AMZN - Amazon.com Inc.

[JAllen]

what do the operating margins look like if you overlay them on the same chart?

 

 

Everyone knows that operating margins are essentially zero.  Do you believe this is the only thing investors should consider and that GAAP numbers portray the truth?

[dwy000]

No, but I believe operating margins are more important than gross margins.  Just like I believe that free cash flow (after adjusting for stock based comp) is more important than GAAP earnings.

[PatientCheetah]

just like there are a variety of investment horizons, there are a variety of investor base. in the end of day, we all should do what make the most money for us. thanks to this thread, i am happy with my amazon gains, i understand the speculative element in the investment thesis. If I see a shift in the amzn investor base's belief system, i will be flexible enough to sell.

[JAllen]

I wrote up our notes on today's conference call here:

 

 

http://jallencapitalmanagement.com/amzn-amazon.html

 

 

A couple highlights:

AWS reported usage growth of 90%We believe this is the first time AMZN has reported this figure. Usage growth of 90% with price declines of ~40% to revenue growth of ~55%.

 

AMZN is now expensing $100 million per quarter on original video content alone

Mr. Szkutak stated that AMZN is expensing $100 million per quarter on original video content that AMZN is producing. He also stated that costs are not capitalized (at: 23:25), which we believe is a departure from how other companies that produce their own video content like Starz (STRZA) account for their self-produced content. We believe that AMZN now spends at least $2 billion on video content per annum.

 

[Laxputs]

-Large earnings miss.

-23% growth over last year's quarter.

-Highest gross margins ever at 31%.

-Stock down 10% after hours.

 

It's hard for me to comprehend the amount of investment capital expenditures taking place at Amazon:

-Started an innovative smartphone company.

-Funding pilot programs for Fire TV.

-Massive infrastructure spending at home and abroad (India, China).

-Amazon Game Studios putting out new games.

-Prime music.

-Kindle Unlimited.

-Amazon Fresh expansions.

-AWS expansions

 

The company's revenue can organically grow for years and years at double digit numbers given trends of e-commerce. The company's revenue will also grow from apparent multiple new revenue streams. My investment thesis is based on normalized earnings after expansions/growth spending have stopped. I can't imagine expansions stopping for several years though. I would guess, based on previous earnings margins in several years before the massive fulfillment center expansions and massive growth expansions, they have underlying earnings margins of between 7-12%. And I own a company that is priced around 18-40x normalized earnings that is growing like a weed.  I get rich if the estimation is conservative. I have reasonable returns if it's at the high end.

[dwy000]

Tough quarter.  Same old story:

- good revenue growth;

- gross margin growth but operating margins crushed;

- every category of operating expense increased as a % of revenues;

- negative free cash flow for the quarter (before stock based comp);

- TTM free cash flow of only $1.0bn (again, before subtracting stock based comp).

- guidance that things are only going to get worse on the expense front - op losses of $400 to $800MM?!?!

 

"Other" revenue growth slowed to 38% from over 60% (Other is assumed to include AWS). 

 

Employee count is astounding - up 8,000 in the quarter alone.  Up 35,000 in the past year.

 

The "invest for the long term" thesis may continue to hold for some, but the time frame to convert to "normalized" operating earnings appears to be getting further away not closer.

 

Investor (and stock) reaction would suggest the patience to prove out that thesis is waning.

[LC]

I wrote up our notes on today's conference call here:

 

 

http://jallencapitalmanagement.com/amzn-amazon.html

 

 

A couple highlights:

AWS reported usage growth of 90%We believe this is the first time AMZN has reported this figure. Usage growth of 90% with price declines of ~40% to revenue growth of ~55%.

 

AMZN is now expensing $100 million per quarter on original video content alone

Mr. Szkutak stated that AMZN is expensing $100 million per quarter on original video content that AMZN is producing. He also stated that costs are not capitalized (at: 23:25), which we believe is a departure from how other companies that produce their own video content like Starz (STRZA) account for their self-produced content. We believe that AMZN now spends at least $2 billion on video content per annum.

 

 

thanks for sharing.

[DTEJD1997]

Maybe AMZN is just going to lose a very little bit of money on each sale...

 

BUT

 

They are going to make up for it by doing VOLUME!

