Everyone with a vested or emotional interest in Amazon.com (Nasdaq: AMZN) -- and that seems to be just about everyone who pays attention to the stock market -- got another chance to sound his opinion of the company again last Tuesday, after it held "Analyst Day." Why shouldn't I take my turn?
Lots of folks got their undies in a bunch over the news that Amazon would be getting into the personal computer business. Well, "getting into" it isn't the correct term, since Amazon won't be handling inventory. Essentially, it will just be offering a link to Dell (Nasdaq: DELL), Gateway (NYSE: GTW), Hewlett-Packard (NYSE: HWP), or the like. The companies will coordinate on shipping, so the bearer of the costs is uncertain, but Amazon will take title of the computer before it reaches the customer, which means it will be responsible for subsequent customer service.
Forbes.com seemed to make the mistake of thinking that Amazon would actually manufacture the computers, and so compete in a highly competitive, low-margin industry. No. This will actually be a high-margin offering for Amazon, once it gets some scale, since Amazon will basically be a middleman shaving a little piece off the pie. After basic costs are covered, most of the money made in this unit will be blueberry gravy. It just won't be very lucrative, since the cut per PC will undoubtedly be small. My colleague, Jeff Fischer, discussed the Forbes error sufficiently in a recent Fool News story, and there's not much to add about that.
Initiatives with high returns on investment
The PC store initiative, like all of Amazon's recent offerings, seeks to generate high returns on investment from a variety of niches. These include:
- PC Store
- Cell Phone store, which, like the PC Store, partners with original equipment manufactures (OEMs). Amazon takes no inventory risk, but takes a middleman's slice.
- Amazon.com Used, which works like eBay's (Nasdaq: EBAY) Half.com: People in Amazon's community sell items directly to customers. Amazon has no shipping or customer support responsibilities here; it simply takes a small percentage of the sale. After six months, it has 775,000 sellers and 10 million items listed.
I like all of these ideas, since they take advantage of Amazon's network effects and brand name without costing the company much. Incremental revenue in these businesses comes at increasingly high margins. All told, though, they will probably not account for more than a small fraction of total income for some time. They may, however, add significantly to total revenue, since gross sales in the PC and Cell Phone stores (not in Used store) will be booked entirely as revenue. This aspect needs close attention.
A while back, Priceline.com (Nasdaq: PCLN) created a big stink when someone with a soapbox cottoned on to the fact that the company was booking as revenue the entire price of airline tickets it sold. It's a somewhat disingenuous practice. Priceline takes no inventory risk in the exchange, since it takes money from the customer before obtaining the ticket from the airline. That method differs from that of traditional travel agencies, which book only their commission as revenue.
Many viewed it as an accounting trick to make sales look better than they are, which may be true, but I don't think it's a nefarious practice. I never really understood why everyone was so mad at Priceline. Their revenue-booking method may be unconventional and aggressive, but it's in accordance with General Accepted Accounting Principles (GAAP) since the company temporarily holds the plane seat in its inventory. As for the abnormally high revenue, even a moderately attentive analyst would quickly get past the issue by noting that cost of goods sold was comparably high.
In its PC and Cell Phone stores, Amazon will similarly book the entire amount of the sale even though it may never actually touch the product. With high-priced items like computers, these stores could impact revenue meaningfully, but almost all of the gain would be deducted from the company's gross profit.
A word of warning
As long as you're not foolish enough to try to value companies solely by price-to-sales ratios, which are totally useless measures of value on their own, you won't get burned by it. (And if you'd like to hone your ability to analyze a company's financials, you might want to sign up for our Choosing Stocks With The Motley Fool online seminar.) Of course, that was part of the problem in the go-go late '90s: Analysts started to use such things as meaningful metrics. No doubt that Priceline took advantage of the silliness, but anyone who was suckered by it has no one to blame but themselves.
Here, then, is a word of warning to Amazon analysts and investors: If revenue increases, you can be sure that the company will trumpet that fact. Make sure that you take the rise in context. If cost of goods sold rises more than revenue, then higher revenue doesn't mean much. Train your eye to get past the headline of the press release and the first line of an income statement.
You'll be glad you did.
Brian Lund missed most of the go-go stock market, but he came along at exactly the right time for the Go-Go's. Of the stocks mentioned above, he owns Dell and eBay. See his profile for a list of his holdings. He doesn't own Amazon, but the Motley Fool has a business relationship with the company. The Fool is investors writing for investors.