Amazon in the Year 2000

Ravi Suria painted the picture of company growing money. The only triple-digit growth that mattered, he argued, was in Amazon’s cash-flow losses. The report shook many remaining stalwarts, and the stock dropped 19% in one day. Suria addressed Wall Street’s darkest fears, that the business model on which Amazon–and for that matter, most e-tailers–is based may be flawed.

Arguing that excessive debt and poor inventory management will make Amazon’s operating cash-flow situation worse the more it sells, Suria suggested that cash was being devoured at such a rate that the company might eventually find it difficult to meet its obligations by the end of the first quarter next year. Suria’s report got Wall Street’s attention because it had the audacity to evaluate this icon of the New Economy as a traditional retailer. Up until Suria, Amazon was usually viewed under a rose-colored microscope that overlooked divergence by dot-coms from standard business measures.

Suria’s reasoning was simple: Because Amazon has built up a vast infrastructure of warehouse and distribution centers to house burgeoning inventories of product lines, relies on brand-name identification, and needs to spend relentlessly to attract each dollar of sales, it faces many of the same difficulties managing its business as old-line retailers do. Ironically, a key contributor to this first-quarter debacle was Amazon’s efforts to implement its strategy for growth.

By adding product lines such as electronics and toys, and building distribution centers all over the country, the job of policing its inventories became much more difficult, particularly for a retailer that concedes it is lacking in retail experience. On $676 million in sales in the fourth quarter, Amazon was forced to take a $39 million writedown on inventory. Suria and other critics also point out that Amazon’s ability to turn over its inventory rapidly enough has declined since the end of 1998; that, too, is a classic measure of poor retail management.

Amazon’s rate of inventory turnover plummeted from 8. 5 times in the first quarter of 1998 to 2. 9 times for the first quarter of this year. In 1999, when Amazon’s sales grew 170% from the previous year, its inventories ballooned by 650%, Suria pointed out. ”When a company manages inventory properly, it should grow along with its sales-growth rate,” he noted. When inventory grows faster than sales, ”it means simply that they’re not selling as much as they’re buying. ” Amazon’s fast-growing debt load, which has risen to a staggering $2. billion, is also a source of concern.

From 1997 through the latest quarter, the company may have reported as much as $2. 9 billion in revenues, but it raised $2. 8 billion to meet its cash needs–amounting to 95 cents for every $1 of merchandise sold, Suria noted. In the future, Amazon will be under far greater pressure to meet its obligations by generating its own cash. ”Bondholders are in effect being paid cash from money they lent the company,” says Marie Menendez, Moody’s senior corporate finance analyst of the interest payments of about $150 million a year.

Indeed, many analysts believe the Amazon of year 2000 is actually in better position than ever. Operating losses fell from 26% of sales in the fourth quarter to 17% in the first quarter. As a result, analysts expect operating losses to drop to a single-digit percentage of sales by yearend–when books, music, and video are expected to be profitable on their own–and they predict a companywide operating profit by the end of 2001. Says Merrill Lynch & Co. Internet analyst Henry Blodget: ”I’m not at all concerned about the cash side. ”

One controversy seems to be over the vast network of distribution centers that Amazon built over the past couple of years. While largely empty and unused, the centers gave Amazon a leg up on online and traditional rivals last Christmas: It could ship on time over the holidays, creating an intensely loyal customer base. In the first quarter, repeat orders constituted 76% of sales. Ultimately, Amazon and those on Wall Street who still back it have made a giant bet that none of these factors will be enough to keep it from boosting sales enough to get to profitability.

At base, it is a bet on Amazon’s ability to outrace the financial squeeze that all money-losing e-businesses now face. But as the difficulties of beating the debt clock increase–and the questions multiply about how the numbers will ever add up–a growing number of investors and analysts are bailing out, no longer liking the odds. Who is right? Coming down on either side ultimately requires something of a leap of faith. The only certainty: In its short life as a public company, Amazon’s experience has often set the rules under which e-commerce companies operate. Survive or stumble, that will continue to be the case.