[Palantir]

I dare you guys to short it.  ;)

[peter1234]

Maybe AMZN is just going to lose a very little bit of money on each sale...

 

BUT

 

They are going to make up for it by doing VOLUME!

 

You are obviously not a believer.

;D

 

I appreciate and understand the bull case but would like to see evidence.

 

Being such a large cap that needs to compound at double digit rates over a long term just makes it a tough proposition.

;)

[saltybit]

Amazon to Make It Easier to Buy Its Ads With Self-Serve Tool

 

http://adage.com/article/digital/amazon-make-easier-buy-ads-serve-tool/294243/

 

Amazon doesn't disclose its ad revenue, but eMarketer estimates it pulled in $707.7 million from advertisers last year.

 

[JAllen]

The "invest for the long term" thesis may continue to hold for some, but the time frame to convert to "normalized" operating earnings appears to be getting further away not closer.

 

 

But we've only been talking about it for a single quarter - so being disappointed or surprised that they didn't make money this quarter (not saying you are but others are) is just flatly ignoring what the company repeatedly states over and over.  Some of us are thinking in terms of 40 quarters.  There was frankly nothing really to take away from this quarter except for AWS price declines, AWS usage, Prime sub. strength and growth pretty much the same as it has been for a few years.

 

 

You either think long-term and get that and believe that that's how they're investing or you don't.  And it seems that the vast majority of individuals don't, and that's of course fine.

 

 

I on the other hand am thrilled with how they're running their business, the underlying fundamentals and will probably buy some more tomorrow as the rest of our portfolio has gone up recently so AMZN has shrunk to just a massive position  ;D

 

It seems that the truly long-term approach is so unique that it's nearly impossibly to grasp.  This is what makes it so good for those that believe in it and are practitioners of it.

[JAllen]

So we know that AMZN doesn't show much GAAP/net/headline profitability, we can all agree on that.

 

 

I think we could also agree that AMZN is consistently growing sales at ~22% and gross profit at ~33%.  I don't know what I will do if we disagree on this...

 

 

Here's the question: Do you see something on the horizon that will cause AMZN's sales growth to change?  Do you see an offering that is nearly as good or better?  Is there a retailer with a comparable selection, consistently competitive prices, amazing service, and free two-day shipping and getting faster?  Is AMZN's approach on the verge of being disrupted like RIMM was in 2007-2008?

 

 

I ask because it would be hard for me to have the cognitive dissonance of something like 'This stock is unattractive to me because it doesn't show current profits but I can't see anything on the horizon that will cause its sales growth to slow or reverse'.  Those two things wouldn't sit well in my head.  You can be disappointed all you want with AMZN not generating current income, and that's understandable - I totally agree that buying stocks for 5X current net income is super fun - but don't you think that at some point with the continued sales growth and expansion in their 3 main (large) businesses that they will be profitable at some point, perhaps not super far into the future?  How can you believe one and not the other? 

 

 

Or does it come back to the long-term/short-term perspective thing again?  This seems to be the insistence that stocks investors own have to show positive net income now or soon/on the horizon.

 

 

 

[JAllen]

 

Another question I have is: Do you believe that AMZN is truly the only company on the planet that can't and won't generate material profitability with hundreds of billions of dollars of sales? 

 

Here's a company that says they don't care about current profitability, they're investing heavily - more heavily than they did for a decade prior to this current period.  And they continually harp on the fact that they're not managing the business for current earnings and they also don't indeed generate much current earnings.  They do and say all of these little things like put the cash flow statement first and republish the first annual letter that says 'I will always take the cash flows over profit'. 

 

The implication from naysayers are that even though they say they're intentionally managing the business this way, they're actually lying and just covering something up for some reason (people have actually stated things like this with more euphemistic words) .  Amazon management isn't credible.  They don't have a massive track record of success.  This isn't the way to run a business.  Amazon doesn't have any sort of moat and that if they raised their prices at all people would flee the company.

 

They've managed their business this way and said these things for years, yet it's a surprise that they aren't generating income. What's more is that not many people seem to believe that it's ever possible. 

 

Why don't more people believe Bezos, someone who has been fabulously successful at what he's put his mind to? He's managed to disrupt and dominate no less than three industries in 20 years.  This is an incredible feat.  How many others have disrupted more than one?  You can count them on one hand.  But no one believes that his company will be profitable?  This astounds me.

