AMZN - Amazon.com Inc.

[valueinvestor82]

DTE that's not opinion, that's current financial fact! Reading the theses surrounding the bulls reasons for holding is all I need to read to know that I'm staying away from this one. It will be an interesting case study later (after it collapses back to earth).

[Vish_ram]

we might all agree that a startup will show GAAP losses early on in their lifecycle. Once it stops investing for growth, profits start gushing in.

 

Now AMZN is like collection of startups, the main business as a growing online retail. The startups are AWS, online retail stores worldwide, content biz, ....These startups need enormous capital and main biz funds it. Just take a look at "Technology and content" in income statement. This is a huge expense. The SEC filings clearly state that

 

Technology costs consist principally of research and development activities including payroll and related expenses for employees involved in application, production, maintenance, operation, and platform development for new and existing products and services, as well as AWS and other technology infrastructure expenses.

Content costs consist principally of payroll and related expenses for employees involved in category expansion, editorial content, buying, and merchandising selection.

Technology and content costs are expensed as incurred, except for certain costs relating to the development of internal-use software and website development, including software used to upgrade and enhance our websites and applications supporting our business, which are capitalized and amortized over two years.

 

If you believe that Bezos is a horrible capital allocator who is diworsifying into unrelated businesses, then AMZN is an awesome short. If you believe that he is building a Berkshire Hathaway kind of strong moat businesses, then AMZN is cheap even at this price.

 

Then there is this naive thinking about profits. Look at the growing gross margin. for 2014 it is almost 30%. In 2005, it was 24%. This is remarkable.

 

Many technology companies are like this (see CRM). In growth phase, they show little or no profits. Once they mature they show awesome profits attracting value investors. The early growth investors would have enjoyed unbelievable returns.

 

Bottom line, you need capital to grow. If capital comes from existing operations without insane dilutions, then it is all the more better.

[Liberty]

There's a big difference between not showing a profit because you can't operate profitably and because you are reinvesting everything you make (and more) into the business for more growth. It's the difference between maintenance capex and growth capex; confusing the two can lead to mistaken conclusions.

 

The ambiguity remains because it's hard to prove either way (Amazon is run as a bunch of P&L centers, with some profitable ones bankrolling newers, unprofitable ones). But I don't think it's that hard to reason about. Why should Amazon's retailing be  ever unprofitable while Walmart's retailing is profitable? Maybe Amazon's prices are a bit lower, but their cost structure is probably also a little lower (no stores, fewer employees per dollar of sale, more automation)... And they have higher margin businesses that Walmart doesn't have (third party sales, AWS).

 

If Bezos ever decided to stop optimizing for growth and said "rather than try to grow at 20-30%/year, let's aim for 10-12% a year", what do you guys think this would do to margins and reported profits?

[merkhet]

There's a big difference between not showing a profit because you can't operate profitably and because you are reinvesting everything you make (and more) into the business for more growth. It's the difference between maintenance capex and growth capex; confusing the two can lead to mistaken conclusions.

 

The ambiguity remains because it's hard to prove either way (Amazon is run as a bunch of P&L centers, with some profitable ones bankrolling newers, unprofitable ones). But I don't think it's that hard to reason about. Why should Amazon's retailing be  ever unprofitable while Walmart's retailing is profitable? Maybe Amazon's prices are a bit lower, but their cost structure is probably also a little lower (no stores, fewer employees per dollar of sale, more automation)... And they have higher margin businesses that Walmart doesn't have (third party sales, AWS).

 

If Bezos ever decided to stop optimizing for growth and said "rather than try to grow at 20-30%/year, let's aim for 10-12% a year", what do you guys think this would do to margins and reported profits?

 

+1

 

Seeing the difference between Visa and MasterCard's net operating profits really opened my eyes to this. The businesses are basically the same, but MasterCard has started something like 50+ projects that are weighing down the margins. Kudos to the Amazon folks who saw this way before I came around to it.

[cmlber]

There's a big difference between not showing a profit because you can't operate profitably and because you are reinvesting everything you make (and more) into the business for more growth. It's the difference between maintenance capex and growth capex; confusing the two can lead to mistaken conclusions.

