Dueling Fools
June 30, 1999

Amazing Amazon
The Bull Rebuttal
by Paul Larson ([email protected])

Let's cut right to the chase. Rick contends that sales growth momentum is slowing. I have a one-word rebuttal to that -- Duh. Who really thought that 838% annual sales growth was sustainable? Those wacky growth numbers are possible when you're basically starting from scratch. Regardless, I think it's a fairly safe bet that Amazon will continue to grow between 50% and 100% over the next five years, and perhaps 30% annually beyond that. While "below" the 200+% top-line growth last year, it still adds up to some fairly amazing figures down the road, especially if Amazon starts to see some margin improvement thanks to efficiencies of scale and scope.

Rick then points out that Amazon is not expected to show a profit for the next two years. He's right. But what about three years from now? Or five years from now? Amazon is not nickel and diming to make its next quarter; rather it is building an enterprise for the next several decades. Remember the game of Monopoly -- those who spend more in the initial rounds are more likely to win than those who have a horde of cash after a few spins around the board.

I also think it's worth noting that all the published estimates are for accounting profits (or losses), not real cash flow. Big difference there.

I had to laugh when Rick proclaimed, "Well, it didn't turn out that way." Are we really ready to close the books on anything having to do with e-commerce and the Internet? This is an emerging, nay, exploding industry, and the game is far from over. In fact, we're still in the first period.

Then there's the issue of the low barriers to entry, which Rick addressed with his quote from Michael Bloomberg. Sure, anyone could go into competition with Amazon at this point, but you'd have to be very brave and have extremely deep pockets. There's a wide gap between "competing" and "successfully competing." Amazon's massive market share and efficiencies of scale give it a huge sustainable competitive advantage over its peers.

Let me counter Rick's quote with a quote of my own, this time from Sun Tzu's "The Art of War." Tzu says, "Ground with which we and the enemy can traverse with equal ease is called accessible. In such ground, he who first takes high sunny positions convenient to his supply routes can fight advantageously."

Then there's the margin argument. There's no doubt that Amazon's gross margins are lower than that of its peers, but it is that way by design. The company is aiming to use its inventories and assets much more efficiently. Remember, one sale at a 30% gross margin is worth less than two sales at 20%. Financial success is not just about margin, it is also a matter of volume and effectively using assets.

Allow me to illustrate Amazon's unique financial characteristics in table form relative to Barnes & Noble:

Q1 '99 (millions)             Amazon    Barnes & Noble 
Sales                         $293.6        $718.3
Average Inventories            $37.4        $942.7
Average Fixed Assets           $45.2        $513.0
Inventory Turns (quarterly)     7.9x          0.8x
Fixed Asset Turns (quarterly)   6.5x          1.4x

Next: The Bear Responds