Why the Street loves Amazon.com

Despite losing money with every passing quarter, (AMZN) remains a flagbearer for electronic commerce.

When investors bid up Internet stocks last week, only the profitable Yahoo (YHOO) soared higher than the Net's biggest bookstore. While Yahoo hit 105 a share, Amazon closed at 95--a mere 11 months after it went public at 18. It settled back to 85-1/4 as of yesterday.

Although Wall Street analysts sound almost sheepish about Amazon's high valuation, many are still bullish on the stock's long-term prospects.

"Based on current fundamentals, it's hard to justify $90 a share," said Mitchell Bartlett, who follows retail stocks for Dain Rauscher Wessels. "The market is saying, 'Electronic commerce is very real.' While it's very difficult to conceptualize e-commerce five or seven years down the road, these guys have a significant advantage at this point."

Added Steve Horen of NationsBanc Montgomery Securities: "I wouldn't

Amazon CEO Jeff Bezos on the potential of the Internet

go chasing the stock at these price levels, but I also wouldn't recommend bailing out of it, either."

Financial analysts have roundly praised Amazon for its two-year head start, a brand name that continues to attract new customers, prospects for adding music CDs and videos to its virtual shelves, and plans for foreign expansion (most likely in Germany and Japan.

Amazon's low overhead and well-regarded management team don't hurt, either.

Bret Bullington, executive vice president at Amazon partner Excite, lauded the company's executive corps. "They make instinctively good calls about what are the most valued things to affect their business," he said. "That's hard to do when things are happening fast."

So fast, in fact, that headhunters already have lured away Amazon's former vice president of marketing, Mark Breier, to become CEO of Web software store software.net.

Breier, for his part, still has some thoughts about the company he left behind. "Amazon's biggest challenge is simply scaling [in size to meet rapid growth] systems, people, transactions systems, marketing, and database systems," he said last week. "But Jeff [Bezos, Amazon.com's founder, CEO, and largest shareholder] has been quoted before as saying that Amazon's key competency is scaling."

A January outage that closed Amazon's site for nearly 12 hours revealed the young company's vulnerability for the first time, and growing competition from brick-and-mortar book giants moving to the Net are putting the company to the test.

Barnes & Noble (BKS), for example, tried, but failed, to disrupt Amazon's IPO, launching its Web storefront just weeks after Amazon filed to go public, then suing the start-up just days before the offering. Neither side will talk about the lawsuit, which eventually was settled.

Barnes & Noble--with $2 billion-plus in revenues last year, compared with Amazon's $147 million--soon will be joined in taking on Amazon by Borders, another book superstore that cut its teeth in the physical world, which is expected to launch its site later this month. Also joining the competition is giant direct marketer Cendant (CD), formerly CUC International, which reportedly is sprucing up the Books.com's online operation that it bought last year.

German publishing titan Bertelsmann, which just acquired Random House, is rumored to be planning online book sales as well.

While Bezos is mindful of

Bezos on Amazon's early success

encroaching competition, he notes that Amazon has only boosted its lead since BarnesandNoble.com launched.

"We were estimating that we were about four times larger, and it turns out that we are about 8-1/2 times larger than they are," Bezos said, citing his rival's recently released Internet sales figures.

"We generate more than $300,000 per year in revenues per operating employee," he added. "A traditional bookstore makes about $95,000 per operating employee."

As is often the case, however, Amazon is in no position to rest on its laurels. Further price cuts in the bookselling industry--Amazon.com already discounts some books as much as 40 percent to match the mark-downs of its rivals--could take a toll on the company.

Analyst Bartlett, however, thinks prices won't dip much lower. "The structure of the business is still going to be dictated at retail for a long time. Retailers cannot afford too wide a gap [between online and real-world prices]," he said, noting that Barnes & Noble's online prices already undercut its retail stores.

In explaining Amazon's current dominance, analysts point to one key internal measurement, the percentage of the company's business that comes from repeat customers. According to the latest figures supplied by each company, Amazon boasts 58 percent returns, compared with 40 percent reported by BarnesandNoble.com.

Bezos said he wouldn't be happy with 40 percent. In fact, he's not content with 58 percent, saying that he intends to exploit Amazon's current advantage further by expanding into music and video.

But that move is not a surefire formula for success, said e-commerce analyst Nicole Vanderbilt of Jupiter Communications. "Going into music will have a unique set of challenges," she noted. "It's a slightly different demographic, and a different business."

And while retaining customers is important, Wall Street seems to think drawing new ones is even more critical. "In the game of customer acquisition, they are light-years ahead [of other Internet merchants]," Bartlett said.

He pointed out that Amazon's 1.5 million customers dwarf the next-best online retailers--music sites CDnow (CDNW) and Music Boulevard, which is owned by N2K (NTKI)--by a factor of four.

"They are extremely skilled direct marketers," Montgomery's Boren agreed.

Bartlett believes that Amazon could turn profitable immediately by cutting back on marketing, but he doesn't think it should go that route just yet.

"They're growing so fast that they're producing tremendous losses based on the cost of acquiring customers. Spending money now to acquire a customer appears to be a very profitable expenditure," Bartlett said, echoing Bezos's contention that marketing is an important area of focus now, when the company is in a "critical category-formation time."

While Amazon's plethora of e-commerce partnerships with high-traffic sites such as Yahoo, Netscape Communications, America Online, Prodigy, AltaVista, @Home, and GeoCities certainly have helped it gain a foothold on the Web, analyst Kate Delhagen of Forrester Research suggests that the company may need to ally itself with an established brand offline, someone like Blockbuster or Tower.

"Amazon should be talking to such candidates," Delhagen said. "They lack the real-world promotional machine, and they could get it with a real-world partner."

Under other circumstances, Amazon might be viewed as a juicy acquisition for some real-world retailer awakening late to the Net. But with its $2 billion-plus market value, Amazon.com, like the river it was named after, may be too big to swallow.