Long Amazon.com Tale Still Written in Red Ink


Amazon.com, the first and most celebrated Web retailer, is now the last big one standing. And not very solidly.

On Monday, Amazon is expected to report its 17th consecutive unprofitable quarter, a money-losing streak with few precedents for a company its size in American business history. Yet, by the end of the year, Amazon says, it will achieve a very loosely defined version of profitability.

But that's a mirage, argues a significant group of analysts and critics. Amazon, they say, will crash just like the hundreds of e-commerce ventures, from Pets.com to ValueAmerica to MotherNature.com to eToys, that it inspired.

"I see a real risk of outright bankruptcy," said Robert Tracy, an analyst with the financial site Grantsinvestor.com. "If you look at their financial statements, it's pretty obvious."

Amazon still has plenty of supporters who expect the company to eventually join the handful of profitable Internet companies, such as auction firm eBay. According to one survey, 16 of 31 financial analysts who follow Amazon still recommend buying the stock.

A few years ago, however, everyone was on their bandwagon. The company's early promise helped fuel the investment gold rush that spent tens of billions of dollars to start new Net companies. No other e-commerce company has received as much hype or made as many sales as "the Wal-Mart of the Web." Any meltdown of Amazon would represent an epic failure. And it may kill the notion that a pure Internet retailer can survive and thrive, and diminish further the once wondrous prospects for e-commerce.

"We went through a stage where online retailing was going to conquer the world. No one was ever going to go to a mall again," said Eric Von der Porten of Leeward Investments. "But now it's going to settle down."

In its bid to reinvent shopping, Amazon to date has sold $5.9 billion in books, toys, cell phones and hammers to 32 million consumers, but in the process it's piled up $2.7 billion in debt. Amazon has been forced to retrench everywhere, from closing a state-of-the-art distribution center to laying off 1,300, or 15%, of its staff to canceling plans for a new headquarters building. Some of Amazon's suppliers have expressed nervousness about whether they will continue to get paid, and it loses half of its customers from year to year.

Things have come full circle for the retailer. When Amazon opened its virtual doors six years ago in founder Jeff Bezos' Seattle garage, it was a radical idea to market physical goods through this new thing called the World Wide Web. In the first month, Amazon sold books to people in every state and 46 countries, but for a long time it wasn't taken seriously. When the company went public in 1997, some analysts asserted that it wasn't a real business, just a middleman that anyone could imitate and improve on.

Consumers didn't pay any attention, happily buying ever-expanding quantities of books, CDs and videotapes. Amazon's sales leapt from $16 million in 1996 to $148 million the next year and $610 million the next. Bezos, 37, a former Wall Street executive, became a celebrity, then a paper billionaire, then Time magazine's person of the year. The stock grew from $1.50 a share to $113, fueled by analysts' forecasts that 20% of all retail would be conducted online, much of it at Amazon.

Yet through all of this, the red ink continued to flow. At the end of last year, the retailer's working capital--basically, its cash minus its short-term debts, and a good indicator of a retailer's health--was $386 million. At the end of the first quarter this year, it was $251 million.

The quicker Amazon's working capital shrinks, the faster the end will come, according to Ravi Suria, a former Lehman Bros. bond analyst. A year ago, Suria issued a controversial and influential report that predicted Amazon would run out of cash early in 2001 unless it curtailed some of its free-spending ways. The company did start cutbacks last winter, just as Suria issued a second report moving the day of doom back to the end of this year.

Suria, who now works for a private investment partnership, argued that the disappearing cash would unnerve Amazon's thousands of vendors. Worried they wouldn't get paid, these suppliers would insist on getting paid before they shipped their merchandise to Amazon's warehouses.

Amazon dismissed Suria's credit squeeze report as "silly and chock full of errors." The company went on the offensive, stressing in many media interviews that relations with its thousands of vendors had never been better.

"I just laughed when I heard that," said an executive at one electronics vendor. "Amazon played the slow-pay game with us for about a year." The executive, who agreed to talk if neither he nor his firm was named, finally gave up and scaled back his shipments to Amazon by 90%. "That's a safer bet," he said.

Amazon spokesman Bill Curry responded: "Our relationship with our 10,000 vendors has never been better. On occasion there are invoices that don't get paid immediately because of discrepancies. But we have ample cash to pay our bills. Ravi Suria got it wrong."

At Amazon's annual meeting for analysts last month, the watchwords were "drive to profitability." Dozens of charts were presented, many showing how Amazon was crunching costs or starting new ventures, including a computer store and an institutional book department, in ways that would aid its bottom line. Bezos was, as always, ebullient. If he ever suspects Amazon won't make it, he doesn't let it show.

