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Amazon shares back in favor--for now

Betting against the online merchant during the holiday shopping season could turn into a losing proposition. But how long will the good news last?

Betting against Amazon.com during the holiday shopping season could turn into a losing proposition.

Amazon was among a number of e-tailers who have dispelled--at least for the moment--expectations of poor holiday sales. Merchants including Yahoo Shopping and Bluelight.com joined Amazon in reporting jumps in sales volumes over the Thanksgiving weekend.

Those sales might even help propel the company to a profitable fourth quarter, after a fashion.

News that retailers were seeing better-than-expected sales spooked skeptics of Amazon's business strategy, say Wall Street insiders. As those detractors scrambled in retreat Monday, they helped drive Amazon's stock up 34 percent, the second time in two weeks the company's share price rose 30 percent or more in a single day. Amazon shares retreated 6 percent to $11.48 Tuesday, but are still up 65 percent since Nov. 1.

"It's safe to say that a chunk of the run-up is due to short sellers covering their positions," said Steve Weinstein, a research analyst with Pacific Crest Securities. "Expectations were very low heading into the holiday season, but all the data is saying online commerce has stayed strong considering the economy and global situation."

That positive news has acted as a counterbalance to Amazon's negatives. The company has been profitless and weighed down by massive debt in the six years since launching, factors that began to attract "short sellers" in 1998 after its share price reached an all-time high of $400.

To many short sellers--investors who sell borrowed stock, hoping that the price will drop before they have to buy shares to cover their accounts--there was only one direction such a stock could go. So they made big profits by shorting Amazon shares and watching as they shed 90 percent of their value, say Wall Street insiders.

"Anybody who began shorting the stock when it hit $400 and sold Monday would have profited by more than 370 percent," said John Van, chief financial officer of Van Hedge Advisors, which compiles information on hedge funds.

Short sellers glommed onto e-commerce stocks generally in April 2000, when dot-com companies began to go bust. Since then, the sector has proven fertile ground for them as very few publicly traded Web stores survived the shakeout. Just this year, former e-commerce pioneers eToys and Webvan, both highly shorted stocks before their demise, ceased operations.

Profits on the way?
Many analysts now believe that Amazon will make good on its promise of turning a profit at the end of the fourth quarter--albeit on a pro forma basis, which excludes certain charges.

"I'd be very surprised if Amazon doesn't show a pro forma profit at the end of the fourth quarter," said Ken Cassar, a Jupiter Media Metrix analyst. "But the real question that investors have to ask themselves is whether pro forma is the answer to the question of whether Amazon's model works."

Analysts have also praised the Web's largest mass retailer for striking high-profile deals with established retailers such as Target, Circuit City and Expedia in recent months. In these "service deals" Amazon usually sets up Web operations for the retailers or allows them to tap into its customer base in exchange for a fee or a share in the profits.

But even as Amazon appears to be winning the latest battle with short sellers, analysts are quick to note that the good times probably won't last. They're skeptical about the e-tailer's recent gains, and many have reiterated "hold" ratings. SoundView Technology analyst Shawn Milne said Tuesday that "trading gains may likely be given back in the first quarter."

Short sellers may be losing out now, but analysts say they'll be back as soon as the holidays end. Amazon spokesman Bill Curry said the company isn't concerned with the "short-term fluctuations of its stock price."

While e-tailers are proven cash cows for short sellers, Amazon has at least temporarily bucked the trend courtesy of a spate of positive news.

Curry said that for the three days following Thanksgiving, Amazon sold 700,000 items more than it did during the same period last year. Curry declined to discuss whether the sale of more products led to better revenue than last year as well.

Two weeks ago, Amazon shares rose 30 percent after a Commerce Department report showed that retail sales climbed a better-than-expected 7.1 percent last month. At the same time, an Amazon executive said the company was "happy" with sales during the first part of the fourth quarter. Since hitting its 52-week low on Oct. 1, Amazon's share price has risen by more than twice that amount.

By releasing hints about its sales, Amazon has given analysts just enough information to speculate about the company's fourth quarter. SoundView's Wilne, using his "Estimator," a back-of-the-envelope calculator that's a knock-off of Amazon's "Delight-O-Meter"--a measure of sales--estimates Amazon sales for the fourth quarter could come in at $1.10 billion, up from his estimate of $1.03 billion.

Revenge of the shorts?
Questions about Amazon's business model have hung over the company since the start of the dot-com crash. The company has wrestled with sagging sales growth and ballooning debt, which now tops $2 billion.

Until Amazon delivers concrete answers to those lingering questions, short sellers aren't likely to stay away for long from one of their favorite stocks, Weinstein said. Amazon catapulted into the ranks of the Nasdaq's most popular shorts almost as soon as its stock price peaked at the end of the 1998 holiday season. The naysayers never looked back.

The online retailer was the eighth-most shorted stock, according to the Nasdaq's short interest report for January 1999. Since then, Amazon has been among the Nasdaq's top 16 short-interest positions, at least in absolute terms. Amazon this year has been among the top 10 shorts every month except July, when it was 11th.

Some stocks, like Sun Microsystems and i2 Technologies, have millions of shares being shorted simply because the companies have so many shares outstanding. In fact, a relatively small portion of Sun's total shares--about 0.8 percent--are being shorted. Almost 62 million shares of Sun moved during an average trading session from mid-September to early October. Against that kind of volume, the Nasdaq's last reported short interest of nearly 27 million Sun shares means little.

Amazon shares back in favor
Stock price from November 2000 to present.  
Source: Prophet Finance

But Amazon's short interest isn't merely a function of being a heavily traded stock. Despite its entrenched position as one of the most visible shorts, the stock never moved higher than 43rd in terms of overall average daily volume each month. As of Oct. 8, Wall Street was shorting about a third of all Amazon shares held by non-insiders. And Amazon's short-interest-to-daily-volume ratio of 7.2 is the eighth-largest among the 306 stocks with average daily volume of at least 1 million.

So the short sellers are very likely going to return after the holidays are over, when retailers historically slow down, Weinstein said.

Retail is a seasonal business with most revenue generated in the fourth quarter when holiday shopping is at its peak. Sales are notoriously slow in the first quarter, and this is also the period when retailers must pay manufacturers for the holiday goods they ordered. With a lot of cash going out and little coming in, some analysts expect that it will be sometime after Jan. 1, 2002, before Amazon makes any new promises about reaching profitability.

Some analysts predict short sellers will pounce sometime around Amazon's first quarter earnings report in late January or early February. Amazon is likely to say it can't maintain pro forma profitability in the first quarter and will cut its sales target, which is seasonally lower than the fourth quarter, analysts said.

"From an operation standpoint, it's hard to expect them to be profitable in the first couple of quarters," said Pacific Crest's Weinstein. "I expect that they have enough cash to see them through the year, but they are not in a position to stimulate high growth. The economy is just not supportive of superhigh growth. We'd expect them to lose money."