Amazon.com: Forget Being Earth's Superstore. Can It Turn a Profit?

When is $1 billion in quarterly online sales just not good enough? When you're Amazon.com(AMZN Quote), and you spend more than that in the same time frame.

The Amazon File

Business: Online retailer

1999 Revenue: $1.6 billion

1999 Earnings Per Share: ($2.20)

2000 Estimated Revenue Growth: 103%

2000 Estimated EPS: ($1.21)

Stock Snapshot

Share Price: $22.69 at Thursday's close

52 Week Range: $101.63-$19.38

Percentage Change from Jan. 1: -70%

Shares Outstanding: 356.17 million

Source: Thomson Financial/Baseline, BulldogResearch, Morningstar.

Amazon hopes to achieve the ambitious goal of grabbing 10% of the $10 billion expected in U.S. online sales this holiday season. But the Web superstore, which has racked up $866 million in losses for the first nine months of this year, expects to post a fourth-quarter loss of 26 cents a share, thanks in part to gargantuan marketing costs and discounting efforts. Meanwhile, the stock has lost about two-thirds of its value this year, closing Thursday at $22.69. Is Amazon.com's stock a bigger bargain than the books it's peddling at discount prices this Christmas? Or does it have further to fall if losses continue and the markets perceive the e-tailing giant as a boring old retailer akin to Wal-Mart(WMT Quote)?

That's the question this week's Gut Check put to fund managers and analysts. Their answer: Amazon has 25 million customers in 150 countries buying everything from books to makeup to cell phones to cars. So far, though, only Amazon's original book, video and CD product line is showing any profitability, and a slim one at that. Amazon needs to achieve profitability across the board and quick, fund managers say. That's no short order. Even if it does, they don't expect the stock to approximate the stratospheric dot-com valuations of last year for a long time -- if at all.

Gut Check on Amazon
Pros	Cons
Amazon has 25 million customers and an extensive base of Web partnerships that will help maintain its dominance in e-tailing.	Amazon may have difficulty selling a varied array of goods, each of which has its own peculiarities.
Amazon expects $4 billion in sales in 2001.	Amazon may not turn a profit in 2001 and is carrying $2 billion in convertible debt.
The stock has plunged and may have huge upside potential if profits start rolling in.	The stock still has a way to fall if its valuation levels should be closer to a retailer than an Internet company.
Source: Amazon, BulldogResearch, Sanford C. Bernstein, analysts.

The Upside

While Amazon still hasn't turned a profit, the e-tailer's sales growth has remained strong. The company expects $4 billion in sales in 2001, which would be a 48% increase from sales of $2.7 billion expected for this year. Amazon's sales in 1999 were $1.6 billion.

If overall online sales swell to $184 billion by 2004, as Forrester Research predicts, and Amazon continues to capture at least a 10% market share of these sales, Amazon could become quite profitable in 2001 or beyond, says Dan Gillespie, senior portfolio manager of Rydex sector funds (RYIIX Quote)Rydex Internet and (RYRIX Quote)Rydex Retailing; both have big stakes in Amazon.com.

Stephen Humphrey, lead portfolio manager of the (LALCX Quote)Lord Abbett Large-Cap Growth fund, is optimistic about the company's long-term outlook because of its "first-move position" into the e-tailing sector. In fact, Humphrey expects Amazon to do more than $5 billion in sales in 2001. "We're just looking for opportunities to add to our position right now," Humphrey says. "But it is a risky position; I doubt we will go to more than 1%" of the fund, he adds.

Burn Rate

However, other fund managers and analysts are not as optimistic about the outlook for Amazon in the short or long term. Amazon has gained its sales growth at great expense, they say. Only Amazon's U.S. book, music and video division posted a small net profit of $25 million for the company in the last quarter ended Sept. 30.

"The idea is that the Internet makes it easy to have this huge scale," says David Kathman, a stock analyst with Morningstar. "But it takes a lot of money to build the marketing wherewithal and the inventory and distribution infrastructure to get to that stage. Amazon will have to continue to spend a lot of money and lose a lot of money before it can possibly attain this position."

