Fifteen Years Of eCommerce

Almost 15 years after the advent of the Internet browser in the mainstream market, it is interesting to see how the major eCommerce companies have progressed. Each pioneers in their original niches, are today starting to step on others toes. Amazon’s logical progression will inevitably lead them into Netflix’ territory. They are already squarely in eBay’s.

The end of this movie is yet unknown. Will Amazon eventually end up acquiring Netflix?

This quarter was surprisingly good for all three online players. Amazon, eBay and Netflix announced their results last week, and all of them seem to have performed better than expectations. In fact, Amazon seems to be finally edging its way out of a business model in which they were facing serious bottom-line challenges. What is all the more surprising is that they are doing it in this sordid economic climate.

Q1 revenues of $4.89 billion grew an impressive 18% over the year with EPS of $0.41 compared to $0.34 earned a year ago. The market was looking for revenues of $4.75 billion with EPS of $0.31.

By segment, media revenues grew 7% to $2.72 billion while electronics and other general merchandise revenues grew 38% to $2.05 billion. Within the segments, they saw significant growth in third-party business and Kindle sales. Amazon continued to remain silent on details of Kindle sales but did say that the number was higher than their expectations.

During the quarter,  Worldwide unit sales grew 30% with the active customer count growing 16% to cross 91 million. Worldwide active seller accounts grew 19% to over 1.6 million. Seller units were 32% of total units versus 30% the previous year.

By region, North American revenues grew 21% to $2.58 billion with Media revenues growing 8% to $1.31 million and EGM revenues growing 42% to $1.17. International revenues grew 15% to $2.31 billion or 28% in constant currency terms. International Media revenues grew 6% to $1.42 billion and EGM revenues grew 44% to $0.87 billion.

For Q2, however, Amazon is looking at revenue growth of 6%-17% to $4.30-$4.75 billion compared to analysts’ expectations of $4.60 billion. They are targeting operating income to be between $0.11-$0.19 billion or a fall between 49%-12% over the year. A cautious outlook.

Their strategy regarding fulfillment centers is not one I am in favor of, but they continue to work on this low-margin offering. During the quarter, Amazon managed to realize additional vendor savings through bulk shipments which vendors send to the nearest Amazon fulfillment center. Some of these savings are passed on to end customers via discounts. While the strategy might play off well in the current times, I stand by my thought that Amazon needs to move to some luxury product ranges to ensure that they take margins higher. Another Seattle company Blue Nile could be a good acquisition. They are struggling in this market, but are a very good business nonetheless.

Amazon’s stock has already risen over 30% since the last results announcement and is trading at $84.46 with a market capitalization of $36.20 billion. In fact, it is nearing its five-year high of $91.75 even in these times. Quite an amazing performance!

eBay’s performance was less bright than Amazon’s. Q1 revenues of $2.0 billion were marginally higher than the Street’s expectations of $1.9 billion but declined 8% over the year. EPS of $0.39 was also higher than the Street’s expectations of $0.34 but fell 7% over the year. This is their second-ever year on year EPS decline.

eBay’s core auctions business revenues fell 18%, to $1.2 billion, which was led by a 20% fall in the GMV. This was despite some big offers such as free shipping on nearly 30% of items sold on the site.

Their online payment segment, PayPal and Bill Me Later, continued to perform well and with revenues of $0.64 billion, this segment now accounts for 32% of eBay’s overall revenue. During the quarter, the segment added 22% registered users, taking its total to nearly 73.1 million. PayPal is now also being used by third party e-commerce sites such as Sears and continues to enjoy a near monopoly in the segment.

Skype also performed very well: revenues grew 6% to $0.15 billion and the company added 37.9 million users. Skype also announced a new application for Apple’s iPhone and iPod Touch devices which is installed on nearly 6% of the devices. eBay is finally getting out of Skype. It took a long time, but I am glad to note that John Donohoe’s strategy to turnaround eBay includes spinning off Skype through an IPO. Besides Skype, eBay is also divesting StumbleUpon.

