Sunday, January 17, 1999

This emperor may be stark naked.

I am speaking, of course, about the current emperor of the stock market, Amazon.com(AMZN). Immediately after its three for one stock split earlier this month, the shares surged to $128, an increase of 1145 percent from the previous year. From there, the stock zoomed to $184 a share in a matter of days. An investment of $10,000 last January would have turned into $168,600 according to the charting facility on Microsofts' investor.com.

At that price, Amazon.com had a total market value of $25.4 billion. That's 25 times the current annual sales rate of $1 billion. At the same time, Barnes and Noble and Border, the two largest vendors in the industry, with combined annual sales of $5.5 billion, had a combined market value of less than $4.3 billion.

The Amazon annual sales figure, by the way, assumes a whole lot. While sales in the holiday quarter were $250 million, most booksellers have lower sales in the first quarter. So we are talking about nearly 25 times sales projected from the busiest quarter of the year in an industry where conventional bookstores are valued at less than 1 times sales.

Note that profits have not been mentioned. Amazon is expected to continue in its success next year, racking up a consensus loss estimate of $1.80 a share. That's just a bit more than the $1.66 estimated loss for 1998.

Please excuse me for being crass and incorrigibly tied to the irrelevant past, but I have always thought that one of the primary charms of stock ownership was that your investment was making money. At worst, it would be expected to make lots of money in the near future. Now, however, we are looking at a business that is shipping $1 billion in goods a year and expects to ship $1 billion more in the next year. Without making a dime.

Much of this loss, of course, is due to promotional costs, development costs, and discounting. Some of those costs will decline as Amazon.com solidifies its position as the first and primary seller of books over the Internet. Perhaps.

It helps, at times like this, to do some comparisons. Barnes and Noble (BKS) is the largest bookseller in America. On sales of nearly $3 billion and aggressive expansion of its mega stores, the company dominates the book selling business. In addition to Barnes and Noble stores, they also sell through Book Stop, Book Stor, B. Dalton, Doubleday, and Scribners stores— a total of 1,000 outlets. Of every eight book sales, Barnes and Noble stores account for one. This company has the power to influence what is stocked, sold, and read.

In spite of that, its profit margin is a meager 2 percent and its trailing 12-month profits were only $56 million.

Borders (BGP), the second largest book seller in America, is nearly as large. Borders has sales of about $2.5 billion through 1,100 stores. While Amazon shares were soaring toward $200, Borders shares lost about 20 percent of the market value when management warned of lower than expected earnings.

Which brings us to the future.

Let's suppose that Amazon.com obliterates these two giants or, as an alternative, overwhelms virtually every remaining independent bookstore in America. Let's suppose that Amazon sales rise to $5.5 billion and their profit margin is up there with Borders, 3 percent. Profits would then be $165 million.

This is not expected to happen in 1999. Nor is it expected to happen in 2000. But it might happen, someday.

Now let's put a hefty multiple on those earnings, say the 50x multiple that Barnes and Nobles has. That would give Amazon.com a total market capitalization of $8.25 billion. — About $17 billion shy of the current market value of the stock. If the stock had the same earnings multiple as Borders, 23.7x, those projected earnings would be worth $3.9 billion, less than one sixth of the current market value.

In other words, even assuming that Amazon.com is destined for a near 6-fold increase in sales, healthy profitability, and an industry dominant position, the stock is ahead of itself by somewhere between 66 and 84 percent.

Meanwhile, both Barnes and Noble (www.barnesandnoble.com) and Borders (www.borders.com) have web sites and sell over the Internet. They can duplicate anything Amazon.com does well and can offer convenient pick-up at over 2,000 locations for those who don't want to wait (or pay) for mail delivery.

The Internet is wonderful. Amazon.com is a great idea, beautifully executed. But when it comes to market value, folks, this is looking a lot more like a tulip than a stock.