Rule Breaker Portfolio

<THE RULE BREAKER PORTFOLIO>

Amazon Bonaparte
Conquering and fortifying a New Land

by Jeff Fischer (TMFJeff)

ALEXANDRIA, VA (April 16, 1999) -- If you're the first to discover a New Land, you should fortify a stronghold -- a base -- and then rapidly spread. On the surrounding land that you grab, you should begin to build a great city. If you begin great, people will hear of you, visit, and your economy will grow. The more people that visit, the more you can build. Later, you should have enough wealth and influence that you can build a wall around your city that few can challenge. Everyone will want in. Once they're in, they'll stay.

Amazon.com (Nasdaq: AMZN) is using its equity to grab more land, to build a larger universe, and to build a wall around its property. Amazon -- though New Age to its core -- is, in fact, a classic example of building a defensible business steadily, block by block. The Internet simply has -- for the first time -- allowed investors to watch the building process in action and at great speed. Day-by-day, we've seen Amazon expand its world at ten times the pace that it would have taken in the physical world.

Amazon is being even more aggressive than anyone expected, moving quickly from books to include music and videos, electronics and gifts, to offering total Web shopping services, and then opening auctions, while at the same time taking majority positions in online drug and pet stores, calendars and shopbots, as well as opening stores to serve the UK and Germany. While expanding, management raised over $1 billion in cash through debt offerings. All of this has happened in approximately the past 12 months, and all of it has been beautifully executed. Last year, sales at Amazon climbed to $610 million (from $15 million just two years earlier) and the Amazon shopping experience and customer service didn't decline a whit; rather, it improved.

A wonderful part of Amazon's expansion is that it automatically builds on itself. Management need only add incrementally to be rewarded monumentally. For every brick that the company adds to its business, the "people" add 10 more in support. "Amazon began to sell music! Bid the stock up 30%!" And "Amazon added auctions! Increase the company's equity value by 35%!"

This week Amazon announced plans to purchase Livebid.com, giving Amazon leadership in the expensive auction market and thereby making its site a destination for both traditional, "classy" auctions and online consumer-to-consumer auctions. These businesses won't be small potatoes. The auction industry could generate sales upwards of $30 billion online by 2003 (obviously that's a guess, but not one without reason), and eBay has shown for two years that, if run well, a company can manage 80% to 85% gross margins serving auctions -- Microsoft-type gross margins.

The hope is that Amazon will improve its margins considerably as auctions become a significant part of its revenue in the next three to five years. In fact, auctions could help the company reach profitability sooner than expected. Friday's 13% leap in the stock (up $22 3/4) was arguably sparked by Jamie Kiggen, an Internet analyst at Donaldson, Lufkin & Jenrette who expects profits in 2001. The analyst increased his six to twelve-month price target on Amazon to $280 from $190, citing the strong dynamics of the auction business.

Phrases like "the Wal-Mart (NYSE: WMT) of the Internet" have been thrown around again. Amazon has far to go before getting there. Let's compare numbers. Wal-Mart has $138 billion in trailing (past 12 months) sales and a market value of $220 billion, meaning that the company is valued 1.6 times sales while having 3% profit margins and trading at 49 times earnings.

Comparatively, Amazon has $610 million in trailing sales, or 0.44% of Wal-Mart's sales, and a market value of $31 billion, which is 14% of Wal-Mart's value. What might be more telling, however, is how quickly Amazon has grown to this size. Consider Wal-Mart's history, as discussed in the book Rule Breakers, Rule Makers.

It took Wal-Mart eight years to grow from $0 in sales to $44 million. It took Amazon just three years to grow from $0 in sales to $610 million. When Wal-Mart came public in 1970, sales were $44 million. The company crossed $2 billion one decade later, meaning that it took 18 years total to reach $2 billion. Amazon's sales should easily cross $1 billion this year, less than three years after coming public and after about four years of business, while $2 billion could be reached in another two to three years, meaning that Amazon could hit $2 billion in sales in nearly one-third the time that Wal-Mart needed.

From another angle, it was near 1980 that Wal-Mart hit $2 billion in sales (after 10 years of being public), and 10 years later it hit $30 billion in sales and had $1 billion in profits, for 3.3% net profit margins. So, it took Wal-Mart 28 years to grow sales from $0 to $30 billion (now, nine years later, Wal-Mart has $138 billion in sales, up from $100 billion just 3 years ago), and an investment in the company over the first 20 years that it was public grew $10,000 into nearly $20 million. On a reasonably projectable growth rate, Amazon -- by embracing several revenue streams in the retail-related industry -- could reach $30 billion in sales by the end of the next decade (2009), or in half the time that it took Wal-Mart. (And at that massive level of sales from a mere website, Amazon had better sport at least 3% profit margins.)

When one considers that Amazon is growing much more quickly than Wal-Mart ever did, and that the company's fixed costs are poised to decline (rather than expand) as it grows, the analyst's $280 price target makes a little more sense. At $280 per share, Amazon would be valued at $44 billion before considering debt and the impact of stock options, putting the company at one-fifth Wal-Mart's price. Admittedly, Amazon doesn't deserve to be compared to Wal-Mart yet, but it's the closest thing online to it and, to its credit, Amazon is growing more quickly and with much better free cash flow than it's "mentor" did.

