Wednesday, July 8, 1998
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An Investment Opinion
by Dale Wettlaufer

WSJ Takes on Amazon

Internet stocks were the focus of this morning's "Heard on the Street" column in the Wall Street Journal. Before going on to some interesting quotes from analysts, the column brings up the tired question asked by investors discussing the matter on the Internet long before it was a gleam in the eye of the Journal's writers, "Why is Amazon.com's (Nasdaq: AMZN) market cap twice that of Barnes & Noble (NYSE: BKS) and Borders Group (NYSE: BGP)?" Let's look at the main reason why.

With a nod to the observation that stocks go up because there are more buyers than sellers, the market is a very complex system that correctly discounts the value of companies over time. While there may not be a cognitive process of discounting going on in the head of every buyer and seller, the market is more efficient the longer you stretch out the time horizon. The interplay of rational and irrational buyers works out over time, though the balance can fall to either group in the short term. Morgan Stanley Dean Witter analyst Mary Meeker got it right in a December report quoted in this morning's article. "We have one general response to the word 'valuation' these days. And it's 'bull market.'" Young companies that bring something different to the table and then execute on a business plan will see their equity bid up. What's the evidence of what Amazon brings to the table? Cash flows.

Looking at net cash flow from operations (which takes into account inventory investment, inventory financing from vendors, and only accounts for the cash effect of write-offs and other balance sheet fooling around) and then deducting capital expenditures and the cost of acquisitions, here are the cash flows for the three bookselling subjects of today's WSJ column.

($ in millions)

              1997    1996      1995 
 B&N           47.3  (52.3)   (211.8) 
 Borders       (28)     4.0   (104.3) 
 Amazon.com   (3.7)   (2.9)   (0.284)

Reading all the stuff that's been turned out on Amazon, both online and offline, it's as if no one has ever heard of the statement of cash flows. In its hypergrowth phase, Amazon doesn't consume anywhere near the cash that the traditional bricks-and-mortar companies do. Sure, it will consume more cash this year than last, but it is part of the business model that slow-turning payables finance quick-turning inventories. The growth of Amazon is cheaper to finance than at the other companies, and the magnitude of cash outflows necessary to finance growth is comparatively very small. That's what the market is looking at, and that's where multiples to revenues and year 2002 earnings are off the mark. It's all about how much of the shareholders' cash the company has to spend to grow. Period. With that in mind, investors can forget the flabby theories on retail investors' buying influence and whatever else. What you need to know is on the cash flow statement.


Life sciences research products supplier Life Technologies (Nasdaq: LTEK) rose $7 9/32 to $38 9/32 after specialty materials supplier Dexter Corp. (NYSE: DEX) agreed to buy the 48% stake in the company it does not already own for $37 per share in cash. The purchase price represents a 19% premium to Life Technologies' closing price of $31 per share yesterday. Dexter climbed $5/16 to $31 13/16.

Travelers Group (NYSE: TRV) rose $3 3/16 to $67 3/4 and Citicorp (NYSE: CCI) gained $7 1/16 to $167 9/16 after Merrill Lynch apparently put its stamp of approval on the two companies' proposed merger by raising both firms' intermediate-term ratings to "buy" from "accumulate."

Macintosh and computing products maker Apple Computer (Nasdaq: AAPL) picked up $15/16 to $31 7/16 on the opening day of its annual MacWorld Expo, which has moved to New York from Boston. Separately, a couple of PC makers gained ground this morning. Dell Computer (Nasdaq: DELL) added $3 3/16 to $94 3/16 and Gateway (NYSE: GTW) advanced $2 5/8 to $59 1/8.

Food distributor and grocery store operator Richfood Holdings (NYSE: RFH) climbed $1 1/4 to $21 following reports suggesting the company may sell its 52% stake in bookseller Crown Books (Nasdaq: CRWN) to a New York-based liquidator.

Healthcare management software provider HBO & Co. (Nasdaq: HBOC) rose $1 to $36 this morning. Yesterday, financial services giant American Express (NYSE: AXP) disclosed a 4.5% stake in the company in a federal filing.

Several oil services and drilling companies gained as oil prices advanced this morning after dropping over the past two days. Today's move is being attributed to the apparent dissolution of the military government in Nigeria, which traders believe could help limit that country's oil production. Schlumberger (NYSE: SLB) added $1 7/8 to $68 5/8, Halliburton (NYSE: HAL) gained $1 7/16 to $43 7/8, Global Marine (NYSE: GLM) advanced $9/16 to $18 1/2, Baker Hughes (NYSE: BHI) climbed $7/8 to $32 7/8, and Diamond Offshore (NYSE: DO) picked up $15/16 to $38 9/16.

