Amazon: Heading for a Hangover?


By Rob Hof Late on the morning of Dec. 11, the "Delight-O-Meter" on Amazon.com's home page had logged 42,742,426 orders since Nov. 1. Just 10 seconds later -- the time it took to refresh the Web browser -- that number had shot up by 747 items. Clearly, the online retailer is doing something right, and that partly explains why its stock has been rising almost as fast as those sales-counter readings. After hitting a two-year high of $24.25 on Nov. 25, shares of Amazon (AMZN) still stand at about $22, up 120% in a year that hasn't been too kind to the rest of the market.

No doubt, investors who bought near the 52-week low of $9.03 in January are happy. Maybe they're even spending some of those gains on the millions of items available at Amazon.com. But for just about everyone else, the stock now looks to be on the expensive side, even for e-tailing's dominant outfit. "The price has no justification," says Peter Doyle, who manages the Internet Fund for Kinetics Asset Management. "It's basically nothing more than a minibubble."

OUT OF WHACK. Why? For one, the 8-year-old company won't earn its first yearly net profit until next year. Even on an operating basis, which excludes such expenses as charges for employee stock options, it's expected to earn about $200 million in 2003. That puts its $8.4 billion valuation way out of whack vs. its earnings power.

Its price-earnings ratio is a breathtaking 90 based on 2003 operating profits. That's a way higher p-e than that of even the best retail and technology companies. Both Wal-Mart (WMT) and Microsoft (MSFT) have a p-e of 26 -- without any ifs, ands, or buts on the earnings part of the ratio.

At the same time, Amazon's sales come nowhere near those of more established retailers with far lower valuations. Its market capitalization is nearly double the combined valuations of Borders Group (BGP), Barnes & Noble (BKS), and Circuit City Stores (CC), even though their combined sales are almost four times the $3.9 billion Amazon expects to do this year.

SEASONAL SURGE. Amazon's growth rate -- which it forecasts will be "at least 10%" next year -- may not be all that much higher than established bricks-and-mortar powerhouses Wal-Mart and Target (TGT), either. All that's why only five analysts who follow Amazon rate it a buy -- and then only at target prices close to where the stock already sits. Eight rate it a hold, and one suggests selling it.

So why is the stock soaring? For one thing, the holiday high is a perennial phenomenon in e-tailing. Jazzed by prospects for huge online sales, investors get excited about Internet stocks such as Amazon around this time of year. That boost lasts until January or February, when even good fourth-quarter results never seem to match those high expectations.

Mutual-fund investors have dipped their toes in as well, perhaps because e-commerce is one of the few bright spots in the economy. Says Shawn Milne, an analyst with SoundView Technology Group: "A lot of big fund managers are saying, 'Wow, there's a lot of growth here.'"

"UNABATED SUCCESS." By all accounts, e-tailing is going gangbusters this year. According to market researcher ComScore/Media Metrix, sales since the start of November are up 29% over last year, to $8.2 billion. Says Chuck Davis, chief executive of BizRate.com, an online comparison-shopping site: "It looks like unabated success this year."

Shoppers have apparently responded to Amazon's price cuts on books and its offer of free shipping on orders over $25 for Dec. 24 delivery. Partly as a result, third-quarter sales shot up 33%, to $851 million -- even while Amazon reduced its net loss by 79%, to $35 million. "Maybe this time it's rational exuberance," says Safa Rashtchy, an analyst with U.S. Bancorp Piper Jaffray. He points out that "Amazon's stock is expensive, but people are putting money into it because they have to put money somewhere."

Amazon's valuation is particularly dicey considering the raft of challenges the e-tailer continues to face. For one thing, it's not yet clear whether Chief Executive Jeffrey P. Bezos' bet on low prices and free shipping will pay off. "We like what we're seeing," he told analysts in late October, "but it's very expensive."

UNFAIR COMPARISON. Indeed, Bear Stearns analyst Jeffrey Fieler thinks Amazon may have gone too far and might have to raise the free-shipping threshold back to $49 after the holidays. If so, it could slow the sales growth Bezos has credited for helping him build the economies of scale that are responsible for improving Amazon's profit picture.

Moreover, growth may not be quite as strong as third-quarter results make it appear. Last year, the September 11 terrorist attacks virtually eliminated sales in the last crucial weeks of the quarter, making comparisons to this year less impressive. At the same time, Amazon is struggling to convince customers that it's also the place to buy electronics, tools, and kitchen gear. That unit's third-quarter sales growth of 25% came in less than overall sales growth, and Bezos said it's unclear when it will turn profitable.

Despite the legions of calls over the past few years that its demise was at hand, Amazon is clearly a dot-com survivor. That alone is a huge accomplishment. But its stock price assumes a level of achievement it has yet to attain. Hof is BusinessWeek's Silicon Valley bureau chief


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