 

Wouldn't it be an unprecedented occurrence for a company to consistently not generate income on this level of sales?  It's not a lack of scale, is it?  They have 100 fulfillment and sortation centers (which are yet another recently discovered use of many hundreds of millions of dollars of capex over the last couple of years). 

 

The largest e-commerce company in the world (that actually fulfills orders) just can't generate a profit because users only use it because its prices are so low (which is disproved by gross margins of 31% versus WMT's 24%) and that if they raised prices 5% they would suddenly start trying to buy all of their stuff on walmart.com or deciding to visit multiple stores to purchase what they need?

 

Is it a coincidence that AMZN doesn't generate a profit and management says they don't currently intend to or is it possible that this is actually what they are doing?

 

Is AMZN's long-term strategy working or not?  I think it is.  I think it would be a huge mistake to raise prices at AWS or elsewhere.  Why not widen the moat instead?

 

Late night rant over...

[JAllen]

Ok one more.

 

 

One thing we haven't discussed is how AMZN sells e-books for less than what they cost (so negative gross margins on these sales).  This is to build and widen the e-book moat.  This is paradoxically a smart thing to do.  Publishing is moving towards AMZN.  Amazon pays authors way better than the legacy publishing houses do.

 

 

This is another thing that artificially depresses current income but is designed to build a long-term moat.  This is one of the many reasons there's not much GAAP income.

 

 

Does anyone think this is a wrong approach?  If you do, that's fine, I know it's hard to truly think with the long-term in mind.  That's why there's so much controversy surrounding AMZN. 

[Palantir]

Allah be praised!

 

AMZN is down 11%, need to buy more.

 

I feel analysts might be focusing on the Cloud number. That is interesting.

[Vish_ram]

Ok one more.

 

 

One thing we haven't discussed is how AMZN sells e-books for less than what they cost (so negative gross margins on these sales).  This is to build and widen the e-book moat.  This is paradoxically a smart thing to do.  Publishing is moving towards AMZN.  Amazon pays authors way better than the legacy publishing houses do.

 

 

This is another thing that artificially depresses current income but is designed to build a long-term moat.  This is one of the many reasons there's not much GAAP income.

 

 

Does anyone think this is a wrong approach?  If you do, that's fine, I know it's hard to truly think with the long-term in mind.  That's why there's so much controversy surrounding AMZN.

 

 

Once they built the moat and became a monopoly, the Govt may step in. They'll end up without getting the return that they sought for.

[dwy000]

We have only been talking about it for a quarter but the trends have been going on for many years.  If the thesis is that they will eventually be able to cut the spend or raise prices and this becomes a wonderful cash flowing investment, my,point is that not only are they heading in the wrong direction but that it is getting worse. The deeper the hole, the further you have to climb to get out of it.

 

I get the 40 quarter view.  I do.  The problem with it in my mind is that's been the argument for 20 years now.  At some point the long term thesis needs to turn into results but it just keeps being a long term thesis with no end in sight. What happens if 40 quarters from now they still aren't profitable and say they are investing for the long term?

[JAllen]

Amazon had 10% FCF margins four years ago so it hasn't been twenty years, unless you care more about operating income than FCF.

 

 

Similar FCF margins now would result in FCF of $9B or and the market cap./FCF multiple would be 16X.

[JAllen]

Once they built the moat and became a monopoly, the Govt may step in. They'll end up without getting the return that they sought for.

 

There's not much precedent for actually breaking up monopolies in the U.S.  Standard Oil and AT&T come to mind, both of which actually had monopolies. 

 

WMT is 10X larger than AMZN as a percentage of retail sales in the U.S.  There hasn't been even discussion of breaking WMT up.

 

They might achieve a monopoly with books, but I doubt that will happen with retail or computing.  I'm guessing books will be a $30B industry (it's ~$15B now).  They could break up the book business and we could still do very well.

 

Monopolies are 40%-100%.  They have a retail share of 1% now so let's hope that share grows to something like monopoly status  - 45% of retail  - but that just won't happen (would be 3X my most optimistic expectation).

[Palantir]

In Q2, we had usage growth close to 90% year-over-year for the quarter.

