AMZN - Amazon.com Inc.

[saltybit]

Many brick and mortar stores are struggling right now. I think Barnes and Nobles is the only national book stores left. Some of their problems undoubtedly has to due with AMZN. AMZN is investing in margins right now. It is not inconceivable that when enough brick and mortar stores go under, like any other monopolists, AMZN will probably rise prices.

 

They can also get lower cost of goods as a result of their suppliers not having as much leverage with them. (once enough brick and mortar stores go down)

[JAllen]

JAllen,

 

The ROTC is certainly phenomenal.  No argument.  But the stock is trading at 1400% of Tangible Capital which takes the return on YOUR capital invested very low.  Again, my argument is not the quality of the company but the price of it.

 

We also welcome having our assumptions challenged.  That is a primary motive of posting them here.

 

I wish AMZN had less tangible capital - that would make it an even better business. The automation and software component, not to mention the fact that they don't even own all of the warehouses make AMZN's relatively lightly capital-intensive business (historically lightly capital-intensive that is) very attractive to us.  The best businesses have no tangible capital - money managers, Moody's, etc.

 

It's nitpicking but I'd take the other side on a couple of your assumptions.  First, the concept of maintenance vs growth capex and looking back to 2010 as a basis for maintenance.  Unless Amazon decides to stop growing they are going to need to invest in growth capex and those $ comes straight out of free cash flow.  Also, Amazon has never broken out it's capex spend between maintenance and growth or even that related to AWS vs the retail business.  It's a dangerous assumption (from an investing perspective) to assume that 2010 capex levels can be used as a proxy for maintenance.  For example, they opened 12 new fulfillment centers in 2012 that cost $1.4bn (within capex) - but they still spent $2.4bn beyond that.  And the number was $3.4bn in 2013 and I don't believe they opened another 12 new centers.  Either way, unless you assume growth stops, it's inconsistent to assume growth capex stops.

 

 

It's very much about eventual FCF per share for us.  I'm only 33 so I think to myself: 'which stocks are going to make me and my investors rich over the next twenty years?'.

 

 

And we looked at 2002-2009 for our capex margin, not just 2010 (which is the year spending started to really ramp).  If the capex margin was 8% from 2002-2008, and then 2% in 2009, it would be a mistake to use 2% as our capex margin estimate.  But it was never much above 2% for 8 years in a row, during a time when AMZN was rapidly growing.  AMZN was only spending a couple hundred million a year.  This is why we have conviction about the true maintenance number being in the low single digits.  It was a revelation seeing how little AMZN was spending prior to 2010 for us.  I don't think this can be said enough and it's crucial to be fully aware of to share most of our views about AMZN.  Their capital spending went up literally ten times in four years (from an average of $350M in 2008 and and 2009 to $3.4B in 2013).  Look at how consistently little AMZN spent prior to 2010.  What has changed since then?  Has their business become more inefficient?  Are they less automated now than they were then or more?  Do they have less leverage with suppliers?  Have their infrastructure costs gone up?  I don't know what changed then, but something serious changed internally.  Probably some of it was the U.S. sales tax issue, but spending just really took off then.

 

The second point I'd nitpick with is the opex and that it is inflated due to one time growth initiatives.  It's true that current gross margins less historic opex equate to 13% but that's comparing apples to oranges.  I guess I will believe that it is truly inflated when I see that they are able to bring it back down to historic levels without impacting either sales growth or gross margins.  I think you also need to take into account that gross margin includes growing AWS which is a low COGS, high opex business - so that will inflate gross margins but require an ongoing increased level of opex.

 

 

I agree that the opex is not inflated because of one-time growth initiatives.  They are intentionally investing tons to grow more in the future, which was always been the goal.  Over time, they will have lower operating expenses relative to WMT because of the lack of retail infrastructure.  We're trying to estimate the underlying FCF, and because of the massive spending they're doing, we believe that FCF and operating income are understated.