Arlington, Texas-based homebuilder D.R. Horton (NYSE: DHI) tacked on $15/16 to $23 3/16 after reporting net new home sales contracts in its fiscal Q3 jumped 41% from their levels a year ago. The firm is seeing double-digit sales growth in all of its operating regions, prompting "high expectations" for the rest of the fiscal year. Credit Suisse First Boston upgraded the firm to "buy" from "hold."

Eye care and specialty pharmaceutical products maker Allergan Inc. (Nasdaq: AGN) gained $1 11/16 to $49 1/8 after saying higher sales of its Botox and Alphagan eye disorder drugs will result in fiscal Q2 earnings higher than the First Call mean estimate of $0.37 per share.

Newspaper and lumber company Bowater Inc. (NYSE: BOW) rose $1 3/4 to $49 5/16 after Donaldson, Lufkin & Jenrette upgraded the firm to "top pick" from "buy."

PC and computer products direct marketer PC Connection (Nasdaq: PCCC) climbed $3 1/4 to $17 1/2 after reporting a 43.5% year-over-year increase in net sales in fiscal Q2 to $174.3 million. Average order size in the period rose 18.6% to $600.

Computer network security products developer Network Associates (Nasdaq: NETA) moved up $2 to $50 3/4 after receiving certification from the Chinese government to sell its anti-virus products in the country.


Several Internet stocks tumbled this morning along with Amazon.com. In advance of reporting earnings after today's close, Internet portal company Yahoo! (Nasdaq: YHOO) lost $5 1/2 to $185 1/2. Competitor Excite (Nasdaq: XCIT) shed $4 1/2 to $91 3/4; Infoseek (Nasdaq: SEEK) fell $1 1/2 to $33 13/16; and Lycos (Nasdaq: LCOS) sank $6 3/4 to $78 1/4. Internet advertising firm DoubleClick Inc. (Nasdaq: DCLK) gave back $3 3/4 to $58 1/4; Internet direct marketer CMG Information Services (Nasdaq: CMGI) slid $2 7/8 to $65 3/4; and Internet access provider Rocky Mountain Internet (Nasdaq: RMII) dropped $1 7/8 to $16 5/8.

Motorola (NYSE: MOT) fell $1 1/2 to $53 1/2 after reporting late yesterday second quarter earnings of $0.01 per share (before unusual items), which beat the analysts' revised mean estimate of a loss of $0.04 but was far below the $0.64 profit the telecommunications equipment maker posted in the year-ago quarter. Estimates had been lowered after Motorola issued an earnings warning early last month. The company said it expects that weakness in the semiconductor industry and in the Asian economies will continue to have a negative impact on its business for the rest of the year.

Analog and mixed-signal semiconductor products maker Semtech Corp. (Nasdaq: SMTC) plunged $4 to $10 7/16 after announcing it expects second quarter EPS to be about 40% to 50% lower than in the prior quarter before charges. In addition, the company announced it will take a one-time pre-tax restructuring charge of $2.5 million.

Industrial and aerospace motion and control components and systems manufacturer Parker Hannifin (NYSE: PH) shed $11/16 to $35 3/16 after warning that it expects fourth quarter earnings of about $0.81 a share before charges, short of the $0.89 predicted by analysts. In addition, Q4 results will reflect a $0.66 per share acquisition charge stemming from the recent purchase of UCC Securities Ltd. and a $0.03 charge for the payment of a premium due to the early retirement of debentures. The charges will be offset somewhat by a tax credit of $0.02 a share.

Litigation and claims management consulting company FTI Consulting (Nasdaq: FTIC) sank $2 3/8 to $9 1/8 after announcing it expects Q2 EPS of $0.09 to $0.10, below the $0.15 in the year-ago period and the $0.22 expected by analysts. The company blamed the earlier-than-expected conclusion of several major engagements and the postponement of several others, as well as revenue from subsidiary LWG being adversely impacted by fewer than normal weather-related insurance claims.

PC banking software developer CFI ProServices (Nasdaq: PROI) was down $3 3/8 to $13 1/2 after announcing it expects its fiscal Q2 EPS to be between $0.17 and $0.18, compared with the First Call mean estimate of $0.24, because "several sales opportunities slipped into the third quarter." The company is maintaining its earnings target for the year.

Following the announcement of preliminary Q2 results yesterday, Harbinger Corp. (Nasdaq: HRBC) lost $1 13/16 to $12 15/16 as J.P. Morgan lowered its rating on the electronic commerce software company to "long-term buy" from "buy."

Internet software developer Inktomi Corp. (Nasdaq: INKT) gave back $3 1/2 to $73 after a two-day surge that pushed its share price to $76 1/2 yesterday from $48 at the end of last week -- a 59% increase.


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Contributing Writers
Yi-Hsin Chang (TMF Puck), a Fool
Brian Graney (TMF Panic), Fool Two
Alex Schay (TMF Nexus6), Fool, too
Dale Wettlaufer (TMF Ralegh), Final Fool

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