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Stock Analyst Update

Amazon Gets Pummeled on Debt Concerns

Analyst has harsh words for the e-tailer's leveraged balance sheet.

Shares of Internet retail giant (AMZN) were down more than 20% Friday after a series of negative analyst reports sent the stock reeling to its lowest level since December 1998. An apparent ripple effect was pulling down other e-commerce stocks as well, but this is probably an overreaction, since many of Amazon's problems are tied to its unusually heavy debt load. That debt has always been a risk for Amazon, but the stock's recent slide has made the problem worse.

A scathing report Friday morning by Lehman Brothers bond analyst Ravi Suria hit Amazon with the biggest body blow. The money-losing company has issued about $2 billion in long-term debt to fund its operations until it can become profitable, but Suria's report cast doubt on Amazon's plan. He called its credit "weak and deteriorating", and pointed to Amazon's "weak balance sheet, poor working-capital management, and massive negative operating cash flow--the financial characteristics that have driven innumerable retailers to disaster throughout history."

The report comes on the heels of comments by influential Internet analysts Mary Meeker of Morgan Stanley and Henry Blodgett of Merrill Lynch, both of whom said that they expect Amazon's sales growth to be weak over the next two quarters.

Most of Amazon's debt is convertible, meaning that the company can convert it into stock at a preset price. This financing option was popular last year with Internet companies with soaring stock prices, since it allowed them to issue "debt" that could be repaid by simply issuing more shares. The downside is that if the stock price falls too far, the company can't convert the notes, and it's stuck with real interest payments and real debt that has to be repaid in cash.

That's the situation Amazon is finding itself in. Its $1.25 billion convertible debt offering from last year has a conversion price of $78 a share, while its $600 million euro-denominated offering from this past January has a conversion price of about $95 a share, reducible to $77 under certain circumstances. With Amazon trading at around $33 a share after Friday's slide, it's now a long way from being able to convert those bonds.

Meanwhile, it's shelling out around $100 million in annual interest payments to its bondholders. True, Amazon has about $1 billion in cash, mainly from those debt offerings. But it's spending money at the rate of $1.3 billion annually, meaning it could run out of money within a year unless it cuts expenses or finds more financing.

None of this is news to savvy investors, but the Lehman report seems to have awakened the market to the very real risks Amazon faces. Even though Amazon is by far the strongest e-tailer in terms of name recognition and the size of its customer base, its heavy debt load sets it apart from other online retailers, most of whom have little debt.

These other companies have problems of their own, and many of them will not survive the shakeout which has already started putting some e-tailers out of business. But many people are now starting to think that Amazon's reliance on debt may backfire and cancel out many of the advantages it enjoys. It's the clear leader in e-commerce right now, but its long-term viability is by no means guaranteed.

David Kathman does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.