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