The Ether Keeping Amazon Aloft

Late in January, is set to disclose fourth-quarter sales and losses. Until then, count on hearing no end of market babble. Worriers will fret that a crush of Christmas orders left more red ink than expected at the Internet's leading retailer. The bulls will reply, "Who cares? We don't expect Amazon in the black before 2002."

My advice: Tune it all out as so much short-term noise. If you own Amazon, or are tempted by a stock that has zoomed from its 1997 debut at 1 1/2 to as high as 113 in December, you've got longer-term risks to consider. Amazon recently sank to 76, but that's nowhere near the bargain bin. In fact, in one largely unseen way, the lower Amazon's stock falls the more risky it gets.

If that sounds crazy, please let me explain by diverting your attention from the popular obsession with Amazon's next sales-and-loss report. Instead, take a moment to gaze on the curious picture made by Amazon's last balance sheet, its Sept. 30 snapshot of financial health.

There, you'll discover a company that at first looks nothing like the happy-go-lucky-drunken-sailor Amazon we've come to know, an outfit that has lost a cumulative $559 million and burns cash as if the calendar ran out of pages. At that rate, you'd expect to see its shareholders' equity, or net worth, dwindling, quarterly loss by quarterly loss. Instead, despite $397 million in losses through September, Amazon's stated net worth last year tripled, to $420 million.

How could that be? Most of the credit goes to a $580 million series of acquisitions of three small Internet businesses that Amazon closed last spring. Amazon paid mostly stock, issuing 8 million shares. The accounting gets tricky here, but Carlo Pippolo, an accountant with the Financial Accounting Standards Board, told me that in mergers like Amazon's, the value of shares used in payment must be added to the buyer's equity. If the buyer pays cash, the amount is subtracted from equity.

Amazon followed the rule exactly, with this happy effect: It spent big for a bunch of companies yet--presto!--saw shareholders' equity in its June quarter balloon from $78 million to $571 million, despite a quarterly loss of $161 million. When you hear executives talk eagerly about using stock as "currency" for deals, this is what they mean. The new stock dilutes the position of current shareholders. But it lets execs act as their own central bankers.

For Amazon last year, the method worked great. The potential trouble lies in the future. Amazon pays no dividend, posts no profits, and generates not a cent of cash flow to support the price of its stock. It's held up instead by ether--a belief that Amazon's obviously sharp managers will build a company so big and efficient that black ink finally will flood in.

"GROWTH STAGE." That could happen. At last report, Amazon still had $906 million in the till, enough to keep going for at least another year. It also has registered with regulators to raise an additional $2 billion. Amazon won't give any details. But it already owes a lot, about $1.4 billion, and without the goodwill and other intangible assets on its balance sheet, the company's tangible net worth sinks to a negative $286 million (table). As 1999 started, that deficit stood at $41 million.

Amazon CFO Warren Jenson told me that whether net worth is positive or negative has small meaning at Amazon's current "growth stage" in its life cycle, when it's investing heavily. "The worst thing that we could be doing today is to make a run for profitability at the expense of growth," he told me. Jenson also made plain that Amazon would never issue stock in a deal simply to bolster the balance sheet. "It's just not an effective way to run a business," he said. "Our focus is to continue to do the right things for customers and shareholders every day."

Fair enough. For your part, if the ether around Amazon stock should lose its intoxicating punch and the stock's value as currency in mergers evaporates, count on Amazon to act less like a central banker and more like that drunken sailor, this time with a wicked hangover. That's a risk the crowd is missing.

Questions? Comments? E-mail or fax (321) 728-1711

Before it's here, it's on the Bloomberg Terminal.