To boost sales this holiday season, for instance, Amazon is absorbing shipping charges on purchases of $100 or more, Kathman notes. "While Amazon doesn't have the overhead of a brick-and-mortar store, one of their biggest expenses is shipping, and they've got to get that down," Kathman says. Amazon has also been giving away coupons that effectively give customers discounts of 10% to 50% off purchases, adds Tom Courtney, a managing director with Banc of America.

Not only has Amazon absorbed shipping costs and barraged customers with coupons, but it has also spent a huge amount on marketing and advertising, adds Kevin Murphy, research director of e-business strategy at Gartner Group. While it is true that Amazon doesn't have the physical overhead of a Barnes & Noble (BKS Quote) (which costs Barnes & Noble 6% of its revenue), Murphy says, Amazon has been spending 25% to 30% of its revenue on marketing and advertising, he says. Barnes & Noble, on the other hand, spends 1% of revenue on marketing and advertising, Murphy adds.

"So where's the efficiency of an e-business model?" Murphy asks.

What's the Valuation?

Many fund managers don't believe Amazon's stock should be rewarded a special e-tailing or dot-com valuation. In fact, some fund managers believe Amazon's stock should be valued more realistically, as if it were a traditional retailer like Wal-Mart or Target(TGT Quote).

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If Amazon traded at forward price-to-sales valuations comparable to either Wal-Mart or Target, the stock would trade around $11 a share, says Pat Dorsey, Morningstar's director of stock analysis. "Amazon isn't growing fast enough to justify where it is trading," agrees Banc of America's Courtney.

Eli Neusner, director of research for MetaMarkets' (OPENX Quote)OpenFund, says he views Amazon as a "glorified catalog company" and doesn't believe Amazon's business model is that much different from that of other online retailers. The OpenFund has never owned a position in Amazon but has shorted the stock on many occasions, he explains.

However, Amazon's ability to greatly expand its reach has enabled it to hold up better than many business-to-consumer Net stocks. "Amazon is the only online retailer trading in the double digits; no one else online comes close," says Faye Landes, a senior research analyst at Sanford C. Bernstein.

Earth's Superstore?

Many professional money managers and analysts who specialize in electronic commerce are divided over whether Amazon will indeed become Earth's online superstore. Many fear that in attempting to offer everything to everybody, Amazon by definition is overreaching its bounds. As Morningstar's Dorsey puts it: "Every product category has its own dynamics and competition."

If the market had continued its dot-com bull run for even a little while longer, some believe Amazon could have become what it set out to become: the Earth's superstore. For now, some are beginning to say Amazon may have to curtail its product lines or eventually pull back from its international expansion to ever turn a profit.

"If the euphoric capital environment of two years ago had persisted for another five years, it is possible that Amazon would have been able to become the gargantuan of online retailing," says Kan Cassar, a senior retail analyst with Jupiter Research. "But it is not clear now that Wall Street will tolerate further losses from Amazon. The company must dramatically tune those exasperations down."

E-Believers These funds have made big commitments to Amazon
Fund	Total % of Fund Assets	Date of Portfolio
Legg Mason Focus	5.07%	Oct. 31
Legg Mason Value Prime	4.47	Oct. 31
Rydex Internet	3.98	June 30
WM Growth	3.03	Oct. 31
Smith Barney Large Cap	2.70	Oct. 31
Source: Morningstar

Selling Out These funds have sold big stakes in Amazon in recent months
Fund	Shares Sold	Date of Portfolio
IDEX JJC Growth	672,000	Sept. 30
Janus Advisor Worldwide	464,000	Aug. 31
Morgan Stanley Dean Witter Information	300,000	Sept. 30
Vanguard Tax-Managed Capital Appreciation	73,000	Sept. 30
Rydex OTC	32,000	Sept. 30
Source: Morningstar