Dang! Already the month of February is killing our portfolio, sending us down more than 8% last week. We were doing so well this year, and then the calendar went and flipped to a different month, sending us into a tailspin. Would that we could return to the heady days of January!
I really enjoy saying stuff like that every now and then. It's so absurd, so obviously absurd, and yet so commonplace in financial commentary -- financial commentary in other publications, that is. You won't get that kind of silliness here, except for silliness' sake. Here we aim to help you take charge of your financial destiny. We want to help you get out of debt, pay no more than your fair share of taxes, and get started investing in the best long-term investment vehicle going, the stock market.
Beyond that, The Motley Fool seeks to provide you with useful tools and strategies to make you a better investor. Here in the Rule Breaker Portfolio, we offer a demonstration. We have put real money into our unique method of investing in companies in important, emerging industries that are changing the way we live. The companies we own should be vital to us, or at least to a bunch of us, on a frequent basis.
Fourth quarter wasn't bad
I commented on Amazon's fourth quarter when the company released some preliminary numbers in mid-January. I said that the margins and balance sheet numbers were about as good as we could have reasonably expected. That seemed like good news to me, because it meant that Amazon would probably make it through 2001 without raising more cash, which would come at a high cost.
I also pooh-poohed commentators who had focused on the slackening pace of revenue growth. Sure, I admitted, revenue came in at the low end of expectations, but the whole retailing sector was dead this year. Companies from Wal-Mart (NYSE: WMT), to Barnes & Noble (NYSE: BKS), to Sears (NYSE: S) had fallen short of revenue expectations.
When Amazon issued its earnings report proper, however, it was worse than I thought it would be. It wasn't the current numbers that bothered me. The balance sheet looked as good as it could for a company with $2.1 billion in debt and almost $1 billion in shareholders' deficit. The cash flow statement reflected the fine working capital management that I discussed before. The income statement had comparably decent margins, though fulfillment costs were still higher than they should be.
The future is none too bright
The bad news came in the earnings outlook. While Amazon has targeted Q4 2001 for operating profitability, it expects revenue to increase only 20-30% for the year. That is significantly below previous estimates, the most bearish of which called for at least 40% growth.
It's not surprising that the stock fell 25% in the days following the announcement, in spite of some attempts to ease investors' fears. Amazon indicated its intention to cut costs by announcing layoffs -- which the company made into a worse public relations problem than it had to be. A few days later, the Wall Street Journal reported that an internal memo from CEO Jeff Bezos called for eliminating unprofitable inventory. "The thirty-pound box of nails isn't long for our world," Bezos reportedly wrote.
What's the upside?
Well, that's good and all, but last week left me with one question: What's the upside for Amazon? We used to have a dream that Amazon could become more than a bookstore, that it could deal in digital inventory and come to resemble a kind of media company. We bought a company that had expanding possibilities. I've argued before that Amazon's possibilities have contracted, but last week brought the clearest evidence of that to date.
Amazon is fully focused on profitability, so that it doesn't run out of cash. That's fine -- in fact, that's all it can reasonably do. But:
- It's attempting no new ventures.
- Auctions and zShops (which we hardly even hear about anymore) are flailing.
- Sales in the core U.S. books/music/DVD segment have slowed to 11% and existing stores can expect only 20-30% growth.
In this situation, how good is the best-case scenario at Amazon? The answer seems to me to be, "Not very." Amazon is in a debt hole. It has to dig itself out. Even after it does that, it can't expect to be much more than a narrowly profitable retailer with excellent working capital characteristics. That is certainly worth something, but probably not $6 billion in enterprise value. Not on a revenue base of $3.3 billion in 2001.
As a comparison, consider Best Buy (NYSE: BBY). It has a market cap of about $9 billion on $14.2 billion in sales. Sure, Best Buy doesn't have the cash flow characteristics Amazon has. Best Buy turns its inventory at about half the rate that Amazon does, has some receivables, and pays its bills more quickly. Still, it has four times the sales, no debt to speak of, and -- and this is the kicker -- about the same estimated growth rate. If we can't expect significantly better results with Amazon, why are we taking the risk?
Perhaps it's time to part ways
Amazon came out of the blocks early and staked a claim in online retailing. It was bold, aggressive, and in many ways extraordinarily successful. It's gotten to the point where it has to survive an evolution -- what we Rule Breakers call "Tweening" -- to continue to thrive. Amazon may well survive the chrysalis, but the butterfly that will emerge is looking less and less spectacular.
As a result of all this, I'm tempted to sell. Amazon may be a premier retailer, but it's a retailer nonetheless. Its world-changing days seem to be in the past. It has some brand and working capital advantage over its retail competitors, but AOL Time Warner (NYSE: AOL) looks better-positioned to take serious advantage of electronic exchange of books, movies, and music. Amazon's niche in retailing is carved out, and it doesn't look that great.
If you'd like to chime in on the subject, check out the conversation Jeff started last week on the Rule Breaker Companies discussion board.
Brian Lund lives under questionable circumstances in Alexandria, VA. He owns none of the aforementioned stocks, though he holds eBay, which he thinks is the cat's meow. See his profile for a complete list of his holdings. The Motley Fool is investors writing for investors.