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Amazon crumbles on debt, sales growth worries

Amazon.com was hit with a double whammy Friday. Lehman Brothers is flagging the company's debt load and prominent Wall Street analysts are predicting light sales in the second and third quarters.

Simply put, Amazon (Nasdaq: AMZN) is looking more and more like a plain-old retailer.

Despite Amazon's recent pledge to produce profits, Wall Street analysts said the e-tailer is seeing the effects of its growth-at-all costs strategy. At midday, shares were down 20 percent to 33 7/16, a 52-week low. Losses picked up through morning trading.

Amazon.com has lost about $2.9 billion in market capitalization today so far. And it has lost more than $19.5 billion in market cap since Jan. 3.

Debt piling up

Debt is beginning to pile up at Amazon, and Lehman Brothers convertible bond analyst Ravi Suria said Friday morning in a research report that "the company is displaying the operational and cash flow characteristics of a normal retailer, despite its 'virtual' pedigree."

This time last year, convertible bond offerings were a big fad with high-flying Internet stocks. Amazon was among the leaders funding future growth with convertible bonds. Other companies, including CNet (Nasdaq: CNET), DoubleClick (Nasdaq: DCLK), and Beyond.com (Nasdaq: BYND) also issued convertible debt.

Convertible bonds feature fixed interest payments to coupon holders of around 5 to 7 percent of the value of the note, paid in two chunks a year. Later, the company calls the bonds and investors to convert the securities to stock at a certain price. Last year, many Internet companies set the conversion price at a 20 percent to 30 percent premium to their stock prices when the bonds are issued and raise more cash than they could with a secondary offering.

Amazon has a 4.75 percent convertible maturing in 2009 and a euro-dominated convertible at 6.75 percent maturing in 2010.

Last January, funding growth with debt looked like a great idea. Amazon was within striking distance of calling the bonds, but then shares went into a long tailspin. When shares plummet, convertible debt turns into real debt.

In his report, Suria didn't pull any punches. "From a bond perspective, we find the credit extremely weak and deteriorating," he wrote. "The company's inability to make hard cash per unit sold, is clearly manifested in the weak balance sheet, poor working capital management and massive negative operating cash flow - the financial characteristics that have driven innumerable retailers to disaster throughout history.


'Current cash balances will last the company through the first quarter of 2001 under the best-case scenario.'
-- Lehman analyst Ravi Suria

"Adding to the operational weakness is the mounting pile of debt, as Amazon has essentially funded its revenues through a variety of sources over the past year. From 1997 through the last quarter, the company has received $2.8 billion in funding, while its revenues have been $2.9 billion - a whopping $0.95 for every dollar of merchandise sold."

Pending cash crunch?

The bottom line may be that Amazon could theoretically run out of cash just like its weaker competitors.

"In its current situation of high debt load, high interest costs, spiraling inventory and rising expansion costs, we believe that current cash balances will last the company through the first quarter of 2001 under the best-case scenario," wrote Suria.

Amazon isn't expected to break even until the fourth quarter of 2001.

The biggest difference between last year and this year is that Amazon transformed from a virtual e-tailer to a real world e-tailer. Suria said Amazon can't avoid the liquidity and cash problems that real world retailers have to face.

Because of Amazon's poor operations management the e-tailer looks "a lot more distressed than even mediocre real world retailers."

Suria also said that cost cutting isn't likely to get Amazon out of its current jam. Inventory, warehousing and distribution are fixed costs. "The issue here is not bloated costs, but doubts about the validity of the business model," he said.

Due to Amazon's inability to boost its operational execution, Suria said "the company will run out of cash within the next four quarters unless it manages to pull a financing rabbit out of its rather magical hat."

Slowing sales growth

So why is debt suddenly an issue for Amazon? Sales growth is slowing. Like traditional retailers, Amazon is increasingly becoming a fourth quarter story. Amazon, like other retailers, needs to hit a home run in the busy holiday season.

Amazon has managed to stay above concerns about e-tailers such as eToys (Nasdaq: ETYS), Buy.com (Nasdaq: BUYX) and others, but now the honeymoon may be over.

Morgan Stanley analyst Mary Meeker reportedly told brokers that she expects Amazon's second and third quarter sales to be light. Meeker, like other analysts, are viewing Amazon as a fourth quarter story.


'We are not looking for much, if any, upside to our second quarter revenue estimate.'
-- Merrill analyst Henry Blodget

Meeker's comments come a day after Merrill Lynch analyst Henry Blodget also voiced concerns about sales growth. "We are not looking for much, if any, upside to our second quarter revenue estimate of $585 million," said Blodget in a research note. "This estimate represents nominal growth of 2 percent sequentially, which would be slower than last year's 7 percent pace, and it is below some Street estimates."

Blodget said the weak sales growth can be attributed to a slowdown in the growth of the consumer Internet, slowing consumer spending and the laws of large numbers.

The analyst also opened the door to trimming his third quarter revenue target. "We still do not expect any positive catalysts for the stock until late summer or early fall (when excitement about the holiday shopping season should start to build)," said Blodget.


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