 

The ambiguity remains because it's hard to prove either way (Amazon is run as a bunch of P&L centers, with some profitable ones bankrolling newers, unprofitable ones). But I don't think it's that hard to reason about. Why should Amazon's retailing be  ever unprofitable while Walmart's retailing is profitable? Maybe Amazon's prices are a bit lower, but their cost structure is probably also a little lower (no stores, fewer employees per dollar of sale, more automation)... And they have higher margin businesses that Walmart doesn't have (third party sales, AWS).

 

If Bezos ever decided to stop optimizing for growth and said "rather than try to grow at 20-30%/year, let's aim for 10-12% a year", what do you guys think this would do to margins and reported profits?

 

I can point to a few reasons.  Walmart has a huge scale advantage (not just in purchasing, but also in distribution) over other retailers and many of its stores are in rural areas that can't support more than one competitor.  This advantage might disappear as a result of eCommerce, but it is why historically it has had very high returns on capital.

 

Amazon's competitive advantage is what?  $20 billion in PPE?  A robot company that it bought for $700 million?  Brand recognition?  It's not nearly as obvious what the moat is for Amazon.  I agree with your concept that if Amazon stopped investing for growth it's margins would not be negative, and the business would be worth some large number.  But would they be large enough to justify this market cap?

 

And btw, Amazon's prices are on average HIGHER than Walmart's, not lower. At least according to this study of 16,000 identical products:

 

http://www.profitero.com/2015/07/ecommerce-insights-jet-com-pricing-analysis-vs-amazon-and-walmart/s

[Liberty]

I wasn't arguing for the current valuation. I don't know how to value Amazon and I've never owned it.

 

I'm arguing against the silly idea that they can't make money and are some kind of foolish charity just because the GAAP numbers look bad.

[TheAiGuy]

And btw, Amazon's prices are on average HIGHER than Walmart's, not lower. At least according to this study of 16,000 identical products:

 

http://www.profitero.com/2015/07/ecommerce-insights-jet-com-pricing-analysis-vs-amazon-and-walmart/s

 

so, if I read you right, you're saying that Amazon has higher margins than Walmart.

[cmlber]

And btw, Amazon's prices are on average HIGHER than Walmart's, not lower. At least according to this study of 16,000 identical products:

 

http://www.profitero.com/2015/07/ecommerce-insights-jet-com-pricing-analysis-vs-amazon-and-walmart/s

 

so, if I read you right, you're saying that Amazon has higher margins than Walmart.

 

No I'm not.  I'm saying Amazon charges higher prices.  Despite this, if you take retail revenue less cogs, fulfillment costs, and marketing costs (generously excluding all tech spend and all sg&a), their margins would only be 1.6% higher than Walmarts.  And that includes the marketplace revenue which obviously has way higher margins than a retailer.

[cmlber]

I wasn't arguing for the current valuation. I don't know how to value Amazon and I've never owned it.

 

I'm arguing against the silly idea that they can't make money and are some kind of foolish charity just because the GAAP numbers look bad.

 

Sorry, we're in agreement then. 

[cmlber]

Just curious, have any of the longs here looked at JD?  If you believe that Amazon is worth $315 billion, JD at a $44 billion market cap operating the same business model in a much bigger market with larger barriers to entry due to ownership of the last mile of delivery (instead of outsourcing to UPS like Amazon does) seems like it would be the better buy...

[KCLarkin]

There's a big difference between not showing a profit because you can't operate profitably and because you are reinvesting everything you make (and more) into the business for more growth. It's the difference between maintenance capex and growth capex; confusing the two can lead to mistaken conclusions.

...

If Bezos ever decided to stop optimizing for growth and said "rather than try to grow at 20-30%/year, let's aim for 10-12% a year", what do you guys think this would do to margins and reported profits?

 

2014 Normalized Earnings

 

Scenario A: Reported Earnings = $0

 

Scenario B: Better than Walmart Margins

 

* 4% Net Margins

* 2014 Net Income = $3.56 B

 

 

Scenario C: AWS and Marketplace make retail comps irrelevant

 

* 10% Net Margins

* 2014 Net Income = $9 B

 

Scenario D: The Bull Case

Let's be generous and assume Tech spending line goes to $0. Assume GA is 2/3rd maintenance and 1/3 growth. Fulfillment seems tied directly to unit volume, so assume this is all "maintenance". Marketing is mostly directly tied to revenue (affiliate revenue, search ads), so assume this is all maintenance.

