Amazon Numbers, Pt. 1
...although only the Shadow knows the future

by Jeff Fischer
(TMFJeff@aol.com)

Chicago, IL (Aug. 25, 1998) -- A rising tide lifts all boats, except for those with holes.

The stock market was considerably higher during the day compared to where it ended, and most of our stocks rose and then fell with the ebb and flow of the market. But not all. Starbucks and 3Dfx continued to take in water rather than float higher, and Trump Hotels dove 12%, discovering a new all-time low of $4 1/16.

It seems that we're in a period of light news, and today was no exception. The Fool declined 0.56% on weakness in several issues, including Amazon.com, but without news. America Online and Trump couldn't save us today, nor did the S&P's 0.43% gain benefit the Fool Port.

Starbucks (Nasdaq: SBUX) fell over $2 and is now trading at 30 times the low-end of fiscal 1999 earnings estimates while expected to grow earnings 35%. Perhaps the company will report slow same-store sales for August as it did for July. That concern might be the cause behind the recent weakness. Being a near-term concern, it doesn't change our stance on this long-term investment. Other than that, 3Com (Nasdaq: COMS) was rated a "buy" from an analyst this afternoon.

Our sights are elsewhere, however. Today we're talking about the Big River. Where's it flowing? Or, as the bears hope, will it run dry?

Every quarter the media enjoys reporting that Amazon.com's (Nasdaq: AMZN) quarterly loss has increased greatly. When the company shared second quarter results on July 22, one media service headlined its report on the numbers with "Amazon.com's Second Quarter Loss Widens as Marketing Costs Surge."

The truth of the matter is, however, that expenses are declining as a percentage of sales, and this is the important fact that needs to be analyzed. The fact that losses have grown on an absolute basis is easy and "gripping" to report to the masses, so it's not surprising that the media does so with flair. Of course, though, when a money-losing company increases its business -- all things being equal -- it loses more money. If a company is beginning to lose less and less money as a percentage of sales with every extra sales dollar, however, the faintest light begins to come into view at the end of an otherwise dark tunnel. That light, of course, represents profit.

Amazon's business, though still deep in the tunnel, is already showing some signs of light. The business is beginning to scale (meaning, the more that it sells, the lower its relative expenses), and the quarterly loss is becoming much smaller in comparison to quarterly sales.

In the second quarter of 1997, Amazon's loss of $7 million represented 25% of total sales. In the second quarter of 1998, which was just reported, the company's loss of $11 million represented only 10% of total sales. And from this point forward, many analysts expect Amazon to lose less money each quarter on an absolute basis as well as on a percentage to sales basis.

Consider the following quarterly earnings estimates for the company. They begin with the $0.20 per share loss and the $0.33 per share loss (before charges) already reported in the first two quarters of this year.

  Earnings Estimates (AMZN) 
         (1998 and 1999) 
           Q1  -0.20 
           Q2  -0.33 
           Q3  -0.29 
           Q4  -0.26 
  
           Q1  -0.20 
           Q2  -0.18 
           Q3  -0.16 
           Q4  -0.08
The numbers are descending like a crippled butterfly -- drifting in the wind, fluttering lower and lower to finally rest and recover on peaceful ground... and then take flight.

Seven straight quarters of lower losses are anticipated (not including one-time charges, of course), and if it appears to you from the numbers that Amazon could become profitable in the year 2000, indeed, many analysts so believe. Current year 2000 estimates range from a few pennies per share in earnings to $0.07 per share, assuming that the total sharecount increases by just over 10%. "Seven cents, big deal" -- I know you might be saying. It's what comes after the very first profit that matters, though.

Looking at the current quarterly numbers for Amazon, though, a Fool might ask, "How could any profits at all take place? How could this company become profitable?"

Although Amazon is changing constantly and adding new businesses that we currently know little about financially (including the recent acquisitions of Junglee and PlanetAll.com), its business is still almost entirely selling books and music, and these products will constitute the majority of sales for the foreseeable future. Putting aside the unknowns of the online retailing landscape in the future, we can project sales and costs in the years ahead for a leading online bookseller, and we can estimate growth rates to see how its business model can become profitable with relative "ease" -- if there is such a word in business.

I've developed a Foolish financial model like this for Amazon.com and some of it will be shared now and much more of it later. There are many aspects of it to explore, of course, and there's reasoning to explain.

First, the sales numbers.

With $203 million in sales for the first half of this year, the model projects $476 million in sales for all of 1998 ($119 million in revenue in the current quarter and $154 million in the fourth). It next calls for $678 million in sales in 1999 (that's 42.4% sales growth year-over-year). In the year 2000, the numbers spit out (yes, that's the proper term) $846 million in sales (that's 24.7% sales growth). Finally, sales in the year 2001 are projected to be $1,010 million (just over $1 billion), for 20% growth. (It's interesting to note that studies don't expect the Internet to invade the majority of the consumer market until 2003 or 2004.)

