Amazon Needs a Christmas Present


By David Shook Investors are fretting already about how retailers may suffer through a sluggish holiday shopping season, but nowhere are those fears more acute than at Amazon.com. The online e-tailer, still hanging in there many moons after the demise of hundreds of lesser-capitalized e-commerce companies, saw its stock drop once more in late September after the National Retail Federation made downward revisions on growth prospects for holiday shopping -- predicting 2.2% growth instead of 4%.

Amazon's stock price -- which hit a 52-week high of $16 a share in July -- has been on the downward slide for months now. And swooning consumer confidence in the wake of the terrorist attacks in New York and Washington have sent its shares to around $6 -- close to a record low. Investors now are questioning how Chief Executive Jeff Bezos will deliver on his goal of turning an operating profit on paper by yearend. "That kind of sentiment is priced into the stock right now," says Michael Legg, analyst for Jefferies & Co.

Indeed, the stock is trading at roughly $3 above where it would trade if the shares were worth only Amazon's projected cash position at the end of 2001: $900 million. Small wonder most analysts recommend that investors stay away from the stock for now.

"FOCUSED LIKE A LASER." The next few months will be a crucial test for this pioneering Internet play. Amazon can hardly afford to miss its fourth-quarter target, partly because the company is relying on a sharp rise in cash flows this fall to increase its cash position by 50%. And a significant amount of that cash is needed to make the company's annual interest payments on speculative-grade debt of $2.1 billion.

The suddenly gloomy outlook for the all-important holiday season raises the question: Will Amazon (AMZN) follow other retailers, such as Federated Department Stores (FD), in lowering guidance on earnings? So far, Amazon hasn't budged. "We have not said anything beyond what we've already stated. We're focused like a laser on reaching our goal of pro forma operating profitability by the fourth quarter," company spokesman Bill Curry says.

Analysts are skeptical. Some believe Amazon is simply buying time, hoping to put a positive spin on its more favorable third-quarter results even though Wall Street is already looking foward to the fourth quarter. Bezos & Co. faces one of the biggest challenges in the company's history, analysts say.

DEFINING MOMENT? Anthony Noto at Goldman Sachs has lowered his 2001 e-commerce growth forecast to 25%, from 35% to 40%, because of expected lower demand in the second half of 2001. "If [pro forma profitability] doesn't happen this fourth quarter, it may not happen at all," says Shawn Milne, analyst for Soundview Technology.

He sees a tough fourth quarter for Amazon as a possible defining moment. Without robust sales growth, Amazon may not be able to generate enough cash at yearend to last it through a recession that's expected to last into 2002, some analysts say.

The e-tailer is pinning its hopes on brisk sales generated by customers who, instead of visiting malls in December, decide to stay safe and warm at home. The theory is that more customers will flock to Web sites than ever in these unsettling times, to buy and send Christmas presents. "We've heard this theory before, but we don't agree," says Safa Rashtchy, analyst for U.S. Bancorp Piper Jaffray. "I don't think Amazon or e-commerce in general has enough breadth of products to substitute for going to the shopping mall."

If Amazon can't generate enough revenues, it could be forced to cut costs even further than it did in February, when the company slashed 1,300 jobs, closed a two-year-old distribution center in suburban Atlanta, and cut back use of another facility in Seattle.

Drastic cutbacks would fly in the face of Amazon's strategy: It continues to rely on expansion and deal-making to make it a marketplace for an ever-increasing range of products and services. Already, the company is hawking everything from books and CDs to computers, discount goods, toys, and electronics sold with the help of would-be rivals Circuit City, Toys 'R' Us, and Target.

NOT CONVINCED. At the same time, Amazon continues to comb through its vast menu of offerings, eliminating items that don't contribute to the bottom line or repricing them in a way that boosts gross margins. So, a Delta table saw featured on Amazon sells for $1,400. The saw is out of stock, but when available, the 416-pound machine ships free of charge. That's right, free shipping on a 400-pound table saw.

Amazon's Curry says it's possible the shipping cost is absorbed in the price of the saw, but he acknowledges that a review to ensure every product sold contributes to the bottom line is "a never-ending and relentless effort for us."

All the deals and inventory reviews so far haven't convinced investors that Amazon is poised for profitability. Since a promising second-quarter earnings call in July, when Amazon announced a $100 million e-commerce deal with AOL Time Warner (AOL) to help it build its Shop@AOL site, Amazon shares have tumbled 62%. Looking back further, the stock has declined 83% since November, 2000, when it traded at a 52-week high of $42.

PROMISE. The news isn't all so bleak. Wall Street expects sales of $650 million and a net loss of 16 cents a share for Amazon in the quarter that ended Sept. 30. But as analyst Jeetil Patel of Deutsche Bank explains, "the third quarter is not as important for Amazon as the fourth," when the company has promised that a net loss of 6 cents a share on sales of $1.1 billion will finally bring Amazon to cash-flow profitability. Take out a lot of the nonrecurring expenses, and you've got a company that, after seven years of heavy losses, finally breaks even.

If Amazon could do that, it could move toward reducing an accumulated $3 billion of debt on its balance sheet. But with recession now a near certainty, it's clear that Bezos' strategy for leading Amazon to profitability has become more difficult. And some analysts predict he won't be able to get any more financing help from the credit and equity markets if a truly deep recession sets in. "That would not be an option," says Michael Legg.

Given the uncertainty, it's easy to see why so many investors are passing on the cheapest Amazon stock price in the company's five-year history. Shook covers financial markets for BW Online in New York


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