Brian Lund: What was the thinking behind the purchase of Amazon.com (Nasdaq: AMZN) in 1997?
Jeff Fischer: Amazon.com was the first-mover in creating a book-buying experience tailored and optimized for an online audience. The thinking at the time of the purchase was that Amazon.com would move in a like fashion into various portions of consumer e-commerce -- and do so first. As we bought it, we saw how the company was utilizing its community to make bookselling much more than normal bookselling. And, we saw the potential to expand into all kinds of product and sales platforms.
David Gardner: Exactly. And, we saw it building a lasting brand and business, with incredible customer info. Overall, by its positioning as a leader square in the middle of a tsunami, it could become a publishing company, or a delivery service like Webvan (Nasdaq: WBVN) -- it owns 30% of HomeGrocer.com (Nasdaq: HOMG) -- etc.
Jeff: And, it always had the buzz, Amazon. It has had that magic branding buzz since the beginning. (Explaining why or how that happens is not easy.)
Brian: Has anything changed?
David: It's gotten bigger, perhaps even over-expanded in product categories. The most profitable and easiest to do are consumer information and entertainment products, stuff that could eventually be digitized.
Jeff: Just in the past week, Amazon has made interesting moves in new directions. It is beginning to leverage its strength: customer traffic and retention. I don't believe that we'll see Amazon add much more inventory (or new "physical" product categories) anytime soon. Instead, it is partnering to provide inventory and acting as the higher-margin customer attractor and deal-maker.
Brian: The Toys "R" Us deal seems good to me. It allows Amazon to use its strengths and lets "Toys" use theirs.
Jeff: Amazon's car-selling partnership is another example. And, management is thinking about how to best utilize its strengths and leverage its electronic medium in its Microsoft book deal (again, no real inventory to carry). Amazon's URL has incredible value, with some 25 million registered customers. Amazon can pull and push the necessary levers to turn that traffic into profits, long-term. So, these recent decisions by management are encouraging to me.
David: Yes, Jeff. And, most of those 25 million customers are purchasers, not just lurkers.
Paul Commins: Amazon should abandon lawn tractor inventory and return to the "ruthless ringmaster" model. Hold the core user base, partner for non-core products, and expand only when they have a good chance to dominate quickly and completely.
David: I want to say one thing about this whole "business-to-consumer (B2C) is dead" thing. This is speaking from the standpoint of sentiment. I can't believe what overkill the media (and markets) have done to these companies, Amazon included. Sentiment is such today that we're almost being led to believe that consumers aren't going to use the Internet anymore to buy stuff or pay anything to anybody. Sorry, but consumers are continuing to flock in increasing numbers to use the Internet in increasingly relevant and numerous ways. I think Amazon down in the $30s will prove, long-term, to have been a great deal. Same with eBay (Nasdaq: EBAY) right now. In fact, I think both make excellent long-term investments from their prices right now.
Paul: The overkill was present on both sides. The same irresponsible media has led us to a choice between Al Gore and George W. Bush. The whole "e-commerce is everything" followed by "e-commerce is dead" thing is entirely a media creation. Meanwhile, e-commerce continues to be what it has always been, regardless of how much promo it gets.
David: E-commerce is much closer to "everything," though, than it ever will be to "dead." Anyway, I just wanted to put in a quick word of support for "B2C," which is an idiotic phrase. Because no one was using that phrase until the business-to-business (B2B) hype and buzz, then all of a sudden people start saying "B2C" as if it's this new but old thing. Most great investments you and I make over time have always been in "B2C," whether it was Sara Lee (NYSE: SLE), Wal-Mart (NYSE: WMT), Coca-Cola (NYSE: KO), what have you.
Brian: True. The question is, can Amazon make a good return on invested capital (ROIC) in online commerce? The company has a lot of debt -- high-cost debt.
Jeff: I can't believe how often the media has ignored (from one side of their mouths) the fact that Amazon is still building, building, building. Amazon plans to earn three to four times the ROIC of a traditional retailer. It has been sinking all its costs in the past five years, building for a large sales base. Eventually, the costs dwindle as the sales fill the facilities to capacity, and then you'll begin to see ROIC rise as the inventory turns.
I wrote this summer that Amazon's prospects look better now than ever, at least from a competitive standpoint. I ask you all now: Can you name a single online retailer that today is posing a real threat to Amazon's online retailing platform? If you can't name a company now, then how will a new company come along and upset Amazon in the next few years? This is why I think the company is poised to dominate a good portion of online retail.
David: They are poised to dominate, come the holiday season. There has been a shakeout -- third- and second-tier companies that were jamming the airwaves last Christmas season. Many of those will not be around. Amazon's need-for-speed strategy has worked.
