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Commentary: Amazon&#039s high-margin revenue hopes dashed by dot-com woes

Just about six months ago, Amazon.com (Nasdaq: AMZN) rattled off six equity and marketing deals that had analysts gushing. Since Amazon's margins are generally thin, the company planned to have e-tailers such as Drugstore.com (Nasdaq: DSCM) pay lofty sums to gain access to Amazon's customers.

"Amazon has signed six new equity/ marketing deals representing an aggregate of $500 million in high margin revenue ($130+ million annual). We view these deals as an excellent way for Amazon to monetize its greatest asset -- its customer base," said Merrill Lynch analyst Henry Blodget, in a February research note.

Blodget was so pumped about this high-margin revenue stream that he even reckoned that Amazon could be profitable in 2001. The Amazon Commerce Network was going to be huge -- really huge.

Now let's fast-forward a few months.

"We have been disappointed by the company's ability to monetize its customer base. To date, Amazon has announced several deals with pure play dot-com companies. We are concerned that most, if not all of these companies will be unable to pay Amazon in future years," said Lehman Brothers analyst Holly Becker in a research report on Wednesday.

By the way, she "threw in the towel" on Amazon.

And now Amazon has admitted its dot-com pals can't pay up. Officials said during Amazon's second quarter earnings conference call Wednesday that the company would have to renegotiate its contracts with its dot-com tenants. Why? "Changing circumstances," said Amazon CEO Jeff Bezos. That's putting it mildly.

E-tailing stocks stink (just ask Amazon shareholders) and the free flow of capital has dried up. Simply put, Amazon isn't going to get its money. To make matters worse, Amazon took equity stakes in its partners. Now Amazon has a pitiful portfolio and no high-margin revenue stream. As Yahoo! and America Online cushioned the dot-com woes with big offline partners, Amazon focused on pure play e-tailers. Here's a look at some of the deals that may be renegotiated:

  • Ashford.com (Nasdaq: ASFD) in December 1999 signed a multimillion dollar deal to partner with Amazon, which took a 16.6 percent stake in Ashford. The luxury e-tailer reported its earnings this morning and ended the second quarter with $38 million in cash. It also established a $25 million line of debt financing.

  • Greenlight.com (privately held) on Jan. 21 agreed to pay Amazon $82.5 million over five years. Amazon took a 5 percent stake with the option to bump its stake up to 30 percent. Greenlight.com was probably thinking an IPO could pay the bills.

  • Drugstore.com (Nasdaq: DSCM) on Jan. 24 said it would give Amazon $105 million over three years. Amazon has a 28 percent stake. At the end of its first quarter, Drugstore.com had $174 million in cash. We'll soon find out how much it burned in the second quarter.

  • Audible.com (Nasdaq: ADBL) on Jan. 31 said it will pay Amazon $30 million over three years. Amazon took a 5 percent stake. Audible, which reported earnings on Wednesday, had a little more than $25 million in cash, cash equivalents, short-term investments and interest receivables at the end of the second quarter.

  • Living.com on Feb. 1 said it would pay $145 million to Amazon over five years. Amazon took a 18 percent stake with warrants to acquire an additional 9 percent. The company was obviously hoping for a big IPO. It isn't going to happen.

    Amazon execs said they disclosed the renegotiations because they didn't want investors to be surprised. There'll be a lot more disclosure to come.

    Bezos changes his tune

    Amid a falling stock price, sales growth that impressed no one and more vague projections about a push to profitability, Bezos did his best profit pitch Wednesday night.

    Bezos said Amazon's investor relations staff was bombarded with questions about Chief Operating Officer Joe Galli's departure to VerticalNet (Nasdaq: VERT). Galli represented profits and Bezos represented growth-at-any-cost losses forever.

    Bezos said he merely suffers from a "perception issue."

    "As CEO I'm relentlessly committed to driving profitability, efficiencies and balanced growth," said Bezos, who added that half of the company's technology spending is allocated to boost profits.

    Gee, I wonder why investors think Bezos wants nothing to do with profits. Maybe it was the PC Expo speech a few weeks back where he joked about the company's money losing ways. Maybe it was the endless conference calls where Bezos wouldn't even mention the "p" word. Maybe it's the fact that Amazon made losing money cool.

    Maybe it's the fact that Amazon still won't project a profit date. Morgan Stanley analyst Mary Meeker tried to pin a profit date on execs, but Bezos and company said they were too focused on the next two quarters to get specific.

    Galli's market call

    Aside from his "personal reasons" for leaving Amazon, Galli at some point had to project where Amazon shares were heading in the long run. Galli had to make his own market call. According to his employment letter, he received $200,000 in annual salary, a $7.9 million signing bonus over three years (roughly $5 million was left on the table), and a boatload of options.

    Specifically, Galli had two 20-year option grants. Under the two grants, Amazon granted Galli the option to buy 1,960,000 shares over 20 years. The catch was the options had a strike price of 56.813, the price of shares on June 24, 1999, the day Galli started at the company. Galli's options went underwater in April and never really recovered.


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