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January 10, 2000

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Subject:  Case for Selling Your Amazon
Author:  soldat4800

These are the bear arguments, as I understand them. I apologize for the length, but there are just so many things wrong with Amazon. I am sure that Gordon66, RJ Mason, MMMMMbeer and others could further expound on these arguments. I have tried to speak on behalf of the bulls to, though I am sure I have not done so as eloquently as coralville could have.

1. Amazon may be a hugely successful company someday, but it is way overvalued today

Amazon is a retailer in an incredibly competitive environment in which some companies are willing to sell the same products as Amazon at cost in order to derive advertising revenue and in which many, better financed than Amazon, companies are willing to bleed red ink in order to be the last man standing. Cisco Systems, which has both first mover advantage, proprietary products, gorilla status in the marketplace and more money than most third world countries, operates at a 15% profit margin. Dell, which many Amazon bulls like to compare Amazon to, operates at a 7% profit margin. The most profitable retailer in history, Walmart, operates at a 3% profit margin.

The total world wide market for books is about $90 Billion. The total world wide market for music is about $40 Billion. If Amazon gets all of that (if they put every other purveyor of books and music out of business) and they manage to get a 1% profit margin (which I doubt is possible), their profit will be 1.3 billion dollars per year, which will give them a PE of 18 at their current stock price. If they have the entire market, their sales will only be growing at 4% per year and they won't deserve a PE of 18.

The bulls point out that there's another $60 Billion dollars in toys to go after, not to mention small electronics, tools, and other consumer goods. The bulls also want to believe that Amazon will get an 8% profit margin � which will really tick off all the e-tailers willing to sell at cost.

The bulls have recently begun to chat about monetizing eyeballs. Amazon is, after all, one of the web's most popular destinations. On the other hand, Yahoo had sales of $480,000,000 in the last 12 months. Yahoo is also competing with Amazon. If the most successful of all the web eyeball monetizers can only sell a billion dollars worth of eyeball candy, it's doubtful that Amazon will be able to make enough money from eyeballs to significantly impact their bottom line, though it may keep them out of Chapter 11.

2. Amazon is about to run out of money

These are Amazon's current assets from the October SEC filing (all amounts in thousands):

Current assets: Cash $43,149
Marketable securities $862,536
Inventories $118,793
Prepaid expenses and other  $55,590
Total current assets $1,080,068

and current liabilities:

Accounts payable $236,711
Accrued advertising 24,567
Interest payable 10,045
Other liabilities and accrued expenses 73,572
Current portion of long-term debt and other  12,776
Total current liabilities $357,671

Subtracting the current liabilities from the cash and marketable securities leaves Amazon with about $548 million dollars to operate their business. Bear in mind that they lost $197 Million in the third quarter. They probably lost even more in the fourth quarter, but we know they didn't lose less because they said so last Thursday, causing their stock to plunge. That means they have no more than $351 Million in operating cash. There's no reason to think that they won't lose as much in the second and third quarters this year as they did in the third quarter last year. That means they're going to run out of money around June 7, 2000.

The bull take on this is that Amazon doesn't have to pay that $236.7 Million dollars in accounts payable for 90 days, so they have at least 90 days longer and won't run out of money until September. In fact, if the accounts payable gets larger (say accounts payable for the 4th quarter were $500,000,000) then Amazon will be able to use the $650,000,000 they received almost instantly from the credit card companies for 90 days while the book wholesalers scream for their money. That is only partially true, however. Most wholesalers charge interest for accounts past 30 days. But it is a cheap method of financing operations. However, the $500,000,000 will be due before June 7th and chances are that sales will be below $650 Million in the coming quarters. By July, there will be no float from the suppliers to keep the doors open.

Since Jeff Bezos came out of finance, it's doubtful that he'll let the company run out of money. His obvious choices are: another convertible issue, a secondary stock offering, merge with a well-heeled partner, or borrow. The convertible issue is the most attractive to current Amazon stockholders, though it could be ruinously dilutive. A secondary stock offering would be a disaster for share price (bear in mind, however, that Bezos claims not to care about share price). Merging with a well-heeled partner might be attractive, but who is going to dilute their company with $24 Billion in intangibles (see below). I doubt any bank will lend Amazon a billion dollars. The $1.4 Billion Amazon already owes had to be raised as junk bonds. The company balance sheet looks much worse today.

Amazon recently bought 1/6th of for $10 Million (about an 85% discount). If Amazon sells itself or issues a secondary, you can expect a similar discount. Oh, and by the way, Ashford is down 20% since Amazon bought in, but they're still way ahead on the deal. Their stock is worth almost $90 Million. That will appear on the next 10Q adding more than $0.25 per share to book value.

At one point, coralville was saying that Amazon was generating Free Cash Flow at a much earlier date than Dell. Their latest 10Q indicates that they used $122 Million in cash during the first nine months of 1999 but ended up with $17 Million more (coralville's FCF) almost entirely due to their borrowing. It would be great if someone who understood accounting explained what that meant. In any case, $17 Million is about 5 cents a share.

