February 11, 1998
Amazon.com Bull's Pen
by Louis Corrigan (TMF Seymor)
Let's say you want to open a bookstore. You need a convenient location and a good selection of books. You want a cool place where it's possible to find intelligent conversation and maybe some cute sales clerks. You also need a workhorse information system so you can control inventory and costs with the penny-pinching precision of a pensioner. Plus, you need to deal in high volume so you can offer low prices. Finally, you want to give your customers such awesome service that they tell their friends.
Ok, so Amazon.com is missing the cute sales clerks. Otherwise, Amazon has done pretty well. Wherever you go, it's there. Amazon has an eye-popping 1.5 million in-print titles and another million titles they will track down for you. It has unbeatable prices, with bestsellers discounted 40%, hardcovers 30% off, and paperbacks 20% off. As for intelligent conversation, what are the chances of walking into your local bookstore and finding people who can give you their take on Kathryn Staley's The Art of Short Selling or Peter Duesberg's Inventing the AIDS Virus? At Amazon, the conversation is always available.
And talk about information systems! Outside of a couple of distribution centers and some corporate offices, Amazon is just one big, awesomely intelligent information system. As soon as I walk in the door, the site greets me by name and is ready to suggest a bunch of titles that I might be interested in. No surprise, then, that Amazon has attracted over 1.5 million customers since opening its doors in July 1995. Repeat customers accounted for 58% of sales in the fourth quarter of FY97 when revenues rose to $66 million, up 74% versus the preceding quarter.
Still, is this now unprofitable company, trading at $59 per share, worth $1.4 billion bucks? Let's try a word association game. Name the first company that comes to mind when I say... soft drinks... athletic shoes... online service... home improvement... toy store ... microprocessors.... Internet search engine... razors... coffee shop... online retailer...
I bet that every company you came up with -- save one -- is many times larger and more profitable than Amazon. The exception is the search engine company. If you said Yahoo (Nasdaq: YHOO), you're talking about a barely profitable firm valued at $2.7 billion (at $64 per share), or 42 times sales of $65 million. At $59, Amazon trades at 9.5 times trailing sales and just 5.3 times the fourth quarter's revenue run-rate of $264 million. In fact, just 15% sequential quarterly growth (conservatively measured from Q3 '97 sales of $37 million rather than the seasonally strong Q4 of '97) over the next three years would give Amazon about $242 million in revenue this year, $423 million for FY99, and $747 million in 2000. So it's trading at maybe 5.7 times FY98 sales, and 3.3 FY99 sales.
Now consider what it would cost for another company to create a brand as well-positioned as Amazon. Amazon is synonymous with "online bookseller," and category killers can be worth a bundle. But the last item in my word association game above was online retailer. If you answered Amazon.com to that (as I would), then clearly this company has a capacious mindshare. Amazon has become a common online destination for people looking to buy stuff. That makes it a gateway with highly profitable billboard space to rent. It also has a shot at reaping transaction fees for bringing customers to other businesses. Sounds a lot like what America Online (NYSE: AOL) is doing and Microsoft (Nasdaq: MSFT) has tried to do.
Bottom line, every investor should want to own Amazon. It's also a fun stock to own. You can sit at your desk and make your company more money just by sending your friends and family gifts. You'd also be providing free and highly effective advertising for your business since people who receive books from Amazon often become hooked, too.
Still, an investor needs to come up with some estimates. Falling back on Jeff Fischer's reasonable Fool Portfolio guesstimates, let's assume Amazon can do $1 billion in sales in 2000 or 2001 and trade at two times revenues. With book retailer Borders (NYSE: BGP) now at 1.2 times sales, that may seem pricey. Yet Amazon could squeeze out at least 5% profit margins eventually. That's 56% better than Border's current 3.2% margins. Two times sales would be $84, good for a market-beating annualized return (on a typical year) of nearly 13% over the next three years, assuming the current price of $59. Given Amazon's stellar online brand, even two times sales may be too conservative. If it could trade at three times sales, then we're talking a three-year price target of $126, or a 29% annualized return from here.
Still, when a stock gyrates as wildly as Amazon's has, there is considerable risk. As much as I think Amazon is a stock you want to own, you probably shouldn't rush to buy it unless you can justify more aggressive sales and earnings estimates than Jeff offered. There's just a lot of risk for the expected returns. At $50 a share, though, the annualized three-year return (based on a $84 target) would shoot up to 19%, making for a more compelling story. So call me a confirmed but cautious Amazon bull.
Next: The Bear Argument