Amazon Sheds the Baby Fat


By Stefani Eads and Margaret Popper In June, just seven months ago, Amazon.com CEO Jeff Bezos confidently addressed a full auditorium at PC Expo, the annual computer hardware trade show. "Our goal is to provide our 20 million users with 20 million different stores," he said, showing off his company's latest innovation in personalization technology. "Our primary motive is to provide universal selection and be the one place where people can find anything they want to buy."

But Bezos was crooning a different tune in a companywide e-mail sent Feb. 1. Titled "Get the Crap Out," the memo lacked the stale rhetoric of growth-before-profits he has spouted for the past five years. Rather, it spelled out a plan to "ferociously manage the products we carry" by eliminating unprofitable ones and slashing distribution costs.

A day earlier, Amazon eliminated 1,300 jobs -- 15% of its workforce -- in the retail giant's biggest layoff ever and closed a two-year-old distribution center in Georgia and a 400-person customer-service center in its home-base city of Seattle. The company's original distribution center, also in Seattle, will be one of seven remaining physical facilities but will operate only during peak holiday seasons.

A PROFIT, SORT OF. If one of the first signs of maturity is the willingness to do something undesirable for the sake of a greater benefit, then it seems Amazon is finally on its way to becoming a grown-up. Bezos apparently has finally surrendered to Wall Street and promises that Amazon can turn a pro-forma operating profit in the final quarter of 2001. That is, of course, if investors will ignore noncash costs such as acquisitions and personnel stock options.

While Bezos' change of heart is good news in theory, many analysts are wondering whether the company's latest efforts might be too little too late. Abandoning the stock may not make sense. But if you don't already own it, even though it's cheap, it probably makes sense to wait and see whether Amazon can either make a reasonable stab at profitability or get bought out by fiscally stricter management.

For now, the tables have turned, and it's growth that will be sacrificed in the name of profitability. And what a sacrifice it's going to be. Amazon says year-on-year sales growth will increase 20% to 30% in 2001 rather than the originally projected 40%. According to the company, revenues will range between $3.3 billion and $3.6 billion, far below its initial prediction of $4 billion. And the customer growth rate will hover between 20% and 30% -- a decrease of more than half the earlier estimate of a 60% to 70% rate.

PICK A TARGET. All this scaling back of expectations focuses on revenues. The company is nowhere near as precise about earnings. Even though analysts seem to buy the company's revenue estimates, the consensus opinion on the Street is that Amazon will have lost 35 cents a share by the end of 2002, or a total of $122.6 million, on estimated revenues of $4.35 billion, according to First Call data. True, that's a lot better than what analysts are projecting for 2001: revenues of $3.65 billion with a loss of 82 cents a share, or a total loss of $287.2 million.

What this means in terms of share value is anybody's guess. Surprisingly, analysts' 12-month target prices for Amazon's shares range from $17 to $55. Go figure. That means that at its current price of around $14.50 -- down some 86% from its 52-week high of $91.50 -- the stock could have upside of anywhere from 17% to 279%. Caveat emptor when you see that wide of a spread on target prices.

Once considered the online-commerce bellwether, Amazon now seems to be standing on shaky ground. Although fourth-quarter revenues rose 44%, to $972 million, compared to the same period last year, they barely topped the company's revised estimates of $960 million and missed analysts' initial consensus forecast of $1 billion. According to Amazon's preferred pro-forma measurement, it narrowed its loss to $90 million in the fourth quarter, compared to $185 million a year earlier. But if charges incurred for writing down the value of dot-com acquisitions and investments are added, that loss jumps to $545 million, compared to $323 million in 1999.

AHEAD OF ITS TIME. Even the bullish analysts question the company's cost structure. Bezos & Co. built the company inefficiently and spent unwisely for direct-channel distribution in an effort to become as big as possible, says ABN Amro analyst Kevin Silverman. "I would say Amazon has about $5 billion worth of distribution capacity but is only using about a third of it. The company was grown to handle the kind of demand we're likely to see two to four years from now."

Amazon spokesman Bill Curry acknowledges that the company has "ample capacity to get it through Christmas 2001." And it remains on track to break even in 2002 without the need for additional capital, Silverman predicts. Yet he downgraded the stock to accumulate from buy following Amazon's fourth-quarter earnings release for 2000 and reduced his 12-month target price to $30 from $60.

To hear the skeptics, the outlook is downright dire. "The major moving parts of Amazon's business model are incompatible with each other," writes Robertson Stephens analyst Lauren Cooks Levitan in a Jan. 31 report. "Given the trends suggested by Amazon's [fourth-quarter] results and management's forward guidance, we struggle to understand how Amazon can continue to generate top-line growth without reduced revenues from coupons, reduced gross margins from free shipping, or increased operating expenses from advertising."

COSTLY DELIVERIES. Levitan sees slower growth ahead for the company's core business of books, music, and videos, which accounts for about 53% of total revenues. In the fourth quarter of 2000, this division came in with $511.7 million of revenues. That's 11% year-on-year growth, vs. 82% for the same period a year earlier. Levitan believes it's unlikely that Amazon's newer, lower-margin businesses, which generate gross margins of 8%, are going to make up the difference to achieve its much-talked about 30% growth overall.

What's more, Levitan says, high levels of split shipments and long hauls resulted in higher-than-expected fulfillment inefficiencies in the fourth quarter. "Amazon reported fulfillment costs of $130 million, or 13% of sales, missing our target of 12%," she writes. "[But] we are not surprised."

Amazon argues that it may not have to eliminate some unprofitable but popular items to improve margins. It may also have to change the way it distributes those products by either having the manufacturer ship directly or partnering with other distributors. But for now, it doesn't help matters that Amazon is forecasting a particularly dismal first quarter. Expected sales growth of 13% to 22% means revenues will be at least $100 million less than the initial $806 million consensus estimate, the company says.

ANTI-UNION? To further cloud the picture, many critics question whether the company's recent fixes are the right ones. Although Bezos insists that January's cuts are in Amazon's best interests in order to achieve profitability, he may risk tarnishing its image of excellent customer service. "The call-center closure is a little more dubious than the distribution center because Amazon competes more on customer service than on price," says Bear Stearns analyst Jeffrey Fieler. Rumors persist that part of the reason it shut the center was in response to unionizing efforts. "Of course not," says Amazon's Curry. "It was closed because it was our most expensive customer-service facility."

While the company clearly has its work cut out, it could have good reason to continue striving to survive as an independent e-tailer. ABN Amro's Silverman says online sales will be 7% of total retail sales, or $400 billion, by 2010. He estimates that Amazon could grab 5% to 10% of that e-commerce pie.

At the very least, such differing interpretations among analysts suggest the stock's future will be volatile. "As we've said time and time again, what's good for the consumer isn't always good for the investor," Levitan says. "Unfortunately, this is the situation for Amazon." Eads and Popper write for BusinessWeek Online in New York


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