The Little Numbers Betray Amazon, Too

Amazon.com's (AMZN) second-quarter earnings report Monday evening gave Wall Street plenty of numbers to look at.

But as the stock plunged Tuesday, some observers were talking more about the figures that the company wasn't playing up.

Though Amazon's reduced revenue guidance grabbed the headlines, investors were equally unnerved by the company's crumbling customer base and the possibility that it could face tightening credit terms from vendors. With the economy suffering through a slump and growth at Amazon's profitable books unit slowing to a crawl, those fears are quite real, observers say. Investors agreed, sending the stock down $3.97, or 24%, to $12.06 Tuesday.

Down Low Next to the Base

First, take the company's customer base, which has long been considered one of Amazon's most valuable assets. For the 12 months ended June 30, only about half of the company's 17 million active customers made purchases, noted Mark Rowen, an analyst at Prudential Securities who has highlighted the issue in past research reports.

Cliff Diving Amazon's Tuesday plunge

It was the sixth-straight quarter that this metric has declined. "We have been increasingly concerned over the past few quarters that the company's 'valuable asset' had a significantly higher churn rate than we would expect from loyal customers," wrote Rowen in a report published Tuesday. "Amazon's valuable customer base appears to be a rapidly depreciating asset." (Rowen has a sell rating on the stock, and his firm does not have a banking relationship with Amazon.)

One hedge fund manager and Amazon bear reached the same conclusion.

"I don't think they are facing up to the reality that they are having a tremendously difficult time with their customer base," says Eric Van der Porten, a hedge fund manager at West Coast money management firm Leeward Investments, who owns put options on Amazon stock, a way of betting the share price will fall.

And those customers' average purchases are clearly not growing as they once did, notes Van der Porten. Amazon used to love boasting about the strong growth in sales per customer: In last year's second quarter it was $125 over the trailing 12 months, up from $108 in the prior year. But in Tuesday's release, one had to go deep into the 25-page press release to find that the measure came in at $136, up just a buck from the prior quarter.

"They used to be touting that," Van der Porten says. "Now, they're not even mentioning it."

The Cash and I

Monday's quarterly release also revived the question of how healthy the company's balance sheet is. Earlier in the year, a report released by Lehman Brothers bond analyst Ravi Suria questioned whether the company would be able to pay its bills as it seeks to become profitable. He predicted the company could face tighter credit terms from vendors.

That debate was on the back burner until Monday. The company said it would have $600 million in cash by the end of the third quarter, and $900 million by the end of the year. These were the same figures the company gave earlier in the year, yet it now needs the extra $100 million from AOL to reach those targets.

"This is obviously a significant miss," Van der Porten says. But what is more important -- and what the company is not revealing - is what the cash balance will be by the end of next year's first quarter, after it pays its bills from the holiday season. "They are not addressing at all what their cash will be by the end of March."

Working capital -- current assets minus current liabilities, which some say is a better measure of a company's creditworthiness -- fell to $161 million at the end of June from $559 million a year ago, Rowen noted in Tuesday's report.

"As long as Amazon continues to narrow its losses, we do not believe the company's vendors will necessarily impose stricter credit terms over the next few quarters," he wrote. "However, we believe Amazon could conceivably have negative working capital and little cash on hand by the first quarter 2002, unless it is able to raise additional funds." Amazon has long said that its cash position will not prevent it from reaching profitability.

"We also caution that any sign of deterioration in future-quarter results may lead its vendors to tighten up credit, which would exacerbate the weakening working capital situation," wrote Rowen.

Some investors, though, aren't waiting around to see.

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