Is Amazon's biggest critic crying wolf?

The debate over Suria's report underscores a rift between two sides of Wall Street--the bond analysts who pick over balance sheets and assess credit risk and the equity analysts who look at company fundamentals. Amazon executives maintain Suria was just looking for some attention. Suria said he would let his report do the talking and declined to speak on the record.

That state of affairs left the analyst community to pick through Suria's report point by point to figure out if there is a chance Amazon could get squeezed by suppliers as its working capital disappears.

The crux of Suria's argument revolves around Amazon's working capital, defined as a company's current assets minus its liabilities. Suria argues working capital is the main measuring stick vendors use to determine whether or not to extend credit to retailers.

Suria, Lehman's vice president of convertibles strategy, said that while Amazon claimed to have more than $1.1 billion in cash and short-term investments at the end of the fourth quarter, the online retailer only has $386 million in working capital.

Suria claims that without any additional cash infusions, Amazon's working capital will slip into the red later this year for the first time in the company's history. As a result, vendors will eventually stop shipping CDs, books and other merchandise on credit.

"We believe that once the working capital levels turns negative in the second half, the company is likely to face a creditor squeeze, as suppliers tighten up on trade terms," he wrote in his research report. "By definition, a negative working capital means that the company is using its vendors to finance cash outflows in operations and interest payments, which is a nonsustainable condition."

What's in it for Suria?
Although Amazon spokesman Bill Curry called Suria's report "silly," none of the equity analysts interviewed for this story could find any motive behind the bond analyst's berating of Amazon's balance sheet, aside from the obvious ramifications for convertible bond investors. A convertible bond is a hybrid security that usually offers current income and can be converted into company stock. Its fortune is closely tied to the underlying stock price

"He's a convertible bond analyst," one equity analyst said. "How many other convertible bond analysts have you heard of? He got good publicity from his previous reports, and he's getting more publicity from this one."

That argument may have had more credibility the first time around, but Suria's consistent hammering on Amazon makes the publicity angle ring hollow. Like it or not, Suria's determined to keep rattling his saber about Amazon's prospects--until Amazon either runs out of money or people stop listening to him.

It should also be noted, however, that Suria doesn't spend all of his time targeting Amazon. Last year, he penned a report concluding that highly leveraged telecommunications upstarts were headed for disaster--a prediction that was right on target.

Suria, who continues to advise investors to avoid Amazon's convertible bonds, points out that Amazon's 4.75 percent convertible bonds maturing in 2009 were recently trading at 44.5 cents on the dollar with a yield to maturity of 18.2 percent. They are convertible into Amazon shares at $78.03, meaning they are "way out of the money."

Credit rating agency Moody's Investors Service rates Amazon's convertible bonds "Caa3." Another agency, Standard & Poor's, rates them "CCC-plus," roughly two notches higher. Both grades are considered low junk grades.

By comparison, Wal-Mart, which returned a profit of $1.4 billion, or 31 cents a share, on sales of $45.7 billion in its latest quarter, has a $4.5 billion credit line at an "Aa2" rated bank credit facility.

Even a retail analyst at his own firm refused to comment on either Suria's report or the methods he used to draw these conclusions.

Truth or consequences?
It comes as no surprise that Amazon executives and equity analysts strongly disagreed with Suria's premise. Analysts admit the company is cutting it close but is in no danger of running out of cash or being cut off by its distributors.

"I disagree with his whole premise," said Jeffrey Fieler, an analyst at Bear Stearns. "Amazon generates negative working capital with each sale. That's the way the business model was set up. To call that a reason for Amazon to go out and try to raise cash makes no sense."

Suria contends that Amazon misled investors when it claimed to have more than $1.36 billion in total assets at the end of its fourth quarter. Those assets included $1.1 billion in cash and short-term investments, about $175 million in inventory and roughly another $100 million in miscellaneous assets.

However, Suria points out that Amazon exited the quarter with more than $975 million in outstanding short-term debt, most of which is owed to its distributors. That's real money owed that must be paid some time in the next year.