 

Other revenue in NA was 1168. Assuming a price cut of 25%, which is on the low end, that implies without the price cut, the revenue would have been 1168/0.75 = 1557. Which means usage growth of 1557/844 = 84.5%, which matches their figure, considering I used a smaller discount.

[dwy000]

In Q2, we had usage growth close to 90% year-over-year for the quarter.

 

Other revenue in NA was 1168. Assuming a price cut of 25%, which is on the low end, that implies without the price cut, the revenue would have been 1168/0.75 = 1557. Which means usage growth of 1557/844 = 84.5%, which matches their figure, considering I used a smaller discount.

 

I think it's tough to extrapolate usage and revenues.  He sidestepped the question a bit on the call but if the usage figure referred mostly to storage - which is effectively free - then the numbers won't tie and the metric isn't meaningful.  But if usage referred to analytics and computing then that's going to be higher revenue business and is very positive.  They won't give details though.

[dwy000]

JAllen.  You asked a couple of questions.  But first, my comment on the past 20 years is that they have said "focus on the long term" for 20 years.  They got to FCF positive briefly and then immediately turned it around.  I question (don't think) they can get back there.  When does long term become now?

 

Is something going to cause sales growth to change?

 

A couple of things there.  a) size ultimately.  It's tough to grow 20% indefinitely at $100bn in revenues.  The fruit is higher and higher up the tree and the investment required to get them gets higher and higher  b) competition - already happening on AWS as price is offsetting volume growth but other retailers are starting to get their act together (Walmart grew online 30% last year, Alibaba is coming, etc.);  c) most importantly!!!!  I firmly believe the only way they can continue the growth is if they maintain a focus on sales over profits.  The minute they shut off the freebies, cut spending or raise prices, they lose their competitive advantage and growth will slow substantially or stop.

 

Do you believe that Amazon is the only company that cant/wont get material profitability on multi $-billions of sales:

 

Well actually there are lots of billion-$ retailers that can't or don't make money (Sears, JC Penney, Radio Shack, etc).  Many, many in the retail graveyard.  The question of whether Amazon can is still to be seen.  They certainly aren't showing a willingness to even try.

[dwy000]

I also want to reiterate - I think Amazon is a fantastic company.  I use them regularly.  I would even invest in the stock very happily given the moat I think they have.  But anything near today's stock price just doesn't make sense to me.

 

Market cap is over $150bn and there's $1bn of FCF.  If you are investing for the next 40 quarters, to get say a 12% annualized return on your investment (which is not excessive given the time and risk) implies that in 10 years the market cap will be $520bn.  Assuming that it is then trading off of a FCF multiple (and not still a revenue multiple with no profitability), even at a 20x multiple implies $26bn of FCF.  That's a MASSIVE assumption for only 12% annual return.

[JAllen]

AMZN generated 5-10% FCF margins for a number of years.  But then that stopped right when they massively increased the growth rate of FCs etc.

 

 

The retailers you cited above made money for many years.  They didn't not make money in every single year of their existence.  Even Costco earns 3% operating margins on their 13% gross margin.

 

 

They don't have to 'shutoff any freebies'.  I don't watch Instant Video nor do I use the Kindle book library.  That's not why I and many others shop at AMZN.  It's because I trust that I'm getting a good price and what I order will reliably arrive in two days.  I don't even price shop anymore (except for the occasional large ticket item).  I don't listen to the music either. 

 

 

I believe AMZN can continue to grow at comparable rates for a number of years because of its small size relative to retail sales and the fact that cloud-computing is still nascent.

 

 

I'd rather be AMZN than Walmart any day of the week when it comes to e-commerce. 

 

 

Size will ultimately drag on growth, but not for ten or more years.

 

 

The FCs and logistical knowledge are competitive advantages.  The Kiva robots are competitive advantages.  The Kindle ecosystem is a competitive advantage.  The dozens of applications they've built for AWS are competitive advantages. The fact that I don't price shop and now think of AMZN when buying pretty much everything except for food and some clothes is a competitive advantage.

 

 

The logistical stuff takes years to figure out and build.  If they stopped tomorrow they would still have lower costs and better knowledge at this stuff than anyone else.  But why would you ever want to stop when you could have more in the future? 

 

 

WMT is good at the retail store model, but AMZN handles 100X the number of items and e-commerce ultimately presents different logistical challenges.