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Problems at eToys Raise Questions for Amazon

George Mannes

Henry Blodget published a worrisome thesis Monday morning: the eToys (ETYS) washout could mean that Amazon.com (AMZN) shareholders are up the creek.

The Merrill Lynch Internet analyst's assessment comes in the wake of eToys' announcement Friday that it wouldn't just miss its month-and-a-half-old estimates for fourth quarter sales; in fact, it wouldn't even make it to the correct hemisphere.

eToys' shares on Monday fell 75 cents, or 73%, to 28 cents. Amazon was down $3, or 13%, to $19.88.

Now that eToys' revenue for the quarter ending Dec. 31 is expected to grow a maximum of 22% over last year's fourth quarter, not the 95% to 125% previously expected, the shortfall raises a troubling question, says Blodget: If e-commerce is supposed to amount to 10% to 15% of retail sales someday, how come a category leader is growing at such a piddling rate? Year-over-year revenue growth of 15% to 20% just won't cut it.

The troubling conclusion that Blodget draws is that, in fact, maybe the online toy business and all the other e-commerce categories won't ever carve out that 10% to 15% of retail that he and others have expected, or if they do, it will be too far into the 21st century to matter to investors in 2000.

Sure, e-commerce leaders Amazon and eBay (EBAY) might meet expectations for growth in the current quarter, with Amazon revenue up 50% from a year ago and eBay up 66%. But it just might be that Amazon's retail gains are coming from market share wins from other e-tailers, not market growth for e-commerce as a whole. And this raises an important question, Blodget writes: "What happens to the growth rate, when, by the middle of next year, all of the weaker e-tailers have thrown in the towel and there is no more market share to gain?" It was concerns about growth rate -- not profitability -- that Blodget said led to his August downgrade of Amazon.com from buy to accumulate. (Merrill hasn't been an underwriter for Amazon or eBay, but was a co-manager of eToys' 1999 IPO.)

A scary thought, says Blodget. If the endgame isn't as valuable as he once thought it was, and the growth peters out, you've got to worry about Amazon's price. At a compound annual growth rate of 40% over the next five years, the Seattle-based e-tailer is undervalued at its Friday close of nearly $23; at 30%, its shares are fairly valued, and it's still a good investment. At a compound annual growth rate of 20%, it's expensive. Right now, Blodget estimates 30% to 40%, but he'll be taking a close look at Amazon's fourth quarter to see whether he can sort the market share from the market growth.

But will there be enough information there? As documented in a recent TSC story securities analysts' are griping that Amazon doesn't provide enough information about various aspects of its finances. On Monday, however, a fair number of people thought they'd seen enough.