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Amazon: Starting on a Long Comeback Trail?

By Amey Stone Call it the Bezos bounce. Chief Executive Jeffrey Bezos has lately shown that he can do what Wall Street has long wanted him to -- rein in spending and focus on turning a profit. Investors aren't necessarily convinced Bezos can turn his lightning rod of a company into a winner, but they're less sure that he'll fail.

That may not sound like much, but for Amazon's stock, the subtle change in perspective has sparked the shares to double in one month. From a low of $8 on Apr. 4, the stock is now trading at around $16.

"The psychology seems to be changing from 'this is a company that is going out of business' to 'this company, while not out of the woods yet, is definitely on a path to being out of the woods,'" says Michael Davey, technology analyst at Investec Ernst. "People are not going to question their survivability anymore. The issue is more valuation and how high quality a business is going to emerge."

Most important to investors, first-quarter results reported on Apr. 24 have given analysts confidence that Amazon will be able to meet its target for breaking even (at least on its own pro-forma operating basis) in the seasonally strong fourth quarter of 2001. "They didn't revise guidance down, which is what we've seen from a lot of retailers," says W.R. Hambrecht analyst Kristine Koerber.

SERVICE CHARGES. Wall Street quietly cheered as the company exceeded targets and showed real progress toward making itself more efficient. Using its own somewhat controversial measure of pro-forma operating profitability (which excludes costs of things like goodwill from acquisitions, stock-based compensation costs, and failed Internet investments), Amazon's operating loss narrowed to $49 million, from $99 million in the first quarter of 2000. Koerber calls that "significantly better" than her estimate for a $77 million loss in the quarter. Amazon's net loss using traditional accounting rules was $234 million, or 66 cents a share -- still a marked improvement from the $308 million loss, or 90 cents a share, a year earlier.

During the quarter, Amazon also lifted gross profit margins to 26.1%, up 3.8 points, due to improved inventory management and better deals with vendors. The best gross margins of all its business segments -- a 67% rate -- came from deals it has made to provide e-commerce services to partners. That includes alliances struck with and Those services added up to only $42 million in sales in the quarter, but analysts expect this number to climb as the company strikes more partnerships, such as its deal with Borders, announced Apr. 11.

Also central to the sunnier forecast: Amazon's results made Wall Street comfortable with the company's cash position. At the end of the first quarter (the most significant one when it comes to having cash on hand, since that's when it pays vendors from the fourth quarter), Amazon had $643 million in cash and marketable securities. It expects to end the year with $900 million in cash, which analysts agree should be enough to last until it reaches operating profitability. "We've put that issue to rest," says Hambrecht's Koerber.

Other measures of Amazon's business are strong. The company earned praise from investors by disclosing more information on its business segments, making it easier for analysts to see where growth is coming from -- primarily electronics and international operations. And it added 3 million new accounts, bringing its customer base to 32 million worldwide. Active customers made $228 in purchases on average in the 12 months leading up to the end of the first quarter, up from $121 a year earlier, Koerber figures.

OSSIFIED CORE? But it wasn't all good news. The latest figures showed slowing sales growth. Amazon increased revenues 22% over the prior year, to $700 million. In the fourth quarter of 2000, year-over-year growth was 44%, and in the third quarter of that year, it was 79%.

Most troubling, Amazon's U.S. sales of books, music, and videos (about half of total sales) grew only 2%, a rate Merrill Lynch analyst Henry Blodget calls "ossified." He predicts the figure will turn negative in the current quarter. The company's U.S. electronics, tools, and kitchen-appliance businesses grew 56%, and its international sales grew 76%. Many analysts lowered revenue targets for 2001 after the earnings call on Apr. 24, and Amazon management admits sales growth will slow, as it focuses more on improving operating efficiency.

Long term, Blodget thinks Amazon can increase sales 18% to 20% a year. He figures that if the company can build revenues around 20% and generate operating margins of 12% (now, operating margins are negative), then it will have earnings of $1 a share by 2005 -- hardly around the corner. At that level, it would be worth $15 to $22 a share today -- right where it is trading.

MURKY PICTURE. Other analysts say they don't have enough information yet to predict when the company will break into the black for a full year. Although it seems Amazon will reach pro-forma operating profitability in the fourth quarter, it will drift back into the red for the next three quarters, before earning $25 million in the fourth quarter of 2002, estimates Koerber. She doesn't project past 2002, but she thinks it's unlikely the company will be profitable for all of 2003.

Right now, Amazon's stock is up because investors no longer think the company is about to go down in a ball of flames. As long as Bezos can continue to make slow and steady progress toward stated goals, the shares should continue to rise. But there's plenty of risk that the stock will fall sharply if it can't meet its target for fourth-quarter operating profit or if it shows any signs of slipping. "They are on the road to operating profitability," says Koerber. "But how long is that road?"

How long, indeed. Investors might have to sit tight for quite a while before a clearer picture on Amazon emerges beyond the murkiness of pro-forma accounting. And price volatility, until that point, will be the norm. Investors should realize they are buying a company that still has a lot left to prove. Stone is an associate editor of BusinessWeek Online

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