 

 

We may not be fully accounting for AWS' higher opex.  We'd be happy to learn more about this.  If we use 28% gross margin - WMT's long-term operating expense margin, we still get to 10% op. income/FCF margins though.  We can be quite wrong about AWS's opex and not much off the mark about our company-wide beliefs.  If AWS is $4B in revenues a year and opex is 30% instead of 15% that's less than 1% of sales difference...

 

 

Final point - even if using the $4bn of FCF that you indicated (using $2bn of maintenance capex and $6bn of Op CF), and increasing that by 250% to $10bn in 5 years (and they've indicated no sign of stopping gowth capex) at 20x FCF it's still only a 45% gain over 5 years.  And that's assuming they buy back stock equal to everything issued over the next 5 years.  How are you working the math on the upside for the stock.

 

 

We can't accurately predict what FCF will be in any year.  We believe that it will be higher than most of us realize because of the way AMZN is managed, its first-mover advantage with selection, automation, and driving costs down, and the long runway ahead.  At some point they won't be able to just throw money at stuff and have higher expenses.  The HBO shows are a prime example: just pay HBO $100M a year, save $40 million in taxes and make customers happier.  This is a no brainer for a rational manager like Bezos.  We hope that they keep massively spending so we'll be earning even more down the road and we pay less in taxes along the way.

 

Great discussion even if we don't see eye to eye on it.  I appreciate having my assumptions challenged.

 

 

As do we!  Happy to be discussing the company more and sharing our views.

[dwy000]

Your statement sums it up for both of us..."it's very much about eventual FCF per share for us"

 

Since inception Amazon has put its pedal to the floor on growth at (almost) any cost and lower prices for consumers even if it eats into profits.  While that has led to phenomenal sales growth, it hasn't resulted in much real FCF to date (less than $10bn over the past 5 years combined - excluding stock buybacks and acquisition spend).

 

Ultimately I think that to be a believer in this stock you have to assume 3 things:  a) the strategy they have followed since inception and that has continued right through 1Q this year, will at some point change to one focusing on cash flow and profitability;  b) they can make that transition without impacting sales growth, margins or competitiveness;  c) the impact of a) and b) together have to be so massive that it justifies the current stock price.

 

I personally question whether management will make this transition (although judging by the stock reaction after the 1Q call the decision may get taken out of their hands at some point) and if they can whether the cash flows can justify today's price.  My value investing background and naturally conservative nature isn't willing to make that bet based upon the current stock price.  Too many alternatives that throw off a ton of cash today but aren't necessarily growing that fast - bird in the hand vs. two in the bush.  I guess it takes two sides to make a market.

 

Good luck with your investment.

[JAllen]

This is an interesting read by the founder of Bonobos.  The post is essentially about Amazon and how one can or can't compete with it.  Nice to read an industry-insider's perspective and not an investor's or journalist's.

 

 

https://medium.com/what-i-learned-building/d233f02d52a5

[JAllen]

Someone mentioned that AMZN is a $180B market cap company. It's actually 'only' $140B right now.  This is quite a bit different from a long-term shareholder's and eventual CAGR perspective.

 

 

Also, if I'm right it's $140B/ ~$7B in FCF, growing at the rate of gross profit growth which is consistently 30+%.  So it's a 5% yield growing at 30+%, that can continue to do so for a number of years.

 

 

It doesn't take very many years for that 5% to become quite a larger number as a percentage of purchase price if AMZN continues to grow at anything like 25-30%.

[Laxputs]

When you say they may grow closer to 30% a year, am I correct in saying it is because their gross margins are increasing due to a higher percent of sales coming from 3P and AWS, which offer greater margins due to less Op Ex? How long are you suggesting that growth rate can continue if you use it as a factor in your valuation? I can see revenue growth continuing for a very long time, but gross margin growth will plateau more quickly, no? Is there a chance gross margins can average out to closer to 24% instead of the 28%?

