Dueling Fools

Dueling Fools
June 30, 1999

Amazing Amazon
Bull Argument
by Paul Larson (tmfparlay@aol.com)

It's been 16 months since the last Duel about Amazon, and few companies have managed to change and grow so much in such little time. The company's stock is up about 10-fold since that first Duel ran early last year, and I think more good times are ahead for Amazon and its owners. I believe that Amazon will continue to dominate and even strengthen its stranglehold on the consumer e-commerce arena as the company continues to build something so massive in scale and scope that it rivals anything ever accomplished in modern retailing.

Big words, no? But Amazon is a big company and getting bigger by the day. First Amazon became the King of online book selling. While still growing its book business, it parlayed that success into becoming the leading seller of music over the Internet. Then it added videos and is now in the process of capturing a wide variety of other retail categories. Any company that can go from not competing at all in a particular market (music, videos) one year to dominating it the next has to turn some heads and attract investor attention.

Nowadays Amazon is trying to repeat its success in the auction business. It was a scant three months ago that Amazon first opened its site to auctions, and now the company has become as large a player as any in that space. eBay (Nasdaq: EBAY) still rules this domain, but Amazon is catching up quickly. Amazon's recently announced partnership with Sotheby's (NYSE: BID) is quite an interesting way to legitimize and grow the extremely lucrative auction business. Plus, there's the plain fact that Amazon has the unique cross-promotional power of its existing products to pump up the auctions (or vice versa). This should yield awesome benefits in the future, just as it did with books and music.

It can be said that Amazon is like a good Monopoly player. When it comes across an available and useful property, it spends the money to buy it. It's one foolish (small F) Monopoly player who passes up an opportunity to purchase a property early and cheap while "saving money" that is only to be lost in later rounds. Plus, every Monopoly player knows that a group of properties is much more valuable than a property in isolation. Amazon may be spending like there's no tomorrow, but that's because Amazon is building a massive portfolio of properties for tomorrow.

Think of it this way. Amazon has "spent" roughly $230 million (its total accumulated losses to-date) to dominate online books, music, and videos. What would it "cost" for another company today to equal Amazon's market share in just one of those categories alone? More, lots more. Internet curmudgeons may point to low barriers of entry in online retailing. I'll respond that the barriers to critical mass and sustainable profits are fairly high and getting higher by the day as Amazon continues to conquer market share.

Just like in the corporeal world, size matters in the online universe. Amazon's scale will give it awesome bargaining and buying power down the road, just as Wal-Mart (NYSE: WMT) can demand favorable terms from its suppliers. The company's size will also give it efficiencies in areas such as shipping and customer service (a.k.a. fulfillment) that the smaller outfits will never match. I happen to think that the large Internet retailers only stand to get much larger while the smaller upstarts will face a steep uphill battle. Speaking of Wal-Mart, Amazon reminds me much of the retailing giant in the late '70s, only Amazon's growth is happening 10 times as fast as anything Wal-Mart ever saw.

Of course, I would be remiss if I didn't mention the awesome cash-flow dynamics that Amazon possesses. The company only has about 14 days worth of inventory (versus a bloated 119 days for Barnes & Noble and 58 for Wal-Mart), a positive cash conversion cycle (working capital? It doesn't need any!), and most importantly, Amazon is not hobbled with rent expenses and zillions tied up in buildings and real estate like its bricks-and-mortar peers. The company has the potential for phenomenal returns on its assets and invested capital because it just doesn't have the large denominators in those equations. In other words, Amazon is running a monster business with a fraction of the fixed assets it would take in the bricks-and-mortar world.

Then there's the issue of brand. Amazon had over 10 million unique visitors in May (making it one of the top-10 Web properties), and it was recently named one of the top 60 global brands. In four years, Amazon went from not even existing to topping Hilton in brand awareness -- yet again the company continues to boggle my Foolish mind.

When one thinks of "shopping the Web," or "online shopping," no other company comes close to having as much mind share or market share than Amazon. This is one of the reasons Amazon can capture new retail categories almost at will. I have no doubt that a few years from now I will be able to buy just about anything through Amazon. Forget about being the world's biggest bookstore, Amazon is heading toward being the world's largest store of any kind. In other words, Amazon isn't just playing to own a small slice of the world's online commerce, it's playing to own all the marbles. I think Amazon stands a good shot at winning.

Sure, Amazon may not have a black bottom line at the moment. But considering the company's positioning for the future, I think the next decade will prove to be a very exciting one for Amazon's customers and shareholders alike. There are so many attractive attributes of e-commerce in general and Amazon specifically that it is difficult to compress all the issues into a single argument. Massive scalability of the company's business and the ability to customize virtual store shelves for individual users are just two of the numerous issues I didn't even get to touch upon. I guess that's what the rebuttal is for!

The bottom line is that if you are a believer in e-commerce like myself, there are few better stocks to own than the feasting 500 lb. gorilla in the market named Amazon.

Next: The Bear Argument