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The Day Ahead: Dot-com woes dash Amazon's revenue hopes

Reliance on dot-com investments unlikely to pay off for Amazon, say analysts
Written by Larry Dignan, Contributor

Just about six months ago, Amazon.com rattled off six equity and marketing deals that had analysts gushing. Since Amazon's margins are generally thin, the company planned to have e-tailers such as Drugstore.com pay lofty sums to gain access to Amazon's customers.

"Amazon has signed six new equity/ marketing deals representing an aggregate of $500m in high margin revenue ($130+m annual). We view these deals as an excellent way for Amazon to monetise its greatest asset -- its customer base," said Merrill Lynch analyst Henry Blodget, in a February research note.

Blodget was so pumped about this high-margin revenue stream that he even reckoned that Amazon could be profitable in 2001. The Amazon Commerce Network was going to be huge -- really huge. Now let's fast forward a few months.

"We have been disappointed by the company's ability to monetise its customer base. To date, Amazon has announced several deals with pure play dot-com companies. We are concerned that most, if not all of these companies will be unable to pay Amazon in future years," said Lehman Brothers analyst Holly Becker in a research report on Wednesday.

By the way, she "threw in the towel" on Amazon.

And now Amazon has admitted its dot-com pals can't pay up. Officials said Amazon second quarter earnings conference call Wednesday that the company would have to renegotiate its contracts with its dot-com tenants. Why? "Changing circumstances," said Amazon chief executive Jeff Bezos. That's putting it mildly.

E-tailing stocks stink (just ask Amazon shareholders) and the free flow of capital has dried up. Simply put, Amazon isn't going to get its money. To make matters worse, Amazon took equity stakes in its partners. Now Amazon has a pitiful portfolio and no high-margin revenue stream. As Yahoo! and America Online cushioned the dot-com woes with big offline partners, Amazon focused on pure play e-tailers. Here's a look at some of the deals that may be renegotiated:

Ashford.com in December 1999 signed a multi-million dollar deal to partner with Amazon, which took a 16.6 percent stake in Ashford. The luxury e-tailer reported its earnings this morning and ended the second quarter with $38m. It also established a $25m line of debt financing.

Greenlight.com on 21 January agreed to pay Amazon $82.5m over five years. Amazon took a five percent stake with the option to bump its stake up to 30 percent. Greenlight.com was probably thinking an IPO could pay the bills.

Drugstore.com on 24 January said it would give Amazon $105m over three years. Amazon has a 28 percent stake. At the end of its first quarter, Drugstore.com had $174m in cash. We'll soon find out how much it burned in the second quarter.

Audible.com on 31 January said it will pay Amazon $30m over three years. Amazon took a five percent stake. Audible, which reported earnings Wednesday, had a little more than $10m in cash at the end of the second quarter.

Living.com on 1 February said it would pay $145m to Amazon over five years. Amazon took a 18 percent stake with warrants to acquire an additional nine percent. The company was obviously hoping for a big IPO. It isn't going to happen. Amazon execs said they disclosed the renegotiations because they didn't want investors to be surprised. There'll be a lot more disclosure to come.

Amid a falling stock price, sales growth that impressed no one and more vague projections about a push to profitability, Bezos did his best profit pitch Wednesday night.

Bezos said Amazon's investor relations staff was bombarded with questions about chief operating officer Joe Galli's departure to VerticalNet. Galli represented profits and Bezos represented growth-at-any-cost losses forever.

Bezos said he merely suffers from a "perception issue".

"As chief executive I'm relentlessly committed to driving profitability, efficiencies and balanced growth," said Bezos, who added that half of the company's technology spending is allocated to boost profits.

Gee, I wonder why investors think Bezos wants nothing to do with profits. Maybe it was the PC Expo speech a few weeks back where he joked about the company's money losing ways. Maybe it was the endless conference calls where Bezos wouldn't even mention the "p" word. Maybe it's the fact that Amazon made losing money cool.

Maybe it's the fact that Amazon still won't project a profit date. Morgan Stanley analyst Mary Meeker tried to pin a profit date on execs, but Bezos and company said they were too focused on the next two quarters to get specific.

Aside from his "personal reasons" for leaving Amazon, Galli at some point had to project where Amazon shares were heading in the long run. Galli had to make his own market call. According to his employment letter, he received $200,000 in annual salary, a $7.9m signing bonus over three years (roughly $5m was left on the table), and a boatload of options.

Specifically, Galli had two 20-year option grants. Under the two grants, Amazon granted Galli the option to buy 1,960,000 shares over 20 years. The catch was the options had a strike price of 56.813, the price of shares on 24 June, 1999, the day Galli started at the company. Galli's options went underwater in April and never really recovered.

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