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THE DAY AHEAD: Lehman bond analyst zaps Amazon again

COMMENTARY -- Amazon.com's (Nasdaq: AMZN) third quarter has a lot of bulls cheering. The company is heading into a strong fourth quarter, showing operational improvement and has plenty of cash. However, Lehman Brothers bond analyst Ravi Suria is raising red flags about Amazon's cash position -- again.

Suria, who started the Amazon backlash in June with a delightfully candid research report, actually gave the e-tailer some credit following its most recent quarter. Suria was the first to flag Amazon over cash worries, but noted Wednesday that the company "posted impressive gains in operating results with solid improvement in the metrics that are important from a credit standpoint." Suria still said investors should avoid Amazon's bonds, but offered a few kudos.

And then Suria read Amazon's footnotes.

Amazon touted how it had $900 million in cash and equivalents and burned through a mere $4 million in the third quarter. Many equity analysts bought into the $900 million line, but Suria didn't.

Citing a footnote at the bottom of Amazon's earnings release, Suria noted in a second research report Thursday that Amazon reclassified its equity investments in Webvan (Nasdaq: WBVN) and Sotheby's as cash and marketable securities, bumping its cash position by $96 million. Excluding the Webvan and Sotheby's holdings and a one-time cash gain of $75 million, Suria reckons that Amazon had actual "operating" cash of $730 million, a sum that "significantly increases worries about the balance sheet."

Amazon classified its Webvan and Sotheby's holdings as marketable securities because it doesn't plan to hold the investment for more than a year.

Suria may have a point. Think about it. Say you wanted to buy a house and needed the down payment within a year. Would you park your money in Webvan? Webvan is trading under $1.

Suria noted that Amazon's allegedly marketable securities have become a growing percentage of the company's cash line -- a big deal given his liquidity crunch thesis. "While treating the stock as an 'available for sale' indicates the company's willingness to sell the stock, what we find disturbing is the amount of stock that is currently classified as cash/marketable securities," wrote Suria in a research note.

Suria also took issue with Amazon's "other investments" line, which covers investments in its Commerce Network (ACN) partners. These partners include Drugstore.com (Nasdaq: DSCM), Pets.com (Nasdaq: IPET), Homegrocer.com, bought by Webvan, Gear.com, Kozmo.com and others. Amazon's Commerce Network accounting has the SEC poking around in an "informal" probe.

Amazon's other ACN partners such as Toys "R: Us, HP and Microsoft pay cash, inflating the cash position via the unearned revenue line, said Suria.

So why should we listen to Suria, who may be holding a grudge according to Amazon?

We'll give you four reasons:

  1. He's a bond guy so he's swayed by numbers, not "stories" like the equity guys.

  2. He doesn't have investment bankers breathing down his neck.

  3. It pays to at least listen to a contrarian viewpoint, especially when momentum and perception often overshadow the fundamentals.

  4. He makes some good points.

Amazon will shoot Suria's theory down. CEO Jeff Bezos and a handful of equity analysts laughed off Suria the first time around. Indeed, Suria speculates that Amazon may have used some of its cash toward its operations so it could say it only burned through $4 million in the quarter. Analysts said the argument doesn't hold up. Simply put, you'll have to wait for the 10Q to resolve this squabble.

That doesn't mean Suria doesn't have legitimate points though. A few points to ponder from Suria:

  • There are three types of marketable securities typically classified: bonds, the trading account and the available for sale account. Amazon classified its Webvan and Sotheby's shares in the third type. However, Lehman accounting guru Bob Willen notes it's usually inappropriate to portray anything in the available for sale account that can be construed as cash equivalents.

    Marketable securities can be considered current assets only if they are "reasonably expected to be realized in cash during the normal operating business cycle." If you follow Willen's advice, you would exclude the marketable securities line, leaving $647 million in cash at the end of the third quarter.

  • Fluctuations in Amazon's cash and equivalents. Suria noted volatility in Webvan and Sotheby's could cut Amazon's cash/marketable securities balance simply based on equity market gyrations.

  • Amazon's accounting of its marketable securities could get the SEC's attention. With the SEC already poking around about Amazon's ACN accounting, Suria's report may be interesting to the regulatory types. Amazon "could potentially face problems with portraying stock as a cash equivalent -- especially if it is now 12 percent of the so called 'overall cash' number."TDAIN


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