Rumble in the Jungle
The Bear Argument
By
Paul Commins (TMF Buster)
I'll admit it, right off the top: This Amazon bear is actually bullish on Amazon the company. As the lone remaining pure Internet retailer, at least of any magnitude, Amazon carries no less than the future of its species on its rapidly evolving shoulders. Following its plight, and associated commentary, is some of the best entertainment available these days. Myself, I think that Amazon will not only survive these rough times but actually fulfill its promise as a dominant retail brand for years to come.
I just wouldn't purchase Amazon stock. I don't believe that the investment story will be nearly as entertaining.
My opponent is the senior co-manager for our online Rule Breaker Portfolio. Since the portfolio owns shares of Amazon, Jeff and I have naturally had many a spirited discussion on this topic. Jeff knows where I'm coming from, so I'll spare the cheap shots and get right to the point.
I won't waste any space talking about the fact that Amazon, as of last report, now has less than zero total equity. That's right. If you take total assets and subtract total liabilities, you get a negative number. How would you like to be the guy who gets to split this virtual pie 350 million ways, one piece for each shareholder?
No, I'll skip that topic, because it's not really the point, and Jeff knows this as well as I do. I also refuse to get dragged down into the debt issue. I mean, who cares if Amazon will be paying $150 million annually to creditors? Hey, they cleared $290 million last year! OK. This was gross profit, before operating costs and taxes, but these are just details. It's not really the point.
Why should I worry about the fact that Amazon's convertible bonds are rated in the "junk bond" category by Standard & Poors, indicating a non-trivial possibility of bankruptcy? OK, it's true that Amazon was counting on rising stock prices to turn this new debt into equity. Yep, bondholders were expected to buy Amazon stock for a song, as the share price spiraled ever upward. Now? Well, the reality of a depressed market will force Amazon to make ongoing, crippling debt payments, for the near-term anyway.
Why would I bring up the fact that Amazon's chief operating officer, a man credited with bringing some real-world restraint to the operation, recently quit to take a job at VerticalNet <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: VERT)") else Response.Write("(Nasdaq: VERT)") end if %>, a struggling business its own bad self? This business-to-business Internet commerce portal builder is hardly taking off. I can't say for sure why this guy left Amazon. In the absence of hard facts, I can only speculate as to why a guy would jump from a $12 billion ship to a $3 billion ship, when both are clearly taking on water.
And it would be the height of irresponsibility for me to bring up the recent analyst snub. Why would I lower myself to talking about a prominent Lehman Brothers bond analyst who was left off the list when invitations went out for this summer's Amazon-sponsored research gathering? It's true that this guy was the first Wall Street pro to be sharply critical of Amazon's financial health, but I can't connect these dots without more evidence. So I'll just leave it alone.
If I were the kind of analyst that engaged in such tedious, personal details -- which, of course, I'm not -- I'd speculate aloud about evidence of a siege mentality among Amazon executives in the bunker. Like a problem rocket, Internet retailing still sits on the launching pad, as takeoff appears to be on hold yet again. This relentless delay combined with a sharply falling stock price could lead lesser men and women to panic, as the "Wait Until Christmas" battle cry began to wear thin, creating the kind of unhealthy environment that leads to executive departures and petty analyst snubs. But this would be sheer, unsupported speculation, so I'll refrain.
Jeff also knows all about the ugly demise of Amazon's retail juniors. These are the Internet puppies nurtured by Amazon cash infusions so that they could grow big and strong and return an ongoing stream of high-margin revenue to Amazon, in return for favorable placement in earth's biggest store. With the recent collapse of Living.com (taking Amazon's home furnishings store with it) and the increasingly precarious position of another little doggie, sporting goods e-tailer Gear.com, Amazon's once mighty kennel now features, as big doggie, Drugstore.com <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DSCM)") else Response.Write("(Nasdaq: DSCM)") end if %>, which currently trades under $3 per share, down from over $50 last winter.
But I don't want to get into all this unseemly dirt. I'd rather stick to the real story. All these muckraking sidelights, together, add up to one supporting point: Amazon is a very risky proposition these days. But this is just a supporting point, so I won't spend any more time on it.
The main point is that Amazon is a retail company. Like its offline brethren, it is essentially a reseller. Its future profits will always be limited by intense competitive forces from both sides. Producers will want their cut of the efficiency-driven Web spoils and consumers will surf actively until they get the price they want. Let's pause and think for a moment about all the highly successful retailers in our economy today.
Hmmm.
OK, there's Wal-Mart <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WMT)") else Response.Write("(NYSE: WMT)") end if %>. Mighty Wal-Mart. This monster has grown net profits by double-digits every year for well over a decade! Just in the last two years, this mature company has grown profits by more than 20%. What kind of market multiple does this kind of dominant retailer get? Well, right now it's trading at just over one times sales. Wow.
By comparison, Amazon is trading at nearly six times sales, even after its recent market trimming. Sure, Amazon is still growing annual revenues at over 100%, but surely the best of this is over? According to the most recent Amazon report from Motley Fool Research, retail sales were up 9.2% in the second quarter this year, but online sales were down 13.2%.
Amazon may very well claw its way to survival. I think it will. But it's also a lot closer to going under than most companies its size ever get, and richly valued to boot. For my money, I'd prefer the kind of upside potential that retail will never offer, if I'm going to take on this kind of risk. That's the real point.
The Bull Rebuttal »