These sales numbers include books and music, but little else, and as of now this isn't an inaccurate business assumption to make. Revenues from other businesses are very slight to nonexistent.

Of course, this barely scratches the surface -- anyone can throw out sales estimates for the next few years (though there was reasoning to it, don't fret, including customer growth projections and average revenue per customer numbers, which we'll cover soon). Where it gets interesting is when you break down all of the annual expenses and see how money could be made in 2000 and 2001 -- and beyond. Once it's shown piece by piece on paper (or on your monitor), you might begin to see what Amazon is striving for by way of sales growth and eventual economies of scale and profits.

Having been a windbag today, we'll begin to tackle all these numbers tomorrow. Before leaving, though, it's worth noting that rumors are surfacing that Amazon.com could be teaming up with Bertlesmann, the largest book publisher in the U.S.

Supposedly BarnesandNoble.com is the other potential Bertlesmann partner. (I'd partner with Amazon if I were you, Bertelsmann, because not only does it have the much larger customer base and momentum, but "BarnesandNoble.com" is plain ugly to type.) Bertelsmann earlier announced that it would launch on online book-selling site this fall, but perhaps management is finding it most feasible to partner with a company that already has a leading foundation built to support the business of selling books online. Bertlesmann also owns a record label.

For more reading tonight, the Drip Port discusses why dividends are such a giant part of market-crushing investing (it opens your eyes!), and the Bore Port provides part 2 of its excellent retrospective. Don't miss this educational series. Finally, please post your questions for the Fool's interview with AOL management tomorrow.

Fool on!

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Bookmark Live Fool Port Quotes

08/25/98 Close

Stock Change Bid ---------------- AMZN -3 1/8 131.63 AOL +1 13/16110.63 T + 9/16 57.63 DJT - 9/16 4.13 DD -1 1/16 59.88 XON - 1/4 70.31 INVX - 1/4 13.00 IP + 1/4 42.94 IOM - 3/8 4.44 KLAC + 5/16 29.13 LU - 9/16 87.19 SBUX -2 1/16 36.50 COMS - 1/16 30.00 TDFX - 1/4 12.63
Day Month Year History Annualized FOOL -0.56% 2.69% 51.03% 406.86% 49.23% S&P: +0.43% -2.49% 12.61% 138.40% 23.89% NASDAQ: +0.39% -3.98% 14.49% 149.64% 25.31% Rec'd # Security In At Now Change 8/5/94 710 AmOnline 3.64 110.63 2942.13% 9/9/97 580 Amazon.com 19.11 131.63 588.75% 10/1/96 84 LucentTech 23.81 87.19 266.21% 5/17/95 1960 Iomega Cor 1.28 4.44 246.57% 4/30/97 -1170*Trump* 8.47 4.13 51.29% 8/12/96 130 AT&T 39.58 57.63 45.60% 2/20/98 200 Exxon 64.09 70.31 9.71% 2/20/98 215 DuPont 59.83 59.88 0.07% 2/20/98 270 Int'l Pape 47.69 42.94 -9.97% 7/2/98 235 Starbucks 55.91 36.50 -34.72% 8/24/95 130 KLA-Tencor 44.71 29.13 -34.86% 8/13/96 250 3Com Corp. 46.86 30.00 -35.98% 1/8/98 425 3Dfx 25.67 12.63 -50.81% 6/26/97 325 Innovex 27.71 13.00 -53.08% Rec'd # Security In At Value Change 8/5/94 710 AmOnline 2581.87 78543.75 $75961.88 9/9/97 580 Amazon.com 11084.24 76342.50 $65258.26 5/17/95 1960 Iomega Cor 2509.60 8697.50 $6187.90 10/1/96 84 LucentTech 1999.88 7323.75 $5323.87 4/30/97 -1170*Trump* -9908.50 -4826.25 $5082.25 8/12/96 130 AT&T 5145.11 7491.25 $2346.14 2/20/98 200 Exxon 12818.00 14062.50 $1244.50 2/20/98 215 DuPont 12864.25 12873.13 $8.88 2/20/98 270 Int'l Pape 12876.75 11593.13 -$1283.63 8/24/95 130 KLA-Tencor 5812.49 3786.25 -$2026.24 8/13/96 250 3Com Corp. 11715.99 7500.00 -$4215.99 7/2/98 235 Starbucks 13138.63 8577.50 -$4561.13 6/26/97 325 Innovex 9005.62 4225.00 -$4780.62 1/8/98 425 3Dfx 10908.63 5365.63 -$5543.00 CASH $11876.47 TOTAL $253432.09

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