 

2014 Net Income = $11B

 

Note: 12% net margins and 100% ROE seem really excessive assumptions for a retailer.

 

---

 

Normalized earnings range is $3.56 B - $11B.

 

Valuation: 30x - 90x 2014 earnings

 

 

 

 

[Liberty]

There's a big difference between not showing a profit because you can't operate profitably and because you are reinvesting everything you make (and more) into the business for more growth. It's the difference between maintenance capex and growth capex; confusing the two can lead to mistaken conclusions.

...

If Bezos ever decided to stop optimizing for growth and said "rather than try to grow at 20-30%/year, let's aim for 10-12% a year", what do you guys think this would do to margins and reported profits?

 

2014 Normalized Earnings

 

Scenario A: Reported Earnings = $0

 

Scenario B: Better than Walmart Margins

 

* 4% Net Margins

* 2014 Net Income = $3.56 B

 

 

Scenario C: AWS and Marketplace make retail comps irrelevant

 

* 10% Net Margins

* 2014 Net Income = $9 B

 

Scenario D: The Bull Case

Let's be generous and assume Tech spending line goes to $0. Assume GA is 2/3rd maintenance and 1/3 growth. Fulfillment seems tied directly to unit volume, so assume this is all "maintenance". Marketing is mostly directly tied to revenue (affiliate revenue, search ads), so assume this is all maintenance.

 

2014 Net Income = $11B

 

Note: 12% net margins and 100% ROE seem really excessive assumptions for a retailer.

 

---

 

Normalized earnings range is $3.56 B - $11B.

 

Valuation: 30x - 90x 2014 earnings

 

http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/amzn-amazon-com-inc/msg246768/#msg246768

[Guest Grey512]

2% unlevered free cash flow yield. Free cash flow growing by double-digits.

 

Good investment if you have to pick a stock and then not touch it for the next 15 years. It's better than cash, with tons of built-in optionality.

 

 

 

 

[KCLarkin]

2% unlevered free cash flow yield. Free cash flow growing by double-digits.

 

Let's agree that 50x FCF is reasonable. Now, we can do a sum-of-the-parts valuation for 2014:

 

FCF: $1,949

Intrinsic Value: $97,450

 

SOP:

(12,050)    - Net Income

74,850      - Giving stock to employees instead of paying cash

48,700      - Float from borrowing money from customers and suppliers

200,400    - CapEx bought with capital leases instead of cash

(214,500)  - Real cash flow

---

97,450      - Intrinsic Value

 

 

* Is it bat-shit crazy to capitalize float (a liability) at 50x? Or add $75B to Amazon's market cap because they pay employees in stock instead of cash? Or ignore capital leases because the accountants classify them as "financing activities" instead of "investing activities?

 

---

BIZARRO AMAZON

 

Imagine an alternative universe where:

- Amazon pays employees all cash (and sells stock to cover the cash currently saved by using stock). The employees then buy the stock on the open market.

- Amazon pays suppliers Cash-on-Delivery. And gets short term financing to cover the lost float

- Amazon charges customers Cash-on-Delivery. And uses short term financing to cover the lost float.

- Amazon pays cash for all CapEx. And gets a bank loan to replace the capital leases.

 

BIZZARO INC. STATEMENT OF CASH FLOWS

 

(241)      Net Income

4,746      D&A

0            Stock-based compensation

0            Changes in working capital

(134)      Other

----

4,371      OCF

(8,901)  CAPEX

----

(4531)    FCF

 

 

Punchline: Economically, these two companies are exactly the same. The only difference is that Amazon's financing is designed to maximize reported FCF. Amazon contrives $6.5 B in FCF by optimizing where the financing lands in the cash flow statement.

 

At Amazon, Profit is an opinion, free cash flow is a fiction.

 

---

Disclosure: No position. But if you are valuing AMZN using Amazon's reported FCF, you are a victim to The Bezzle.