 

Amazon derives relatively minimal revenue from their advertising services: 172m projected for 2014. Google will do 4b. FB 5b. Yahoo 1.2b. Their platforms are different but I believe that Amazon's consumer database information is more valuable given it doesn't say just what they searched for, but what they bought and how long ago they bought it. The ad revenue has grown at 40% for each of the last 2 years and will be interesting to watch.

 

Help me with a valuation range:

 

Very conservative:

78b revenue. 5% net margins. 8.4$/share. Currently 36x earnings.

Grows that 8.4$/share at 15% for 5 years. We would end up with 15% minus the multiple contraction. Going from a 36 multiple to 15 multiple is a negative CAGR of 16% a year (I think). So downside is roughly breaks even?

 

 

Bullish but reasonable:

Gross margins of 28%. WMT Op Ex 18%. Say AMZN are 16%.

78b revenue. 9% net margins. 15.1/share. Currently 20x earnings.

Grows at 25% for 5 years. Is valued at 20x earnings at year 5. We would mimic that CAGR and no multiple contraction.

 

Tails I don't lose much (opportunity costs of investing elsewhere), heads I win a lot?

 

And of course there is the potential that they grow faster, that they make more money from untapped pricing power, cost efficiencies/growing gross margins due to massive investments in massive scale, new revenue streams like Fire TV, more potential hardware, Amazon Fresh, etc. That their actual FCF margin is 10% as it was in previous years with lower gross margins. There are many arguments for the bullish valuation to be much more aggressive.

 

 

 

 

 

[dwy000]

Lax,

 

Where are you getting the 5% net margin?  Their net margin last year was about 0.3% (and negative the year before).  Gross margins have been improving but operating margins have been declining.  Operating, pre-tax margin was 1% last year, 1.1% the year before and 1.8% the year before that. 

 

What are you adjusting for?  If it's for "potential" net margin then you need to be careful about how conservative that downside case is.  Using a scenario that is theoretically possible (maybe) but very inflated from the actual is a good exercise but a dangerous place to use as a starting point (especially for a downside). 

 

Note that the margin improvement from AWS would be gross margin.  But opex will likely be higher because this is a fixed cost business (with healthy capex needs since the routers and servers need to be updated regularly - although D&A will be accounted for in the opex).

[dwy000]

There's a lot of focus on gross margins but not on the opex.  What worries me is that between 2011 and 2013:

  - sales up 50%

 

But look at all the components of opex:

  - fulfillment up 88%

  - marketing up 92%

  - technology & content up 126%

  - general & admin up 72%

Total opex up 97% from 20.6% of revenues to 26.2%

 

Why do you feel they will be able to take this down to 12% (ie to get to your 18% operating margins)?

[txlaw]

I think it would be interesting to discuss possible new billion dollar businesses that Bezos could be working on at AMZN.  Here's what I can think of:

 

-Robotics/automation (e.g., Kiva Systems and drone biz)

-Transport/courier services (competing with UPS, FDX, and asset-lite transport services)

-Media development biz (Amazon-produced content)

 

Anything else?  (Not saying these will billion dollar businesses will materialize.  It's just fun to think about what all that investment is going towards.)

[link01]

I think it would be interesting to discuss possible new billion dollar businesses that Bezos could be working on at AMZN.  Here's what I can think of:

 

-Robotics/automation (e.g., Kiva Systems and drone biz)

-Transport/courier services (competing with UPS, FDX, and asset-lite transport services)

-Media development biz (Amazon-produced content)

 

Anything else?  (Not saying these will billion dollar businesses will materialize.  It's just fun to think about what all that investment is going towards.)

 

off the top of my head, in no particular order there's also:

-tv, tablets, smart phones (rumored), games

-amazon fashion (curated), supply (B2B), fresh (grocery), pantry (bulk)

 

yes, these (including the things you mentioned above) are big, ambitious projects requiring large investments & upfront expenses, which, according to Bezos himself, on average take between 5 to 7 yrs to reach cash flow breakeven in the amazon world

 

its still Day 1...

