Rule Breaker Portfolio

<THE RULE BREAKER PORTFOLIO>

Amazon's Biz to Date:
Net Positive

Plus, EMusic to AOL's ears

By Jeff Fischer (TMF Jeff)

ALEXANDRIA, VA (August 16, 1999) -- eBay (Nasdaq: EBAY) blazed a trail on news that it launched an eBay-branded paging service with SkyTel Communications (Nasdaq: SKYT). The "eBay a-go-go" pager service updates eBay users on the status of their auctions.

In the future, we can expect easy means to actually bid and put items up for auction on eBay through remote access devices, too, such as through PalmPilots. Wireless devices already provide a means to do this, of course, but eBay is working to make its auctions more accessible through small, less powerful handheld devices, as are many other leading online companies. Personalized content for remote access devices is one of the next waves in the Internet's expansion.

eBay pagers can be ordered online at http://www.skytel.com/ebay. They function as regular SkyTel pagers, too. However, you don't even need a new pager to receive eBay a-go-go. The service can be added to any wireless device that can receive text messages and has an Internet e-mail address. Personalized services such as this serve to make the brand-loyal user even more dedicated to eBay, which has over 5.6 million registered users to keep hooked.

After a long period (in Internet terms) of little action, eBay's management has begun to announce new initiatives, including automobile sales and city-specific auction services across the country. With these announcements, investors are reminded that what you see isn't what you get. Once an online company has a strong customer base, leveraging that base becomes more inexpensive. Monetizing a customer in new ways should prove easier and less expensive online than it has ever been in the past -- off-line.

This is exactly what Amazon.com (Nasdaq: AMZN) is building towards: increased ways to monetize customers. It is humorous how few journalists writing about Amazon today have faith in the company's ability to succeed despite management's success to date. Amazon has found that the average customer who first visited the site to buy books will later make more than 50% of their continuing purchases in other categories (as they are added): music, videos, etc. The ratio is higher than anticipated, and it has led Amazon to build new categories aggressively -- and to increase warehouse space.

Hey, what is so horrible about warehouse space, anyway? Why are would-be analysts so obsessed with the piddly warehouse space issue? Warehouse space is relatively cheap, it depreciates reliably, and new warehouses are much more favorable than old, already outdated (in terms of efficiency) warehouses. With plans for nine distribution centers so far, Amazon is on track to have more than ten times the warehouse space that it commanded last December. Thankfully, much of the space will not be needed for some time. I say thankfully because management is thinking ahead a year or two -- um, that's smart.

Amazon has distribution centers that can handle several billion dollars worth of sales and it has scaled to become a billion-dollar annual business. Yet, as of the last quarter, Amazon had used less than $18 million in operating cash. Repeat: less than $18 million in operating cash has been used. I believe that the return on investment will not disappoint.

Amazon is spending now to build a network of customers that will be increasingly beneficial to leverage, while networking effects (largely word of mouth) will make acquiring more customers increasingly less expensive in the future at the same time. America Online (NYSE: AOL) serves as an example. Early customers were expensive to acquire. People moaned over AOL's marketing expenditures for several years. Now the company can crank down that cost and still attract more customers per quarter than any other ISP, largely due to the network effect -- the impact of being the largest and the buzz that comes with it.

Amazon is spewing losses to grow now, but imagine just five years ahead when it has at least 30 million customers, when its fixed costs are actually fixed (not soaring as Amazon builds) and when its margins are steady (of course they're going to decline now, because Amazon is spending to add entire new business lines). And anyway, as much money as Amazon is losing now, it isn't as if it's killing the company. Amazon had $1.15 billion in cash and equivalents at the end of the second quarter, and $1.4 billion in long-term debt. On top of that, despite all the whining that we hear about the company's annual losses, the dollars lost have been all but been earned back (and then some) on paper.
Year      Net Loss (as reported) ($mm)
1996            $6,246
1997           $31,020
1998          $124,546
             ---------
Total         $161,812
$161 million in losses over the past three years en route to creating over $15 billion in market value. Boo hoo. The company is expected to lose about $300 million more from operations this year, bringing the total four-year operating net loss to over $461 million. Wah. I'm going to cry. But now consider what Amazon has gained from just one investment: Drugstore.com (Nasdaq: DSCM). Amazon bought a greater than 40% stake in Drugstore.com for an estimated $35 million.