 

 

 

[rpadebet]

 

This is the problem.  A competitor can be completely irrational and cause terror/confusion to their competitors.  What good is a competitor that operates with no profit?

 

 

A very effective way to win in a negotiation or force your counterparties/ competitors to give you what you want quickly, or fold or make dumb decisions, - is to lead them to think you are irrational or crazy.

 

Retail is a tough game, but at its most basic form, do you agree running a brick and mortar store is more expensive than running a website?

 

Ignore the scale advantages, because scale advantages are product category specific ( Costco showed this) and at this point both WMT and AMZN have enough of scale to squeeze suppliers in the product categories they compete in.

 

I am surprised to see very smart investors here think AMZN retail is unprofitable because it isn't apparent in the numbers.

 

Liberty had a good assessment of this. There is lot of money being poured into gaining optionality at AMZN. Some of it is worthless like the FIRE phone business, but others like AWS turn out great. There is growth capex, maintenance capex running through expenses and investments. It is hard to figure out which one is which and how much each is.

 

If you think Jeff Bezos is irrational, crazy and will set yours and his money on fire, just think why he would want to do that? From what I have read about him and seen him speak, I think he is anything but irrational. Your opinion might be different.

 

For people thinking of shorting this based on numbers, please don't. You can make similar dollars elsewhere more easily.

 

For people staying away for whatever reason, that's perfectly reasonable IMO.

 

 

[cmlber]

2% unlevered free cash flow yield. Free cash flow growing by double-digits.

 

Let's agree that 50x FCF is reasonable. Now, we can do a sum-of-the-parts valuation for 2014:

 

FCF: $1,949

Intrinsic Value: $97,450

 

SOP:

(12,050)    - Net Income

74,850      - Giving stock to employees instead of paying cash

48,700      - Float from borrowing money from customers and suppliers

200,400    - CapEx bought with capital leases instead of cash

(214,500)  - Real cash flow

---

97,450      - Intrinsic Value

 

 

* Is it bat-shit crazy to capitalize float (a liability) at 50x? Or add $75B to Amazon's market cap because they pay employees in stock instead of cash? Or ignore capital leases because the accountants classify them as "financing activities" instead of "investing activities?

 

---

BIZARRO AMAZON

 

Imagine an alternative universe where:

- Amazon pays employees all cash (and sells stock to cover the cash currently saved by using stock). The employees then buy the stock on the open market.

- Amazon pays suppliers Cash-on-Delivery. And gets short term financing to cover the lost float

- Amazon charges customers Cash-on-Delivery. And uses short term financing to cover the lost float.

- Amazon pays cash for all CapEx. And gets a bank loan to replace the capital leases.

 

BIZZARO INC. STATEMENT OF CASH FLOWS

 

(241)      Net Income

4,746      D&A

0            Stock-based compensation

0            Changes in working capital

(134)      Other

----

4,371      OCF

(8,901)  CAPEX

----

(4531)    FCF

 

 

Punchline: Economically, these two companies are exactly the same. The only difference is that Amazon's financing is designed to maximize reported FCF. Amazon contrives $6.5 B in FCF by optimizing where the financing lands in the cash flow statement.

 

At Amazon, Profit is an opinion, free cash flow is a fiction.

 

---

Disclosure: No position. But if you are valuing AMZN using Amazon's reported FCF, you are a victim to The Bezzle.

 

+1.  Great post.

[dwy000]

But once again the question is what it is worth?  Surely it is not a Buy at any price is it?  So at what price is it overvalued and why there vs here (or $300 ago).

[TheAiGuy]

But once again the question is what it is worth?  Surely it is not a Buy at any price is it?  So at what price is it overvalued and why there vs here (or $300 ago).

 

In an optimistic scenario, 40-50x AWS earnings + $1000 per prime customer. That assumes a Costco model for retail and builds in a good amount of growth. In a 10-20 years, that would be like, 12x AWS and $500-750 per prime customers.

 

Edit: that gets me to about $180B if we guess there are 80 million prime customers.

[Aurelius]

The total future value from both segments (ecommerce and AWS) and plus the incremental free cash flow and working capital that will be generated over the next 4 years gives me a base case intrinsic value per share of $2,000 – $2,350 or a 4-year MoM of 3.0x-3.5x.