[Spekulatius]

 

It helps to estimate growth and maintenance capex and subtract maintenance capex from OCF.  Also look at tangible invested capital - it's ~$10B.  So you can look at OCF/tangible capital, compare AMZN's to others and see that it's quite high.  I wrote about AMZN's ROIC in a previous post above and how we can estimate it and I'll write more here.

 

 

Current FCF, or OCF minus current year capex, doesn't account for maintenance versus growth capex at all.  And we all know that Amazon is investing for the future. It helped us to look at AMZN's pre-2010 capex margins, which were very reliably 2-2.5%.  If you assume that maintenance capex for AMZN is now ~$2B, OCF of $6B gets us to $4B of FCF on ~$10B in tangible capital which is is a nice return on tangible capital (Buffett singled out his 60% tangible-return companies in an 80s annual letter).  Of course I don't need to tell anyone that 40% ROTCs are attractive.

 

 

Call us crazy but we actually believe that AMZN's actual ROTC is greater than 50% and that's its true current FCF is almost 10% of sales, somewhere in the range of $7B-$9B now. 

 

Where is the basis for these numbers. I feel they are just made up. AMZN itself states the FCF as ~1.5B$ and even that includes 1.2B$ in proceeds from stock based compensation. While I agree that AMZN cash flow would be higher in a steady state, you cannot do better than adding back the complete Capex, which is  3.8B$ during the last 12 month, more realistically add back 1/2 that.

 

So 1.5B$ nominal FCF-1.2B$ ( stock expense) +0.5x 3.8B$=2.3B$ in steady state cash flow. Not a great deal for a 140B$ market cap company, imo.

[saltybit]

I think it would be interesting to discuss possible new billion dollar businesses that Bezos could be working on at AMZN.  Here's what I can think of:

 

-Robotics/automation (e.g., Kiva Systems and drone biz)

-Transport/courier services (competing with UPS, FDX, and asset-lite transport services)

-Media development biz (Amazon-produced content)

 

Anything else?  (Not saying these will billion dollar businesses will materialize.  It's just fun to think about what all that investment is going towards.)

 

off the top of my head, in no particular order there's also:

-tv, tablets, smart phones (rumored), games

-amazon fashion (curated), supply (B2B), fresh (grocery), pantry (bulk)

 

yes, these (including the things you mentioned above) are big, ambitious projects requiring large investments & upfront expenses, which, according to Bezos himself, on average take between 5 to 7 yrs to reach cash flow breakeven in the amazon world

 

its still Day 1...

 

Advertising. They have the data, and the technology. It sholdn't be too hard to get to $1B for them.

[Laxputs]

Lax,

 

Where are you getting the 5% net margin? 

 

 

I think having 10 years of greater than 5% fcf margins while expensing for growth is so important when analyzing AMZN. To me, using that as a downside doesn't seem unreasonable. I don't think in the time since then their normalized fcf margin has been decreased. I would say it's the opposite. Their moat is growing. Their normalized fcf and their fcf potential is growing.

 

And their gross margins have increased since then. And it seems like they may be aggressively depreciating. And their revenue streams are likely increasing.

[dwy000]

Those 10 years of 5%+ FCF margins were a long time ago.  FCF has been declining on both a % basis and an absolute $ basis every year since 2009.  I'm not sure it's accurate (or conservative) to use that as a normalized basis.  The business has changed since then.

 

You also have to factor in things like:  a) stock based comp - which has been rising fast and in 2013 was over $1.1bn or 20% of operating cash flow (over 50% of FCF);  b) growth in unearned revenues which in 2013 contributed some $400M of cash flow;  c) negative working capital. 

 

The gross margins have been growing but operating expenses have been increasing even faster.  Operating margins have been steadily declining. 

 

You can normalize for all these things if you feel the current situation doesn't reflect the ongoing norm, but what's the basis for considering 2008 and earlier the norm?  Or that they are heading back towards that.  If anything it appears they are headed further and further away from it.