Drugstore.com as an Amazon Investment
Amazon's estimated cost: $35 million
Current est. value of investment: $700 million+
Amazon's gain on paper: $665 million+

So don't cry for Amazon. It is doing just fine. The company is creating value on the market and with investments. Amazon has similarly sized investments in Pets.com, Gear.com and HomeGrocer.com, companies not yet public.

True, the company is losing money on operations as it builds its business, and this will continue -- and it is meaningful. We do want the company to be profitable from operations, of course. In due time. For now, though, we're not lamenting the billions in value it has already created.

Iomega (NYSE: IOM) shipped its first rewritable CD drive, the internal ZipCD. News.com covered the story well.

America Online (NYSE: AOL) announced a partnership with EMusic for Web music delivery. EMusic will pay AOL a fixed marketing fee over three years. Seeing the size of recent agreements, the fee will almost certainly be several million dollars. Speaking of music, a longtime Fool has an excellent recording on the market that I've wanted to mention for a long time. Jeff Bjorck has been a Fool for as long as I can remember, and he's a pianist and a songwriter as well. His all-original musical recording has earned excellent reviews on Amazon. The music could accurately be called "music to invest by." It is wonderfully done. Maybe EMusic will offer it.

To close, we're looking for more Fools! Jeff is already duly employed. Maybe you are, too. However, would you like to throw off your fancy shoes and put on a Fool cap full-time instead? Consider Fool Jobs. In editorial, we're especially interested in writers and company analysts, and we also have an opening for a research product manager. Consider the Fool for your future.

Fool on!

--Jeff Fischer

08/16/99 Close
Stock  Change    Bid 
------------------ 
AMGN  -  7/16    83.38
AMZN  +  7/8     98.31
AOL   -1 15/16   94.81
ATHM  +1 1/16    38.06
CAT   +  1/16    62.31
CHV   -  7/8     95.88
DD    -  3/4     72.00
DJT   -  1/16     4.63
EBAY  +11       109.00
GT    -  7/16    56.94
IOM   +  1/8      4.19
SBUX  +  3/16    20.88
TDFX  -  7/16    14.06


                  Day     Month   Year   History   Annualized 
      R-BREAKER  +0.12%  -0.06%  10.26% 1006.73%   61.28%
        S&P:     +0.23%   0.15%   8.84%  204.56%   24.79%
        NASDAQ:  +0.28%   0.26%  20.64%  267.31%   29.52%


    Rec'd    #  Security     In At       Now      Change
   8/5/94  2200 AmOnline       0.91     94.81   10332.14%
   9/9/97  1320 Amazon.com     6.58     98.31    1394.28%
  5/17/95  1960 Iomega Cor     1.28      4.19     227.04%
 12/16/98   580 Amgen         42.88     83.38      94.46%
  4/30/97 -1170*Trump*         8.47      4.63      45.39%
  12/4/98   900 Excite@Hom    28.04     38.06      35.74%
  2/23/99   300 Caterpilla    46.96     62.31      32.68%
  2/20/98   260 DuPont        58.84     72.00      22.36%
  2/23/99   180 Chevron       79.17     95.88      21.10%
  2/23/99   290 Goodyear T    48.72     56.94      16.88%
  2/26/99   300 eBay         100.53    109.00       8.43%
   7/2/98   470 Starbucks     27.95     20.88     -25.33%
   1/8/98   425 3Dfx          25.67     14.06     -45.21%

    Rec'd    #  Security     In At     Value      Change
   8/5/94  2200 AmOnline    1999.47 208587.50  $206588.03
   9/9/97  1320 Amazon.com  8684.60 129772.50  $121087.90
 12/16/98   580 Amgen      24867.50  48357.50   $23490.00
  12/4/98   900 Excite@Hom 25236.13  34256.25    $9020.12
  5/17/95  1960 Iomega Cor  2509.60   8207.50    $5697.90
  2/23/99   300 Caterpilla 14089.25  18693.75    $4604.50
  4/30/97 -1170*Trump*     -9908.50  -5411.25    $4497.25
  2/20/98   260 DuPont     15299.43  18720.00    $3420.57
  2/23/99   180 Chevron    14250.50  17257.50    $3007.00
  2/26/99   300 eBay       30158.00  32700.00    $2542.00
  2/23/99   290 Goodyear T 14127.38  16511.88    $2384.50
   7/2/98   470 Starbucks  13138.63   9811.25   -$3327.38
   1/8/98   425 3Dfx       10908.63   5976.56   -$4932.06

                              CASH   $9924.87
                             TOTAL $553365.81
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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