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Amazon.com: Wild about Harry
The latest Potter book should boost sales for Amazon.com but can it lift the stock out of its funk?
June 21, 2005: 1:09 PM EDT
By Paul R. La Monica, CNN/Money senior writer

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Lazy river: Amazon's stock has lagged Internet rivals and the broader market for the past year and a half.
Lazy river: Amazon's stock has lagged Internet rivals and the broader market for the past year and a half.
The latest Harry Potter book isn't due out until July 16, but Amazon.com has already received more than 600,000 orders for it in the U.S.
The latest Harry Potter book isn't due out until July 16, but Amazon.com has already received more than 600,000 orders for it in the U.S.
Legendary singer-songwriter Bob Dylan is going to help Amazon.com celebrate its 10th birthday with a performance in Seattle.
Legendary singer-songwriter Bob Dylan is going to help Amazon.com celebrate its 10th birthday with a performance in Seattle.

NEW YORK (CNN/Money) July 16 is going to be a big day for Amazon.com.

The most eagerly awaited book of the year, "Harry Potter and the Half-Blood Prince", goes on sale that day. The online retailer has a Harry Potter meter up on its Web site tracking domestic orders, and as of early Tuesday, more than 612,000 copies of the sixth book in the series have been ordered on the site.

July 16 also marks Amazon.com's 10th anniversary. And to celebrate, the company is having a concert in Seattle featuring Norah Jones and Bob Dylan -- an event that will be streamed for customers on Amazon's Web site.

A business that's lasted for 10 years on the Internet is a feat worth noting. But Amazon.com (Research) investors haven't had much to cheer lately. The stock's down about 20 percent this year after a 16 percent decline in 2004.

So is the stock a buy now? It depends on which of the former Mr. Zimmerman's song titles you think more appropriately describes Amazon's future "Don't Think Twice, It's All Right" or "You Ain't Going Nowhere."

Many analysts think it's the latter. Wall Street is decidedly bearish on Amazon.com's prospects.

Harry's not so magical

According to Thomson/First Call, only five of the 23 analysts following Amazon rate it a "Buy." Twelve analysts rate it "Hold", which is usually considered a nicer way of saying "Sell." And the remaining six analysts actually have slapped a "Sell" rating on the stock.

Sure, Amazon should see a boost to sales from the latest Potter book. But it probably won't be significant enough to juice the company's results.

At $17.99 a pop, Amazon stands to reap at least $11 million in sales from the new Potter book, based on current orders. But that's a tiny fraction of Amazon's expected $1.8 billion in revenues in its third quarter, when sales of the new book will first be reflected.

"Harry Potter is one of only a few products to have a measurable impact but Amazon is such a large business now," said Steve Weinstein, an analyst with Pacific Crest Securities.

Plus, the biggest problem Amazon faces is not sales growth but profit growth. Analysts forecast sales growth of 22 percent this year and 17 percent next year for Amazon, on average. But the retailer warned in April that its second quarter operating income would be lower than a year ago due to increased spending.

Specifically, the company probably will see higher shipping expenses from its new Amazon Prime program, which allows customers to receive unlimited two-day shipping of products for just a $79 annual fee.

As a result, analysts slashed their earnings targets for the company by more than 40 percent in the past two months, and earnings per share excluding one-time items are now expected to tumble 33 percent in 2005.

And while analysts expect profits to bounce back in 2006, they've recently slashed those estimates to the point that the average forecast of 89 cents a share for next year is lower than the 93 cents a share Amazon earned last year.

"It all boils down to when is this company going to show us better profit margins and cash flow margins? Investors are waiting patiently," said David Garrity, an analyst with GVA Research LLC, an independent research firm.

The stock is not on sale

Scott Devitt, an analyst with Legg Mason, thinks Amazon could start to show stronger profit growth in the fourth quarter as its investments begin to pay off. But he still rates the stock a "hold" and thinks there is no hurry to rush in. "I'm warming up to the company and the opportunity it has. But at the same time, investors need to have patience with it. Sentiment won't change overnight."

Amazon is clearly now a mature company. After 10 years, investors are looking for consistent results, not its old strategy of gaining market share at the expense of profits, which is so 1998.

"Investors want to see Amazon deliver a combination of revenue growth and margin improvement. The company has shown an ability to do one or the other but they need to show both," said Pacific Crest's Weinstein.

What's more, unlike eBay (Research), another online business that's struggled lately, Amazon does not sport a valuation that makes the stock attractive.

eBay is trading at 37 times 2006 earnings estimates, or about 1.5 times its projected annual long-term earnings growth rate of 25 percent. Amazon trades at 40 times 2006 estimates, only a slight premium to eBay, but Amazon's estimated earnings growth rate is 21.5 percent, giving it a price-to-earnings growth, or PEG, ratio of nearly 2.

That's also a premium to the PEG ratios of fellow online retailer Overstock.com (Research), which trades at 1.8 times its growth rate, as well as online search giants Google (Research) and Yahoo! (Research), which have PEG ratios of 1.4 and 1.7, respectively.

"We believe Amazon will lack any catalysts to move it higher and we consider the stock overvalued compared to peers," Piper Jaffray analyst Safa Rashtchy wrote in a recent report.

So as Amazon.com gets ready to celebrate its 10 years, investors might want to start asking if the next 10 will be as kind to the company. Increased competition from online and traditional retailers could hurt Amazon, not to mention online comparison shopping services offered by Yahoo! and Google.

"I have to give them credit. They are pioneers but are they leaders?" said GVA's Garrity. "And one might want to ask the question that isn't it true that pioneers die with arrows in their backs?"

For a look at more Internet stocks, click here.

For more about the latest Harry Potter book, click here.

Analysts quoted in this story do not own shares of the companies mentioned. Legg Mason and Piper Jaffray have done investment banking for Overstock.com but other firms have not done banking for any of the companies mentioned.


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