 

https://oraclefromomaha.wordpress.com/2015/12/07/amazon-and-world-domination

[rpadebet]

The total future value from both segments (ecommerce and AWS) and plus the incremental free cash flow and working capital that will be generated over the next 4 years gives me a base case intrinsic value per share of $2,000 – $2,350 or a 4-year MoM of 3.0x-3.5x.

 

https://oraclefromomaha.wordpress.com/2015/12/07/amazon-and-world-domination

 

I think this was a fairly good write up. Valuation in 2020 is just a stab in the dark. Also, the optionality being created from media, advertising feeding back into retail is pretty hard to model. So his estimates could well be very conservative.

 

I know a lot of posters here will laugh at this :), but it is pretty damn hard to value exponential growth, almost unlimited multiple runways, feedback loops and great capital allocator.

 

If there is one risk I see for AMZN, it is Bezos being hit by a bus. I disagree with the article that this can sustain itself without Bezos. I think his aggressiveness is absolutely critical to this company.

[KCLarkin]

You can eat cash flow.

 

I agree. That's why I think they should pay for all of their operating expenses by issuing stock.

 

CASHAZON INC. STATEMENT OF CASH FLOWS

 

Net Income                          (241)

D&A                                    4,746

Stock-based compensation  84,064

Deferred revenue                  741

CAPEX                                (4,893)

---

FCF                                    84,417

 

Intrinsic Value (50x FCF)                4.2 Trillion!   

 

And if they can get the accountants to treat all their CAPEX as capital leases, they can add another $244 Billion to their intrinsic value!

 

---

Economically the two companies you mentioned are very different.

 

Jawn, this might be too nuanced for you. But if you read carefully, you will see that they aren't materially different. Your points on Stock-Based Compensation and Capital Leases are just wrong (Bizzaro is still issuing stock and financing their Capex, with a brief stop in the financing cash flows).

 

Your point about float is true. But I am assuming they replace the float with short term paper (AA paper yields 0.31%, so assume AMZN can get 1%). I made the assumption (but did not explicitly state it for simplicity) that suppliers would give a discount for paying cash-on-delivery. This could roughly net out to 0% financing. Of course float has value, but you can't capitalize it at 50x! Remember, float is just a loan at 0% interest. It is just an accounting quirk that this goes in operating cash flow rather than financing cash flow.

 

--

 

Amazon's Free Cash Flow is a fiction. If you believe you can eat any of that cash flow, you aren't spending enough time with their balance sheet. Their FCF is so strong that their Long-term debt and liabilities doubled in 1 year.

[Guest Grey512]

The total future value from both segments (ecommerce and AWS) and plus the incremental free cash flow and working capital that will be generated over the next 4 years gives me a base case intrinsic value per share of $2,000 – $2,350 or a 4-year MoM of 3.0x-3.5x.

 

https://oraclefromomaha.wordpress.com/2015/12/07/amazon-and-world-domination

 

I think this was a fairly good write up. Valuation in 2020 is just a stab in the dark. Also, the optionality being created from media, advertising feeding back into retail is pretty hard to model. So his estimates could well be very conservative.

 

I know a lot of posters here will laugh at this :), but it is pretty damn hard to value exponential growth, almost unlimited multiple runways, feedback loops and great capital allocator.

 

If there is one risk I see for AMZN, it is Bezos being hit by a bus. I disagree with the article that this can sustain itself without Bezos. I think his aggressiveness is absolutely critical to this company.

+1

The other risk besides Bezos getting hit by a bus is unfavorable attention from regulators re AMZN's tax affairs. These guys likely abuse Irish holdcos, like everyone else.

 

KCLarkin:

 

If I follow your logic, stock comp just turns a $5.5b FCF number into a $3.5b FCF number. So? Still cheap on a long term basis.

 

I hope your viewpoint is more frequently espoused on CNBC and by pundits so that AMZN trades down and I can buy more.

 

 

 

 

 

 

 

[KCLarkin]

The total future value from both segments (ecommerce and AWS) and plus the incremental free cash flow and working capital that will be generated over the next 4 years gives me a base case intrinsic value per share of $2,000 – $2,350 or a 4-year MoM of 3.0x-3.5x.