According to ComScore, Amazon had 60 million visitors on their shopping site compared to 50 million a year ago. Comparatively, eBay had 70 million visitors, down from 80.1 million a year ago, clearly showing how Amazon has the potential to overtake eBay. I have not been bullish on the latter for a while now, and have been anticipating this all along. 

During the quarter eBay announced their intention to acquire Gmarket to expand their presence in the Korean market. eBay expects to use Gmarket’s innovative, competitive platform and the combination of IAC, and their current Korean marketplace business to gain a powerful foothold for long-term growth, both in Korea and in Asia overall.

Going forward, they expect to generate revenues of $1.85-$2.05 billion and EPS of $0.34-$0.36.

The stock is currently trading at $16.78 with a market capitalization of $21.53 billion. I like the fact that John Donohoe is starting to deal with mistakes such as Skype. But it is still unclear where eBay is headed. Is acquiring MercadoLibre part of their strategy? It could certainly give them an excellent growth engine in Latin America.

Netflix also continued with last quarter’s outperformance of market expectations. Q1 revenues of $394 million were higher than the Street’s view of $391 million and grew a significant 21% over the year. EPS of $0.40 was higher than the market’s expectations of $0.35 and grew 76% over the year.

In the quarter, Netflix’s subscriber base increased nearly 10% sequentially to 10.3 million. The addition of 920,000 net subscribers was the largest ever addition in the company’s history.

During the quarter, they spent $43 million on repurchasing 1.2 million shares at an average price of $36.29 per share. They are looking at additional repurchases worth nearly $132 million for the entire fiscal.

They expect revenues in the range of $403-$409 million in the coming quarter, with their subscriber base growing from 10.3 to 10.4-10.6 million by the end of Q2. They raised their outlook for the year to $1.63-$1.67 billion from the previous $1.58-$1.64 billion. They are expecting the subscriber base to go up from 11.2-11.8 million as against earlier estimates of 10.6-11.3 million.

Netflix continued with their investments with the CE manufacturers and hope to form tie-ups so that within a few years, all Internet-connected CE devices to be sold will include a Netflix streaming client.

They have also been investing to help reduce costs. For instance, recently they moved their central operations distribution center from the higher-priced Sunnyvale, California region to a lower-cost and larger space outside Columbus, Ohio. They are perfecting the automated optical inspection of returned disks to help determine more accurately which disks need to be discarded, repaired or sent back to another subscriber to help reduce the number of disks they scrap. Finally, they are working out logistics to help move from a 5-day to a 6-day shipping model.

Netflix is, however, facing stiff competition from the DVD rental kiosks operated by Redbox. These kiosks are located in areas which have significant foot traffic, and Redbox charges only a dollar a day for movie rentals. Netflix is aware that with further refinement to the system, the kiosks will be able to earn profits while supporting lower-traffic locations and will, in the next three years, be present “in every 7-Eleven, every Starbucks and every airline gate”. In fact, Netflix’s churn rate has gone up from the previous year’s 3.9% to 4.2%, and they have seen exiting subscribers talk more about kiosks as the reason for moving out.

But they are not too concerned about the kiosks because the kiosks focus on new-release DVDs, which constitute only about one-third of Netflix’s rentals. Netflix is convinced that their differentiators will be their selection of over 100,000 titles and the ease of ordering movies through the mail and streaming content on the Internet. In support of that belief, they are continuing to invest in streaming content and are looking at spending heavily on marketing their movie download service to be able to compete with the likes of Apple and Amazon.

The stock has been performing well and recently reached a new five-year high of $50.24. It is currently trading at $42.73, taking its market capitalization to $2.51 billion.

Every time I look at these businesses, they remind me of John Doerr’s famous quote: The Internet is underhyped. To think that most of the world – large parts of Asia, Africa, Latin America, China – are not yet on the Internet – is a sobering thought. Can you imagine how many more significant businesses are yet to be built as the next billion gets online?