3. Amazon is already worthless on paper

Total stockholders' equity $419,925,000
Intangibles and other, net $705,932,000

Intangibles and other is the money that Amazon paid for something in excess of that thing's book value (If AOL bought Amazon for $24 Billion, they would get the company and $25.4 Billion (Amazon's market cap plus debt) in intangibles. In other words, Amazon already has a negative value. It's true that what Amazon bought, perhaps it could sell. However, if Amazon get's itself into a situation where it's selling off its possessions, chances are that the value of web e-tailers (the majority of that $705 million) will have fallen precipitously.

Amazon bulls put a high value on the Amazon "concept". In fact, they currently value it at around $25.4 Billion.

4. There are no barrier to entry to keep competitors out

Amazon was launched with $10 million in venture capital and $49 million in an IPO. That's what it costs to compete with Amazon. You don't even need to think any original thoughts as the Amazon web site is there to show you what a good e-tail site should look like. All you need are some computers, a few T-1 lines, and UPS. Oh, and you need $500 million for advertising. But if you can turn that into Amazon's $24 Billion market cap, you've done quite well.

The bulls have lately been saying that the barriers to entry flaw is not a flaw. They point to the Walmart web site and say that it must be harder than we think to open a retailing web site. I doubt it.

The problem that Amazon faces was very eloquently detailed by RJ Mason (which now has 13 recommendations).

Amazon is now competing with:

Microsoft-Tandy/Best Buy

Amazon's biggest problem is that there isn't any motivation for a big player to team with them. Their market cap is twice as big as Sears is. If Sears were to go into business with them, they'd be the junior partner. It's much better for Sears to align itself with Fogdog because Fogdog could still experience exponential growth

5. They aren't retailers

Their key manager (Mr. Bezos whom I have a strange sense of admiration for) is not a retailer. Why does anyone think he can beat out the Walmart people in retail? And in fact, if you look at their latest press release, they mention they've got some inventory problems:

The Internet retail giant said that, while its fourth quarter sales were up more than 150 percent to $650 million, italso incurred higher than expected inventory-related charges and write-downs.

The bull response to this is that they're geniuses, they don't need any stinking retail experience. They are smart, take a look at the resumes of their key players. Then go read the Best and the Brightest (probably available at Amazon). It's a book about a group of even smarter people who got us into Vietnam and then couldn't figure out how to get us home.

6. It's all hot money, and a lot of it belongs to newbies

Amazon turns over it's entire float every couple of weeks. Hot money tends to run at the first sign of trouble. Wile everyone on this board is very nice (mostly), you only need to go over to the Yahoo board to see what the typical Amazon retail investor is like (something like 200,000 posts over there with a signal to noise ratio of zero). Reading some of the posts on Yahoo, you have to think that not a lot of thought goes into the typical Amazon investment (and I apologize to coralville, because he's obviously a really smart guy -- but I doubt he makes up a significant portion of the Amazon market cap).

The bull response to this is that it takes a new kind of investor to understand a new kind of company (new paradigm argument). There's an old saying, it predates the 1970 crash, that the four post expensive words in the English language are, "This time it's different."

7. There's all that insider selling and no buying.

Even when Amazon was selling for a split-adjusted $1.40 per share, there was never any insider buying. The bulls point out, correctly, that any sane person who had 99.999% of his net worth tied up in a single investment would diversify (Mr. Bezos hasn't). Still, back when the entire company was worth less than $400 million, none of the geniuses who run it was willing to buy even a single share.

8. The stock is subject to massive dilution

The 1994 stock option plan had 38,000,000 shares in it. The 1997 stock option plan has 70,000,000 shares in it. I was unable to tell from the 10Q how many of those options had been granted at what price and how many had been exercised. I'm sure the information is available, but Amazon has buried it. They kindly note that they don't include the option shares in their calculation of loss per share because it would make the loss per share look smaller.

In addition to the options, if the stock price gets over 120 and stays there for 30 days, the company can force conversion of the convertible bonds into 16 million shares. They'd do it in a heartbeat, too.

There is no bull response to this problem, other than that Amazon is a rule breaker and you cannot pay too high a price to buy shares in a rule breaker.

9. Their gross margins are falling

Amazon will probably have a negative margin of about 30% this quarter. Their gross margins have been falling steadily even though their revenues have been increasing. This is just awful. hat means they will have to raise their prices (or cut spending) by a third to start making money. However, they have no pricing power.

The bull response to this is that once Amazon has sales of 50 Billion dollars a year, their advertising and operations costs will be negligible.

10. History

Things that are very much like Amazon have happened in the past (tulips in Holland, South Sea Bubble, American Stock Market in 1929, Japanese Stock Market in 1989, Albania just two years ago) and they have all ended badly (well, except for Microsoft). And maybe things really are different this time, but I doubt it.

The bull response is, I kid you not, "This time, it's different."

I would be interested in the bulls doing a better job than I did making their case.


PS: I still think it is immoral for any current shareholders to sell their stock to an even newer newbie.

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