But it's a measure of the skepticism now confronting Amazon that, even as its shares have fallen by half over the last year, short-selling in the stock has more than doubled. (In a short sale, a trader borrows stock and sells it, betting that the stock price will decline, allowing the repurchase of the stock at a lower price and at a profit.)

"Amazon's short position has doubled because the pixie dust sprinkled on all the Internet stocks evaporated when the bubble burst," said Jeff Matthews, a general partner with the Ram Partners hedge fund who has a short position in Amazon. "That gave investors the ability to look at the fundamentals, which stink."

Like every Internet retailer, Amazon always emphasized that it was all about the customers. Now that the initial thrill of ordering online is gone, the question is how many of those folks will stick around. Over the last year, 20.5 million people bought from Amazon; at current rates of retention, only 10 million of them will buy over the next year.

Amazon's oldest product lines--books, music and video--are now profitable on a "pro forma" basis, a kind of grading-on-a-curve measure that excludes such expenses as interest payments. But growth has stalled, rising just 2% in the first quarter from the year earlier period.

Amazon's consumer electronic sales, by contrast, are doing much better, rising 56% to $117 million in the same period. But this segment is also losing serious money: $46 million "pro forma" in the last quarter alone.

And there is the Amazon dilemma. Where it's profitable it's not growing, and where it's growing it's not profitable. Mark Rowen, analyst with Prudential Securities, thinks this is happening because electronics are still heavily discounted, while the discounts have been curtailed on books. "It's easy to sell things if you price them so low you're losing money on each sale," said Rowen. "But as prices go up, demand goes down."

Three years ago, when Amazon was worried about BarnesandNoble.com and other online booksellers, it discounted many books by 30%. Since then, as the competition abated, 20% discounts became more standard.

Late last month, as the final sales were being made that would affect second-quarter revenues, Amazon conducted a pricing test offering free shipping for the purchase of two or more books, CDs or videos. At the same time, Amazon said it was adjusting discounts both up and down.

"They were using the magician's game of misdirection--abruptly raising prices and then trying to disguise that with free shipping," said Glenn Fleishman, who runs a comparative book-pricing engine at http://http://www.isbn.nu.

Amazon introduced a $1.99 surcharge on each of the hundreds of thousands of books that it must special order from publishers before shipping to consumers. After the test, the "sourcing fee" was halved but didn't go away--a buck-a-book premium that wasn't there before.

"They're secretly testing the limits of the customer loyalty," said Fleishman, a former Amazon employee who left on good terms. "They'll keep tweaking until they see signs that sales are suffering."

Another problem for Amazon centers on how it raised a much-needed cash infusion of nearly $700 million by selling bonds early last year. According to a lawsuit filed May 2 in Washington state, Amazon misled its investors.

Sagamore Hill Capital Management, a hedge fund that invested $35 million in those Amazon bonds, points out in its suit that Amazon announced a series of deals with Internet start-ups just before selling the bonds.

On Jan. 21, 2000, Amazon said that it would get $82.5 million over five years from Greenlight.com, an online auto retailer, in exchange for helping to introduce Greenlight to Amazon's millions of customers. Three days later, Amazon announced a similar deal with Drugstore.com. Seven days after that, a deal with Audible Inc., a provider of spoken-word recordings, was announced. The next day, Amazon said it would get $145 million over five years from the home products company Living.com.

Analysts and fund managers cheered the notion of Amazon selling access to its customers. One mutual fund manager said the deals represented "almost pure-profit revenue flowing into the door."

On Feb. 7, Amazon announced the bond deal. The prospectus noted the partnership deals would bring in $362.5 million in revenue over five years.

What Amazon never revealed, the lawsuit alleges, is that the company was being paid in stock rather than cash. That only became clear last fall, after Amazon said it had received "informal inquiries" from the Securities and Exchange Commission about its investments in the so-called Amazon Commerce Network. An Amazon spokeswoman said the company does not comment on litigation.

The Amazon Commerce Network, which totaled at its peak about a dozen companies, now barely exists. Living.com, Pets.com, Webvan and home delivery operation Kozmo.com closed their doors, while Greenlight, sporting goods supplier Gear.com and Wineshopper.com were sold for scrap.

Whatever the fate of the Sagamore lawsuit, Amazon's dream of nurturing many smaller retailers that would then use its vast warehouses and shipping network has hit a wall.

"Clearly e-commerce is not going to have the kind of mass-market adoption that was once envisioned," Rowen said. "I don't hear anyone talking about 90% of the population shopping online anymore, or 20% of all retail being done online." Last fall, analysts estimated Amazon's 2001 sales at $5 billion. Now the company says it will likely be $3.4 billion. It's the difference, perhaps, between e-commerce dreams and reality.

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