AMZN - Amazon.com Inc.

[DCG]

That was a planned recurring sale.

[SlowAppreciation]

Coho Capital just disclosed AMZN has become their largest position in their most recent shareholder letter.

 

I've long been on the fence about investing in Amazon, and it's the only FANG stock I think could be worth their current valuation.

[KCLarkin]

Coho Capital just disclosed AMZN has become their largest position in their most recent shareholder letter.

 

Interesting.

 

Unfortunately, he didn't really address the valuation:

 

Given Amazon’s investment in infrastructure, perhaps a better way to examine the economics of the business is to look at operating cash flows. We believe Amazon is on pace for $15 billion in operating cash flow this year and $21 billion next year. At our purchase price, that represented an enterprise value/operating cash flow multiple of 12.8x, more than reasonable for a business that has compounded cash flow at 30% for the last decade.

 

Using OCF ignores:

- Substantial stock-based compensation

- Capital intensity of AWS

- Large "float" in OCF

 

Not sure why he thinks that is the best valuation metric. Would be more interesting to see him model earnings or free cash flow in 10 years, as he alludes to in the letter.

 

There is some alchemy that allows them to compound operating cash flow at 30% while not earning an accounting profit. But I'm not smart enough to figure it out despite many, many attempts.

[SlowAppreciation]

Coho Capital just disclosed AMZN has become their largest position in their most recent shareholder letter.

 

Interesting.

 

Unfortunately, he didn't really address the valuation:

 

Given Amazon’s investment in infrastructure, perhaps a better way to examine the economics of the business is to look at operating cash flows. We believe Amazon is on pace for $15 billion in operating cash flow this year and $21 billion next year. At our purchase price, that represented an enterprise value/operating cash flow multiple of 12.8x, more than reasonable for a business that has compounded cash flow at 30% for the last decade.

 

Using OCF ignores:

- Substantial stock-based compensation

- Capital intensity of AWS

- Large "float" in OCF

 

Not sure why he thinks that is the best valuation metric. Would be more interesting to see him model earnings or free cash flow in 10 years, as he alludes to in the letter.

 

There is some alchemy that allows them to compound operating cash flow at 30% while not earning an accounting profit. But I'm not smart enough to figure it out despite many, many attempts.

 

I'm with you on most of your points, but if they are able to grow 30% for the next ~5 years and then grow 6% thereafter, the stock doesn't look that insanely overvalued assuming their claimed fixed costs are in fact fixed.

 

Per your point about capital intensity, Amazon is remarkably asset-light. As you mentioned, their operations basically run on float like Dell in their heyday, and it's only getting better.

 

I don't leave out stock expense when modeling Amazon since it's a huge part of employee comp; however, I think the argument could be made that their stated stock-based comp isn't as high as it might appear. I work in the tech industry with a few friends who have worked at Amazon. Almost none stay the full 5 years for their stock to fully vest, and their vesting is backloaded. So in year one you vest 5%, year 2 you vest 10%, year 3 20%, etc. So if people are churning out before they fully vest, I think it'll take that stock-based comp # a little while to reflect what was actually paid.

[KCLarkin]

I'm with you on most of your points, but if they are able to grow 30% for the next ~5 years and then grow 6% thereafter, the stock doesn't look that insanely overvalued assuming their claimed fixed costs are in fact fixed.

 

* 20% of the OCF is the increase in "float". This OCF is a derivative of revenue growth. When the growth slows, this portion of OCF disappears.

 

* 18% is SBC

 

* 53% of OCF is depreciation, which seems a good proxy for maintenance CapEx.

 

OCF isn't a good proxy for value creation. Amazon can generate "float" by increasing unprofitable revenue (this is common in the insurance industry). Amazon can increase OCF by shifting more compensation to SBC. AWS can grow OCF by leasing more and more servers and renting them out at a loss because OCF ignores the economic cost of depreciation.

 

I don't think it is true in this case, but you could argue that OCF growth is actually a proxy for value destruction.

[SlowAppreciation]

I'm with you on most of your points, but if they are able to grow 30% for the next ~5 years and then grow 6% thereafter, the stock doesn't look that insanely overvalued assuming their claimed fixed costs are in fact fixed.

