Amazon.com Bear's Den
by David Forrest (TMF Bogey)

First off, Amazon.com is a very exciting company. It has a ton of momentum in sales and "promotion" right now. The Internet is HOT HOT HOT, and Amazon is building a nice name for itself. The company is taking advantage of a growing distribution channel with the Net and it's paying off. As a company, I have no real problems with Amazon. My "bearishness" on Amazon.com is directly a result of what I think the stock price will look like in 5 years and the annualized rate of return that results from this projection. If you are looking at a different time frame, you may see different things than I do.

Bottom line with Amazon's business is that the company sells books. It's not the cure for cancer, nothing revolutionary. It just sells books. (Now, before you flame me, I know that Amazon sells music and other stuff too, I'm just making a point.) The business is not groundbreaking. People are pumped up about the company because of its distribution channel -- the Internet -- not the core business.

To project a decent price target for Amazon.com in the next four or five years, I think we have to make several assumptions. First, the fairly intense competition that exists in book selling through traditional outlets (malls, super retail stores, etc.) will migrate in a major way to the Internet. Money smells money. Just recently I was given a press release by a co-worker that said Barnes and Noble.com, the Internet wing of Barnes and Noble <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BKS)") else Response.Write("(NYSE: BKS)") end if %>, expects to have revenues of more than $100 million in 1998. So, the competition is coming, which can only mean that margins will tighten and advertising expense will stay the same or rise in order to maintain market share.

Second, we must also assume that as Amazon matures as a company. The valuation that the Street is willing to give it will most likely start regressing back towards the valuations that the other, more mature booksellers get. So, for guidance, I look at the valuations Borders Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BGP)") else Response.Write("(NYSE: BGP)") end if %> and Barnes and Noble are getting now. Borders, which has $2.1 billion in revenue trades at 1.0 times sales, or a $2.1 billion market capitalization. Barnes and Noble, with $2.7 billion in sales, trades at 0.79 times sales, also a $2.1 billion market cap. Amazon, by comparison, has $147.8 million in sales and trades at 9.5 times sales, or a $1.4 billion market cap.

Make no mistake, Amazon is growing much faster than the other two companies and deserves higher multiples. The question is, how much higher? Even assuming that Amazon grows revenues at 75% a year for the next four years (a tremendous feat, in my opinion), it would have $1.37 billion in revenue. I would imagine that the hyper growth in sales will take place in the first few years with a tailing off towards the end, leaving multiples smaller at the back half of our four-year period. Being generous and giving it twice the market multiple that the other book chains are getting now, Amazon would trade at a $2.7 billion market cap. Based on today's (2/6/98) closing price of $59, Amazon has a market cap of $1.42 billion. If you annualize the growth from here, based on my projections, the return per year only works out to around 16%. Not bad, for sure, but probably not what you were dreaming about, eh? Given that Dow Dividend investing has given investors annualized returns over 20% since 1971, 16% isn't all that attractive, especially when considering the risk.

For what it's worth, I've given you what I consider to be the best case scenario for Amazon.com -- 75% annual sales growth through the year 2001. What happens if there are bumps in the road? What happens if better known names like Borders and Barnes and Noble get a larger share of the market than people think? What happens if the economy slides a bit and doesn't forever plow forward forcing discretionary spending on things like "leisure reading" down the tubes? What happens when people decide that they don't have the discretionary income to spend $20 to find out how Jenny Jones ticks in the latest expose? I can tell you for sure, unless all cylinders fire at full blast, Amazon will get hammered somewhere along the way.

And, even if it DOES fire on all cylinders, I don't think we'll be all that impressed with the returns in four or five years. Assuming the fundamental situation doesn't change, I'd be much more interested in Amazon at prices between $35-$40, which would translate into a four-year annualized return of over 30%. Oddly enough, that's exactly where the Fool Portfolio bought the stock, so maybe they knew something!

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