Amazon suffers second investment blow with Pets.com

With this week's news that Pets.com is going out of business, Amazon.com has seen the second of its more than a dozen e-commerce investments go belly up--and several others are showing signs of wear.

Pets.com: What went wrong? Matt Stamski, analyst, Gomez

In addition to Pets.com, one of the first companies that Amazon invested in, Amazon partner Living.com went out of business in July. The two companies were part of an Amazon investment strategy launched last year to diversify the types of products Amazon offers.

"There's no question that a lot of Amazon's properties have struggled," said Ken Cassar, digital commerce analyst for Jupiter Media Metrix. "The Amazon partnership, in retrospect, does not look like the godsend that it did a couple of years ago."

All told, the Seattle-based e-tail giant has investments in at least 10 public and seven private companies running the gamut from luxury goods e-tailer Ashford.com and traditional auction house Sotheby's to online car store Greenlight.com.

For those companies, many analysts and competitors thought an affiliation with Amazon would give them an advantage. The reality has been a series of layoffs, management changes or plunging stock prices for most of the companies.

The arrangements have helped Amazon diversify its product offerings but have done little to boost investment returns.

Amazon defends its investments, adding that it has not ruled out more such investments in the future.

"I don't think we ever claimed that it was the Midas touch," Amazon spokeswoman Patty Smith said. However, she added, "We're always going to be on the lookout for opportunities that make sense for our shareholders and our customers."

Other tales of woe
Amazon is not alone in trying to create an e-commerce portfolio to blossom with the growth of the Internet. With the boom in Internet stocks last year--especially e-commerce stocks--many companies wanted to get a piece of the action.

Internet incubators CMGI and Idealab, for instance, nurtured or took stakes in a range of e-commerce players, from Furniture.com to eToys. Even traditional companies such as Walt Disney tried to get in on the e-commerce boom by buying stakes in e-tailers.

When the bull market for Internet stocks went bust this spring, many of these investors saw their once thriving portfolios begin to unravel. Earlier this week, MotherNature.com and Furniture.com, both backed by CMGI, said they would close their doors. And Disney-backed Toysmart.com in May said it would shut down.

Amid this turmoil, though, Amazon's investments stand out. The 800-pound gorilla of e-commerce, Amazon has been among the most aggressive of investors in the business-to-consumer market.

The investments were part of the company's strategy to branch out from its core books, music and video products to become "the place where customers can find, discover and buy anything online," as Amazon's Smith puts it. Following that path, Amazon chose to open some stores such as its lawn and garden area on its own.

For other products, Amazon decided that it needed to rely on the expertise of other, more experienced companies. Thus, Greenlight operates Amazon's new car store, and Drugstore.com runs Amazon's health and beauty area.

"At the time (of Amazon's investments), business-to-consumer, pure-play e-commerce looked like it was the way to go; Amazon had a $400 price target and hit it," said Matt Stamski, an e-commerce analyst with Gomez.

Although investing in other, largely niche e-commerce players, seemed a good decision at the time, Stamski questions that decision now. "Whether it was hubris or stupidity, I don't want to be the judge of that."

By diversifying its products, Amazon had the potential to draw in new customers whom it would not have attracted with books alone. For instance, in the wake of Amazon's recent deal with Toysrus.com, traffic on Amazon's toys site has already doubled, Amazon chief executive Jeff Bezos said in a conference call with investors last month.

"One plus one equals more than two in the early days of this relationship," Bezos told investors.

Strength in numbers
Partnerships have also brought Amazon a new source of cheap revenue. With its books and music stores, Amazon has to carry inventory and incurs costly shipping expenses. But Amazon's partners pay those costs in the stores they operate. Amazon essentially serves as an advertiser for those companies, which have agreed to pay Amazon big money to try to reach the company's customers.

And that money is making a difference. In the most recent quarter, for instance, Amazon's gross profit margin--the difference between what a company charges customers for its goods and services and what it pays suppliers to provide those goods and services--was 26.2 percent of the company's revenue. Without the money Amazon received from its promotional deals, its gross margin would have been 23.7 percent, according to the company.

But despite these benefits, Amazon's partnerships have been troubled lately. In July, the company warned that its revenue from such partnerships would be lower than expected. Last month, it closed down its high-end auction site, jointly operated with Sotheby's.

And in its quarterly report last month, Amazon told investors that the Securities and Exchange Commission had launched an informal inquiry into the company's accounting practices related to its partnership deals and investments.

Amid this scrutiny, more Amazon investees are experiencing trouble:

• Pets.com announced Tuesday that it plans to close shop.

• Living.com filed for bankruptcy in August.

• Gear.com laid off 30 percent of its work force amid a companywide restructuring in September.

• Kozmo.com has gone through two rounds of layoffs, including a staff cut of 10 percent in August.

• Drugstore.com laid off 10 percent of its staff in October.

• HomeGrocer was acquired by rival Webvan in September. Following the merger, Webvan laid off 50 HomeGrocer employees from the company's headquarters in Kirkland, Wash. Since Webvan completed the acquisition, its stock has fallen about 65 percent to $1.41 on Wednesday.

Still, even if all of Amazon's investments eventually fail, the company has not lost a whole lot, said Dan Ries, a financial analyst who covers Amazon for C.E. Unterberg Towbin. Amazon did not invest a lot of cash in its partners, Ries said; instead, it often received stock in its investments in exchange for promotional services.

"The bad thing is that the value of what they had is down," Ries said. "The positive is that if they want to go into watches, for example, they don't have to compete against an aggressive Ashford."