A Question of Cash at Amazon.com
Barron's Online, Feb. 21, 2001


Who would have thought that something as pedantic as the cash flow analysis of an online retailer would spark a raging debate in the popular press?

OK, perhaps the debate isn't exactly raging. But the scrutiny of Amazon.com's cash burn by Lehman Brothers bond analyst Ravi Suria has performed a public service. While we honestly think that liquidity analysis is about as titillating as watching paint dry, Suria has inspired brokerage equity analysts to show us the money in their spreadsheets and has forced bullish investors to face harsh realities regarding the company's sputtering growth and dwindling cash. Indeed, Prudential Securities analyst Mark Rowen issued a "sell" rating on Thursday.

Last week, we foreshadowed a rebuttal by Henry Blodget to Suria's forecast of a creditors' squeeze play. Since then, Blodget has obliged by publishing a sunny contrast to Suria's pessimistic prediction for Amazon. Sure enough, many of their assumptions are contradictory, which unsurprisingly has produced conflicting conclusions. But this exercise in feeling the burn has prompted Blodget to make some subtle admissions that may reveal a darker side, which we will get to later.

First, we would like to point out that all of this hoo-hah about yearend cash isn't nearly as telling as counting cash at the end of the first quarter. Regardless of whether it was by accident or by design, the fact that Amazon's fiscal year mirrors the calendar year is a stroke of brilliance. It also happens to run counter to retail industry norms. Most retailers operate on a fiscal calendar that ends in January or February so that the companies can pay their vendors for the merchandise it sold during the holiday-driven fourth quarter.

That way, the yearend financial snapshot provides a more useful and accurate picture. Contrarily, in the case of Amazon, it helps the company distort its fiscal prowess by showing abnormally high cash balances at the end of the quarter.

As for most any retailer, the fourth quarter is hyper-critical and accounts for huge revenues. But most retailers settle their debts to their vendors before tallying up the results for the quarter. Not so for our friends at Amazon, where the company will not have to subtract its holiday debts from income until the first quarter of the following year. Presto! A higher cash balance appears for the final quarter of the year but diminishes during the subsequent quarter when the bills get paid.

That's why, with everyone talking about Amazon's cash-or lack thereof-we think its interesting to look at what Amazon's elusive cash position would look like at the end of March. Last year, Amazon reported about $1 billion in cash after paying off its Christmas bills (and that included about $680 million raised by a controversial convertible bond deal earlier in 2000). But Merrill's Blodget predicts that the Seattle e-tailer will have only $567 million in greenbacks come the end of March this year. The upshot: Amazon could easily blow though more than 400 million bucks during the 12 months ended March 31. It smells like something could be burning up in Seattle, and we don't suspect it is books.

Of course, the bull line is that the company is buckling down and focusing on execution with an eye toward pro-forma profitability. But for all of the misplaced hype about an eminent faux profit, the reality is that Blodget is forecasting a GAAP net loss of $1.3 billion in 2001. "That is one of those numbers that's so majestic, you almost have to just sit back and appreciate it for a while. It takes some real effort to lose $1.3 billion, especially after losing $1.4 billion in the prior year," says hedge fund manager Eric Von der Porten of Leeward Investments in San Carlos, California.

Scores of companies are in business for many, many years and never manage to achieve such jaw-dropping losses.

Of course, the $1.3 billion is that silly accounting standards-base d number that incorporates plant closing costs, investment losses, goodwill charges and such. Meanwhile, the "cash" loss is estimated at, ahem, a meager $317 million, or 87 cents a share. Still, that's up from the $235 million, or 63 cents, Blodget was expecting a week or so ago.

Even at $317 million, Amazon would be losing nearly 10 percent on each sale, Von der Porten asserts. "Why not just tape a $10 bill to each $100 shipment and make everyone happier?" he says.

Getting back to Blodget's analysis of the analysis, the man from Merrill's primary objective was to demonstrate that Amazon is not vulnerable to a cash crunch, which was Suria's primary contention. To that end, he does a credible job of evaluating working capital requirements for the rest of the year, illustrating that as long as creditors cooperate, cash should be adequate.

But what puzzles us is how, on January 29, he estimated in a research note that "the cash balance will bottom around $700 million in the first quarter and increase from there." Then, on January 31st, he forecasted that cash "should bottom at $650 million-plus in the first quarter." But he wasn't done with his eraser. On February 12, Blodget predicted that "Amazon's cash balance will bottom in second quarter or third quarter at more than $400 million."

What's a few hundred million dollars among friends? To be honest, we could not figure out how Blodget in his pre-February notes could expect the company to increase its cash during the second and third quarters while losing money. Perhaps, Suria's research has made it evident to him that it can't. In fairness, in Blodget's latest note, he qualifies the "more than $400 million" with the caveat "probably much more." Nonetheless, that's still a galaxy away from his initial forecast and now he thinks cash will hit bottom in September. We dialed up Blodget, who is always accommodating and accessible for our thorny queries, to ask for an explanation for the plunging projections. "I didn't think the Lehman report was silly, and I just wanted to be very conservative" with this working capital model, Blodget says.

However, he added that new information revealed by the company during its quarterly financial call sprung a few small surprises. "Losses were higher than we expected and revenues were lower," he says. He also notes that working capital was generating less cash than the previous year and that a $50 million restructuring charge caught him off guard.

Fair enough, even if one of the revisions came immediately after the company's quarterly call. But working capital and cash aside, Blodget's balance sheet model has some critics scratching their heads, including Von der Porten, who has owned Amazon puts from time to time. Given Blodget's assumption for a standard accounting loss for the year, shareholders' equity should logically fall from a negative $967 million at the end of 2000 to a negative $2.3 billion at the end of 2001. But Blodget's balance sheet shows than number slipping down only to a negative $1.3 billion.

The ramifications are that if Blodget plugged the GAAP net loss figure from his own income statement in to his model, his balance sheet would show assets of $1.1 billion versus liabilities of $3.3 billion. Instead, Blodget forecasts that Amazon will have $2 billion of assets at the end of the year against the same $3.3 billion in liabilities. "We projected shareholder equity from our cash flow statement instead of the income statement, 1/8 which 3/8 for the purpose of projecting cash values is fine," Blodget explains. It may be fine, but it is somewhat unusual, Von der Porten noted. If he had used the GAAP net loss as most accountants would, liabilities would be a precarious three times assets.

"There are very few companies-much less retailers-in the history of American business that have thrived with liabilities three times the level of the company's assets. Regardless of whether cash lasts through yearend or not, that's a deeply troubled financial position," Von der Porten argues.

Von der Porten had some other bones to pick with Blodget's report, which estimates that Amazon's pro forma loss in 2002 could be as low as $74 million, or a net loss of $634 million. To arrive at that conclusion, however, Blodget shows interest expense declining from $132 million in 2001 to $80 million in 2002. "Given that Amazon has no ability to repay debt, that interest income on cash balances is declining, and that the company's convertible bonds are in no danger of converting to stock any time soon, that seems to be a preposterous assumption," Von der Porten asserts.

Still, Blodget's primary goal in issuing his latest report was to argue that Amazon's cash will be fine, and its vendors will not put pressure on the company. "I just don't think you'll see that," Blodget says.

But we wonder whether the staunch Amazon bull is showing glimpses of doubt judging by his comments on the cover of his report: "We continue to believe that the major issue for Amazon's stock is decelerating revenue growth (and, therefore, valuation), not cash and, or, liquidity. This said, it is unfortunate that a company as strong as Amazon has gotten itself in a position where it is even possible to argue that liquidity is an issue."

Not exactly a ringing endorsement.