(By the way, it's funny how the much talked about (buzz buzz) $400 price target of last winter -- which was $133 post-split -- has been crushed by this new $280 price target. $280 is an $840 price target before the January stock split.)

Amazon was instrumental in the Rule Breaker's 2.4% gain to end the week, a week that saw the portfolio drop 4.5% while the Nasdaq fell 4.2% and the S&P lost 2.1%. Our Foolish Four stocks continued to be strong while @Home (Nasdaq: ATHM) continued to decline following its earnings report. The report was solid and @Home remains the premier high-speed Internet connection company, of course. Given its high profile (and the high expectations), the stock will continue to be volatile, we suspect, in every direction.

Iomega (NYSE: IOM) reported first quarter results on Thursday that met expectations. The company broke-even, which is better than last year's $18 million loss, but the quarter left little to be excited about. Revenue declined to $386 million from $408 million last year. Zip sales were healthy, but Jaz sales declined over 40%, while the company's new Clik! product isn't large enough to make a splash. At least Iomega was cash flow positive by $6 million, a credit to its tight cost-cutting and inventory control. The company expects the second quarter to mirror the first. For the year, $0.29 per share in earnings is hoped for.

End a Foolish week by reading about the Fool's new monthly Jester Award. Every month, we award one book -- generally on investing, finance and business -- the much-coveted (or soon to be!) Jester Award. April's award has been announced. Give her a look-see. And be sure to Fool on!

What's up with Harry Jones today?

04/16/99 Close
Stock  Change    Bid 
---------------- 
AMGN  -2 1/16    66.81
AMZN  +22 3/4   190.00
AOL   -2 1/2    142.00
ATHM  -7 9/16   144.94
CAT   +2 1/16    63.81
CHV   +3 1/8     98.88
DD    -  5/16    67.63
DJT     ---       3.88
EBAY  -2 7/8    176.00
GT    +  1/2     57.25
IOM   +  1/8      5.13
SBUX  -  5/8     31.94
TDFX  -1 1/8     19.88


                  Day     Month  Year   History   Annualized 
      R-BREAKER  +2.44%   4.06%  65.39% 1559.99%  81.91%
        S&P:     -0.29%   2.54%   7.62%  201.30%   26.48%
        NASDAQ:  -1.54%   0.91%  13.29%  244.92%   30.17%


    Rec'd    #  Security     In At       Now      Change
   8/5/94  2200 AmOnline       0.91    142.00   15524.14%
   9/9/97  1320 Amazon.com     6.58    190.00    2787.87%
  5/17/95  1960 Iomega Cor     1.28      5.13     300.26%
  12/4/98   450 @Home Corp    56.08    144.94     158.45%
  2/26/99   300 eBay         100.53    176.00      75.08%
 12/16/98   580 Amgen         42.88     66.81      55.83%
  4/30/97 -1170*Trump*         8.47      3.88      54.24%
  2/23/99   300 Caterpilla    46.96     63.81      35.87%
  2/23/99   180 Chevron       79.17     98.88      24.89%
  2/23/99   290 Goodyear T    48.72     57.25      17.52%
  2/20/98   260 DuPont        58.84     67.63      14.92%
   7/2/98   470 Starbucks     27.95     31.94      14.25%
   1/8/98   425 3Dfx          25.67     19.88     -22.57%

    Rec'd    #  Security     In At     Value      Change
   8/5/94  2200 AmOnline    1999.47 312400.00  $310400.53
   9/9/97  1320 Amazon.com  8684.60 250800.00  $242115.40
  12/4/98   450 @Home Corp 25236.13  65221.88   $39985.75
  2/26/99   300 eBay       30158.00  52800.00   $22642.00
 12/16/98   580 Amgen      24867.50  38751.25   $13883.75
  5/17/95  1960 Iomega Cor  2509.60  10045.00    $7535.40
  4/30/97 -1170*Trump*     -9908.50  -4533.75    $5374.75
  2/23/99   300 Caterpilla 14089.25  19143.75    $5054.50
  2/23/99   180 Chevron    14250.50  17797.50    $3547.00
  2/23/99   290 Goodyear T 14127.38  16602.50    $2475.13
  2/20/98   260 DuPont     15299.43  17582.50    $2283.07
   7/2/98   470 Starbucks  13138.63  15010.63    $1872.00
   1/8/98   425 3Dfx       10908.63   8446.88   -$2461.75

                              CASH   $9924.87
                             TOTAL $829993.00
Note: The Rule Breaker Portfolio was launched on August 5, 1994, with $50,000. Additional cash is never added, all transactions are shared and explained publicly before being made, and returns are compared daily to the S&P 500 (including dividends in the yearly, historic and annualized returns). For a history of all transactions, please click here.

</THE RULE BREAKER PORTFOLIO>

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