 

* 20% of the OCF is the increase in "float". This OCF is a derivative of revenue growth. When the growth slows, this portion of OCF disappears.

 

* 18% is SBC

 

* 53% of OCF is depreciation, which seems a good proxy for maintenance CapEx.

 

OCF isn't a good proxy for value creation. Amazon can generate "float" by increasing unprofitable revenue (this is common in the insurance industry). Amazon can increase OCF by shifting more compensation to SBC. AWS can grow OCF by leasing more and more servers and renting them out at a loss because OCF ignores the economic cost of depreciation.

 

I don't think it is true in this case, but you could argue that OCF growth is actually a proxy for value destruction.

 

Sorry, I wasn't arguing that OCF is a good proxy for value.. I personally prefer residual income models to DCFs where these aren't a concern as it uses GAAP #s. And even still, with 30% growth for the next ~5 years (and then 6% growth) thereafter, one could make the argument AMZN isn't too crazily valued.

[kab60]

Coho Capital made Amazon it's biggest investment during the recent pullback - wrote 9 pages on the business (but seems to forget SBC in the valuation?): https://www.dropbox.com/s/np9texmxoy0itbb/Coho%20Capital%202016%20Q2%20Shareholder%20Letter.pdf?dl=0

[Aurelius]

Thanks for sharing, kab60 -- looking forward to reading it!

[SlowAppreciation]

Coho Capital made Amazon it's biggest investment during the recent pullback - wrote 9 pages on the business (but seems to forget SBC in the valuation?): https://www.dropbox.com/s/np9texmxoy0itbb/Coho%20Capital%202016%20Q2%20Shareholder%20Letter.pdf?dl=0

 

Haha that links to my Dropbox account. I also posted here a few messages ago

[fareastwarriors]

The Real Story of How Amazon Built the Echo

 

The talking speaker started as part of a secret augmented-reality project and ended up as a surprise hit.

 

http://www.bloomberg.com/features/2016-amazon-echo/

[KCLarkin]

http://www.cnbc.com/2016/09/20/amazon-says-it-puts-customers-first-but-its-pricing-algorithm-doesnt.html

 

I'm seeing more and more evidence of Amazon flexing it's pricing power. Amazon selling products at 2x the price at big box stores. 3rd parties selling some items at 10x the retail price. Amazon charging more per bottle if you order a two pack. I've started doing price comparisons. I don't mind paying a bit more for Amazon's service but I can no longer trust that their pricing is fair.

[arcube]

+1. I am a big Amazon fan (both Company as well as stock) and a long time Prime member and I have to agree with you, their algorithm will get you if you don't price compare. Surprisingly they overcharged me on a few things and I returned and ordered same half price from eBay. Beware of the Machines! ; )

 

http://www.cnbc.com/2016/09/20/amazon-says-it-puts-customers-first-but-its-pricing-algorithm-doesnt.html

 

I'm seeing more and more evidence of Amazon flexing it's pricing power. Amazon selling products at 2x the price at big box stores. 3rd parties selling some items at 10x the retail price. Amazon charging more per bottle if you order a two pack. I've started doing price comparisons. I don't mind paying a bit more for Amazon's service but I can no longer trust that their pricing is fair.

[Jurgis]

http://www.cnbc.com/2016/09/20/amazon-says-it-puts-customers-first-but-its-pricing-algorithm-doesnt.html

 

Excerpt:

 

(The prices Amazon shows are ranked correctly for those who pay $99 per year for Amazon's Prime shipping service and for those who are buying $49 or more in eligible items.)

 

This.

 

But sure, for a lot of grocery-type products both Amazon's and its 3rd-party merchant pricing sucks.

 

It's not "Amazon flexing it's pricing power". Their grocery prices sucked, suck and will probably continue to suck. No change.

 

For groceries and big ticket items I price-compare. For books, cheap things, and things I price-compared before, I don't.

 

YMMV, do your own dd, have fun.

[fareastwarriors]

Amazon’s Newest Ambition: Competing Directly With UPS and FedEx

 

To constrain rising shipping costs, the online giant is building its own delivery operation, setting up a clash with its shipping partners

 

 

http://www.wsj.com/articles/amazons-newest-ambitioncompeting-directly-with-ups-and-fedex-1474994758

[Liberty]

http://www.recode.net/2016/9/27/13078526/amazon-online-shopping-product-search-engine

 

Another year, another data point showing Amazon has surpassed Google as the default search engine for shopping.