Brian: Hasn't the shakeout hurt Amazon, too? Partners like Living.com are falling, taking Amazon's partnership revenue -- which is mostly in the form of rapidly depreciating equity -- with them.
Jeff: I'm surprised the stock didn't react to the Living.com news more, actually. It is a blow to Amazon in the near-term, the loss of several million dollars from contractual deals.
David: Only in a short-term sense can this hurt Amazon. The field of competitors has fallen away like knights before Lancelot.
Paul: For Amazon to fulfill its destiny, though, margins are everything. I don't see how they can ever grow revenues to $150 billion or more -- which they'd need to do to deliver on the investment at traditional retailer margins -- so, they have to beat traditional retailer spreads by a consistent point or three.
Jeff: I disagree that margins are everything. Volume and efficient fulfillment are more important. Look at Wal-Mart's margins. They're low.
Brian: Amazon doesn't have Wal-Mart's asset turnover, though.
Paul: Nor are they likely to, if they get too heavily into the mix of warehoused goods that Wal-Mart covers so well.
Jeff: Cash flow is the focus. Nobody expects Amazon to be a high-margin company. They do expect ROIC of three to four times a traditional retailer, though, and very favorable cash dynamics (cash comes in right away, bills are paid on the shipped product weeks later).
Brian: But, can they profit from it? Look at the latest balance sheet and cash flow statement. Float diminished and cash flow worsened as payables went way down. That's a loss of leverage, possibly because of the recent unpleasantness.
Jeff: Looking at the past quarter, one of the weakest of the year, is not a good way to judge where the company may be five years from now.
David: That was one quarter. Not a great one, admittedly. But, we'd need to see more before calling it a trend.
Paul: Surely Amazon won't beat Wal-mart in supply chain planning?
Jeff: Is Wal-Mart unbeatable? How come?
Paul: Not unbeatable at all.
Jeff: You said "surely."
Paul: I just don't think the way to beat them is by attacking their core strength, especially if inventory management hasn't been your strong suit. I think it all comes back to re-trenching on high-margin digital products, leveraging the advantage they were supposed to have from the beginning as an Internet retailer.
David: Wal-Mart is embarrassingly late to the e-commerce dance, but frankly I'm not sure Wal-Mart ever would've been a big player online, since so much of its stores are stocked with stuff people wouldn't want mailed.
Brian: I think Wal-Mart will be a big player online.
Jeff: Comparing Wal-Mart's offline operations to Amazon's online operations has limited value. Amazon isn't attacking Wal-Mart's core strengths, if you believe Jeff Bezos. He sees offline retail as a different business than online.
David: Remember, though, Amazon can be a publisher, where now it's just a retailer. Amazon could be a broadcaster, etc.
Paul: OK, I'm confused. Can we start all over on ROIC? Unless I'm missing something obvious (likely), there are three ways to improve ROIC -- better margins, better turnover, and higher leverage. Now, let's assume that they continue to expand into the traditional retail products that Wal-Mart also sells. Wal-Mart is the established king of turnover. Amazon won't beat them at diapers. Leverage is covered, but due to debt, not due to any business advantage. That leaves margins.
Jeff: Amazon will beat Wal-Mart handily in invested capital (the sheer amount it will need to invest).
Paul: How? I'm still clueless.
Jeff: Amazon will turn over much more inventory on a much lower base of invested capital.
Paul: Agreed, as long as this inventory is not diapers or lawn tractors.
Jeff: By selling online, Amazon's invested capital will begin to max out much sooner than Wal-Mart's. Amazon's capital expenditure spending is on the decline now, even.
Brian: It's in their control, anyway, and they don't have to spend much to grow more. Let's wrap up with one last thought each.
David: I continue to see great additional potential for the company beyond what we consider its present business and business model to be, and they are a hell of a brand. No one is taking my Amazon shares from me.
Paul: I agree that the potential is vast, as long as they get back to the clever stuff that made them big in the first place, and get away from taking on traditional retailers in their breadbasket. Focus on the markets that Amazon can make special. Amazon adds the brand, the customers, and the Web-personalization technology.
Brian: I agree that the brand is great. It gives them great mobility. I believe Amazon will remain the online merchant king, but considering the dilution, the debt, and the big early stock price run-up, I'm not sure that it'll be a great long-term investment.
Jeff: The debt is another big issue, of course, that we all dislike. But, I believe the working capital (and debt, I hope!) management will improve greatly in the next 18-24 months. And, I continue to believe that Amazon has more potential now, as a long-term business (10 years or more), than it ever has, partly because a majority of its competition is failing.
Your Turn: Let us know how you feel about Amazon on the Amazon discussion board. Also, please take part in our poll:
What do you think of the chat format?
- I like it. It adds vivacity and a variety of perspectives.
- At least it's easy and fun to read.
- It's no better or worse than your normal columns.
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