 

https://oraclefromomaha.wordpress.com/2015/12/07/amazon-and-world-domination

 

I think this was a fairly good write up. Valuation in 2020 is just a stab in the dark. Also, the optionality being created from media, advertising feeding back into retail is pretty hard to model. So his estimates could well be very conservative.

 

I agree that his estimates are very conservative. But you have to think about opportunity cost. I found another IT vendor with even more upside:

http://people.stern.nyu.edu/adamodar/pdfiles/eqnotes/Buffett.pdf

 

each dollar invested by Cisco in its business will generate a return of $1,025,600,000,000 (yes, you read correctly: a return in excess of $1 trillion).

[KCLarkin]

KCLarkin:

 

If I follow your logic, stock comp just turns a $5.5b FCF number into a $3.5b FCF number. So? Still cheap on a long term basis.

 

Grey, you didn't even remotely follow my logic. Perhaps I was too subtle: You have no clue how to read a cash flow statement or a balance sheet. You should not be trying to value companies. You should give your money to Jack Bogle.

 

---

And don't think I am making this personal. I am genuinely concerned that very smart people are being fooled by Amazon's accounting. Still, this will probably go to $1 trillion. You will tell me I was wrong. And I will tell you that you had a good outcome, but a terrible process.

 

---

 

If you read the Amazon 10k, you will see this:

 

All of these free cash flow measures have limitations as they omit certain components of the overall cash flow statement and do not represent the residual cash flow available for discretionary expenditures. For example, these measures of free cash flow do not incorporate the portion of payments representing principal reductions of debt or cash payments for business acquisitions. Additionally, our mix of property and equipment acquisitions with cash or other financing options may change over time.  Therefore, we believe it is important to view free cash flow measures only as a complement to our entire consolidated statements of cash flows.

 

In other words, our reported Free Cash Flow is completely meaningless. Don't sue us if you lose money because you used our bullshit FCF number to value the company.

 

---

 

Grey, my quick calculations show -$2.4B in FCF over the last twelve months. You don't need to agree, but if you are long you might want to understand why there is a $6 B difference of opinion. Or at least understand why there is a $5.1B difference between FCF and net income.

 

[Guest Grey512]

KC,

 

Slightly insulting and unprofessional. Calm down. Ignore the P&L for now. Walk with me here.

 

CFO for the last 12 months to Sep-15 is $9.8b. That includes $1.9b of add-backs relating  to stock-based comp. Let's pretend they are cash-based. That gives us an adjusted CFO of $7.9b.

 

Capex: $5b

Interest expense: $0.4b.

unlevered FCF: $3.3b.

 

You with me?

 

Your logic (multiplying everything by 50x) is puzzling. Puzzling here is a charitable way to describe it.

Finance leases have an asset on the other side of the balance sheet attached to them. If you multiply (or capitalize?) the liabilities by 50x, why not do the same with the economic utility of the assets? Let's say the warehouses or R&D that Amazon buys on lease are super-warehouses and superR&D. Etc. That's just ridiculous.

 

Similarly, the more acceptable way to try to frame the argument your way is to strip out the lease-related expenses (e.g. add-back $3b to my unlevered FCF calculation above) and then add back the full $31b "OBS" liability to the net debt. I'm not even multiplying that number by 0.7x or whatever it is that people do nowadays. As I add it to the "net debt", that will probably double-count some of the things in the EV calculation from Bloomberg, but whatever.

 

So that's $6.3b / $360b EV now.

 

 

Multiplying/capitalizing *everything* that moves on the liability side of the B/S by 50x implies that all those liabilities have the same growth profile as, say, Facebook, i.e. that Amazon is massively value destructive to equity. That's just ridiculous.

 

Finally: the NWC float that Amazon gets is a reasonably important part of the business, one of the reasons why I find the business attractive. One of the reasons people find (found?) it attractive to invest in the large supermarkets & grocers globally. Ignoring that and minimizing the importance of this effect is not too different from saying "let's ignore BRK's float" or something.

 

Those are my early thoughts on your tirade. I'll come back and post some further thoughts later.