Give or take a few dollars, Suria said the company only has about $386 million in working capital left for the rest of the year.

Suria expects the company to post an operating loss of around $140 million in 2001, though most analysts see that figure closer to $160 million. He's projecting $130 million in interest payments, a $50 million restructuring charge, and $120 million in capital expenditures this year.

That?s roughly $440 million in debt--though the capital expenditure outlay could certainly be adjusted--and only $386 million in working capital, according to Suria, leaving it $54 million in the red.

According to his calculations, which have been disputed by Amazon and several equity analysts, Amazon will run into a negative working capital position by the third quarter.

"We have ample cash to pay our bills. You don't pay your bills with accounting metrics. You pay them with cash," Curry said.

Curry also takes exception to Suria's prediction that Amazon will burn around $489 million in cash in the last three quarters of 2001.

"That's absolutely at odds with our recent history," Curry said. "In the last nine months of 2000, we generated more than $190 million in cash. According to our most recent guidance, we expect to improve our cash position by $250 million in the last nine months of 2001."

Cause for concern
One analyst that isn't dismissing Suria's report is Merrill Lynch analyst Henry Blodget. The analyst, who made his career by predicting a $400 price target for Amazon in 1998, said that Suria's assumptions raise some interesting questions, but his report discounts the company's moves to curb expenses and manage inventories.

"(The report) is not silly by any means," Blodget said. "The fact that we're in a position where this argument can even be made is unfortunate."

Blodget said he didn't agree with some of the projections in Suria's model, which he characterized as a "feeling that a reformed alcoholic is eventually going to fall off the wagon."

"He's basically expecting a dramatic drop-off in sales, operating margins, gross margins, and out-of-hand inventories in the third quarter. We're not expecting that at this point," Blodgett said.

Analysts following the stock agree that Amazon's schizophrenic business model in the past year makes it more susceptible to these type of stinging research reports, especially since the company continues to run in the red and has lowered its sales growth guidance for 2001 to somewhere between 20 percent and 30 percent.

Amazon has projected sales of $3.3 billion to $3.6 billion in 2001 with an operating profit in the fourth quarter.

Equity analysts contend Amazon's working capital is expected to run at a negative level, but this eventuality won't discourage vendors from extending credit to the company.

Suria, who first blasted Amazon back in June and then again in October, acknowledges that negative working capital can be a positive financial metric--for healthy retailers who actually turn a profit and have enormous credit lines.

"Obviously, revenue is the primary source of cash flow for any company," said Sasha Kostadinov, an analyst at McDonald Investments. "Amazon's balance sheet is a reason for pause for any creditor. But as long as they can keep paying their bills, the vendors will keep shipping to them."

Suria disagrees. Amazon's consistent operating losses and declining working capital, he said, puts the online retailer into the category of a "going concern," accounting parlance that means it's now considered a credit risk.

Curry blasted that conclusion. "Our auditors have just completed our annual examination, and it's on the way to the printers," he said. "There's absolutely no issue of us being a going concern."

Jim Ulsamer, president of Black & Taylor Books, one of Amazon's leading distributors, was tightlipped about both Amazon's credit as well as the company's credit policy.

"We look at a number of factors in determining how much credit we extend," he said. "But it's our policy not to comment on the particulars regarding any of our customers. All I can tell you is that it depends on a number of circumstances and, to this point, we've had no trouble with Amazon."

Much ado about nothing?
Blodget and other analysts said it's highly unlikely Amazon would face the potentially lethal prospect of being unable to buy merchandise on credit, primarily because all of its sales are completed within two days through the credit card companies. It typically has 30 to 60 days to settle up with its vendors.

"This is an important analysis but it requires that Amazon's situation deteriorate," Blodget said. "But at least in the past two or three quarters, its cash situation has been improving."

"This is really a case of analysts looking into the dark unknown and drawing very different conclusions," Blodget said. "Clearly it's time for Amazon to get down to business. Suria's report is basically saying they waited too long. My hope is that they didn't."