[Laxputs]

Well they weren't a long time ago: the average fcf margin over the last 5 years is 5%. 2002-2010 was a bit higher. Some years were very high.

 

Can you talk more about growth in unearned revenues please? I'm not sure what that means.

 

And I know nothing about negative working capital but my google search tells me in some cases, like Dell, it is a positive thing. So talking more about this would be good too.

 

Operating margins have been decreasing but it seems Amazon is heavily expensing growth.

[dwy000]

I'm assuming the majority of unearned revenues are related to Prime but the concept is that it represents cash received upfront for something earned over time.  So if you pay them $79 for Prime membership, they get cash upfront.  Cash goes on the balance sheet as an asset and the offset is a $79 unearned revenue liability.  Each month throughout the year they will book 1/12th of that as revenues and reduce the unearned revenue liability.

 

Basically, as long as you are growing deferred revenues you are increasing cash flow.  But it's not really an operating cash flow it's more of a negative working capital item ( where you get paid before having to pay). If growth slows it becomes a usage of cash.

 

I think you may have meant that operating margins have been decreasing not increasing (gross margins have been increasing but operating declining).  What do you mean by "expensing growth"?  You've mentioned that a couple of times.

[Laxputs]

Fixed the typo, thanks.

 

I think a portion of their operating expenses are used for growth initiatives. Between their cost of sales, technology and content, marketing, and fulfillment, I think operating expenses needed to maintain earnings power are being inflated with money spent on growth. But I'm not sure how to break those numbers down any more.

[txlaw]

I think it would be interesting to discuss possible new billion dollar businesses that Bezos could be working on at AMZN.  Here's what I can think of:

 

-Robotics/automation (e.g., Kiva Systems and drone biz)

-Transport/courier services (competing with UPS, FDX, and asset-lite transport services)

-Media development biz (Amazon-produced content)

 

Anything else?  (Not saying these will billion dollar businesses will materialize.  It's just fun to think about what all that investment is going towards.)

 

Speaking of a transport/courier biz push, Alibaba, the AMZN+ of China (amazing how many businesses they're in), is purchasing a stake in SingPost.

 

http://dealbook.nytimes.com/2014/05/28/alibaba-to-buy-stake-in-singaporean-postal-system/?module=BlogPost-Title&version=Blog%20Main&contentCollection=Mergers%20&%20Acquisitions&action=Click&pgtype=Blogs&region=Body

[Palantir]

Hello all, great discussion here.

 

I'm curious to know how you guys derived the 13% operating margin. I suppose it depends on which year we are looking at, but if you look at 2008 which is before the ramp up in CapX, I have GM: 4.27/19.166 = 22.3%. Operating Expense Margin is: 3.428/19.166 = 17.9%. Today, in 2013, I have the GM: 27.3%. So GM-OEM = 27.3-17.9 = 9.4%.

 

Overall, it seems to me that with this 9.4% margin we get about 7M in Operating Income, which is fairly substantial.

[JAllen]

Hello all, great discussion here.

 

I'm curious to know how you guys derived the 13% operating margin. I suppose it depends on which year we are looking at, but if you look at 2008 which is before the ramp up in CapX, I have GM: 4.27/19.166 = 22.3%. Operating Expense Margin is: 3.428/19.166 = 17.9%. Today, in 2013, I have the GM: 27.3%. So GM-OEM = 27.3-17.9 = 9.4%.

 

Overall, it seems to me that with this 9.4% margin we get about 7M in Operating Income, which is fairly substantial.

 

 

It was FCF margin which peaked at 12+% in 2009.  Remove the WC benefit from that year and it's still 9-10%, which is inline with my above comments and your GM-OEM conclusion.  It also assumes slightly above WMT OEM which I think is wrong long-term because of zero retail real estate and a much more automated supply-chain.

 

 

RackSpace has an OEM margin of about 23%, so the notion that AWS has permanently and massively increased AMZN's OEM is false.  AWS should have lower long-term OEM margins than RackSpace due to scale and lesser support services, which is what RackSpace is known for.

 

 

So if you believe that AMZN's costs won't be lower than WMT's in the long-run, you can still get to a ~10% operating margin.  If you believe that AMZN will have lower costs than WMT in the long-run than you could reach an even more contrary-to-popular-opinion conclusion.

 

 

I should note that AMZN's GM continued to expand to 28.8% 1Q 2014.

[Palantir]

Hey, this is the point I was referring to. Just to clarify, you were referring to FCF?

 

 

Here is some of the evidence we have for this:

 

current gross margin minus historical operating expense margin would equal 13% operating margins or $9B of operating income

 

Gross margins cannot be fibbed or manipulated, but operating expenses are inflated by massive investing and spending, e.g. paying HBO, AWS expansion, China competition etc.  AMZN's gross margins are continually increasing, along with its opex.  Since WMT's operating expense margin is 18%, we can conclude that AMZN's will be a few points lower because AMZN doesn't operate any retail real estate over time. A pure warehouse infrastructure is cheaper than warehouses + retail to deliver same products.

[JAllen]

Hey, this is the point I was referring to. Just to clarify, you were referring to FCF?

 

 

Here is some of the evidence we have for this:

 

current gross margin minus historical operating expense margin would equal 13% operating margins or $9B of operating income

 

Gross margins cannot be fibbed or manipulated, but operating expenses are inflated by massive investing and spending, e.g. paying HBO, AWS expansion, China competition etc.  AMZN's gross margins are continually increasing, along with its opex.  Since WMT's operating expense margin is 18%, we can conclude that AMZN's will be a few points lower because AMZN doesn't operate any retail real estate over time. A pure warehouse infrastructure is cheaper than warehouses + retail to deliver same products.

 

 

I've used FCF mostly for Amazon because there are so many non-cash expenses and that's what AMZN management incessantly claims to focus on.  It's also the one that makes the most sense to focus on - you can't buy milk with gross margin, or any other financial metric other than FCF.  The chart I posted earlier is FCF (OCF - All Capex), so yes.

 

 

I think that FCF and operating profit should approximate one another over time excluding stock-comp.  The only differences over time between the FCF and OP, for AMZN, should be stock-comp, interest and taxes.  So I use them somewhat interchangeably but focus more on FCF because it's more accurate; isn't affected by non-cash expenses; is what mgmt. focuses on and deducts both interest and taxes.  It doesn't deduct for repayment of capital leases however, which is a financing cash flow, and one that is quite material.

 

 

So, again, my core thesis is that because AMZN generated material FCF margins in the eight years prior to 2010, and that because not very much has changed with its core business, except for rapidly accelerated spending and investment since then, that AMZN will again achieve FCF margins approaching that range at some point in the next few years.

[Palantir]

I see, how do you get to your 9M OI figure then? Pardon me if you have explained this earlier.

[JAllen]

I see, how do you get to your 9M OI figure then? Pardon me if you have explained this earlier.

 

 

The OI estimate is based on gross margin minus estimated run-rate operating expense margin multiplied by this year's sales of $90B+ or so like you were using above.

 

 

It's nice that estimating operating income this way arrives at a very similar number to the historical FCF margins.  And remember that this uses an OEM 5% greater than the mid-teens OEM AMZN delivered prior to increasing automation and Moore's law cost decreases and accelerating growth four years ago.

 

 

What are your thoughts about all of this?  I am going to go back and re-read the past few pages to make sure I haven't missed anything posted by others...  I'd love to hear from someone that thinks AMZN's long-term costs will be greater than WMT's.

[Palantir]

Great, thanks. I guess my main concern now is that we could be understating Maintenance CapX because those early years will not have the outlay in AWS server infrastructure. That being said, I don't believe AWS is a big contributor to revenues, and supposedly estimated at about 3B so it may not be yet material.