 

Fifty-five percent of people in the U.S. now start their online shopping trips on Amazon.com, according to results from a 2,000-person survey commissioned by the e-commerce startup BloomReach. That stat marks a 25 percent increase from the same survey last year, when 44 percent of online shoppers said they turned to Amazon first.

 

Over the same time, the percentage of shoppers who start product searches on search engines like Google dropped from 34 percent to 28 percent. The number of online shoppers who check out a retailer’s website (other than Amazon) first also shrunk, from 21 percent to 16 percent.

[SlowAppreciation]

Amazon’s Newest Ambition: Competing Directly With UPS and FedEx

 

To constrain rising shipping costs, the online giant is building its own delivery operation, setting up a clash with its shipping partners

 

 

http://www.wsj.com/articles/amazons-newest-ambitioncompeting-directly-with-ups-and-fedex-1474994758

 

I'm very interested to see how this plays out. Fulfillment costs as a % of product rev have doubled since 2008 (~8.5% - 17%). R&D and Marketing have also increased as well, which for me has always thrown cold water on the whole "economies of scale/investing in the future" argument common to Amazon. Curious to see if their encroachment on UPS/Fedex will drive this # down. If so, Amazon could be cheap here.

 

I'd also be interested in the accounting treatment. Since they're building out a big infrastructure, might be more likely to capitalize versus expense.

[Liberty]

The thing with the logistics push is that Amazon doesn't actually have to do what UPS and Fedex does everywhere.

 

They could make a list of the places where doing some of it themselves would be most attractive, and start at the top and go down the list over time until they reach a point where the ROI isn't good. And then let UPS and FedEX keep covering the least attractive places (rural, low density, too few Amazon shoppers to have high utilisation, etc).

 

Sounds like this could hurt UPS and FedEX because Amazon could basically cherry pick their best markets, the ones where most of the profit probably comes from.

[AccentricInv]

Fulfillment costs as a % of product rev have doubled since 2008 (~8.5% - 17%).

 

Also remember, that 2008 vs today isn't an apple to apples comparison.  In 2008, prime wasn't nearly as popular it was today, and many items were still shipped in 5-7 days.  Since shipping costs rise exponentially (not linearly) as the ship time decreases, it only makes sense for fulfillment costs to increase as a % of the price, only partially offset by the benefits of increased shipment density in the last 8 years.

 

It's going to be fun to see what AMZN does on the logistics side, especially on last-mile.  This could be the third leg of their business if done right (e-commerce, aws, logistics).  After the article this morning, I reached out to a PE friend who's involved with a last-mile logistics company on the West Coast.  He reported that last-mile is typically 30% of the overall shipping cost, and that traditional last-mile fulfillers earn 10% margins.  If AMZN can solve this segment, it means huge savings for the amount of volume they're shipping.  Things are going to get interesting.

[SlowAppreciation]

Fulfillment costs as a % of product rev have doubled since 2008 (~8.5% - 17%).

 

Also remember, that 2008 vs today isn't an apple to apples comparison.  In 2008, prime wasn't nearly as popular it was today, and many items were still shipped in 5-7 days.  Since shipping costs rise exponentially (not linearly) as the ship time decreases, it only makes sense for fulfillment costs to increase as a % of the price, only partially offset by the benefits of increased shipment density in the last 8 years.

 

It's going to be fun to see what AMZN does on the logistics side, especially on last-mile.  This could be the third leg of their business if done right (e-commerce, aws, logistics).  After the article this morning, I reached out to a PE friend who's involved with a last-mile logistics company on the West Coast.  He reported that last-mile is typically 30% of the overall shipping cost, and that traditional last-mile fulfillers earn 10% margins.  If AMZN can solve this segment, it means huge savings for the amount of volume they're shipping.  Things are going to get interesting.

 

Absolutely. But it's always given me pause about investing in Amazon.... Free shipping (in the form of Prime) undoubtedly drives sales, so one could argue that without subsidized shipping, Amazon's revenue would suffer.

 

If they can get fulfillment costs down, then I think the stock is cheap. I don't know if they will, but I really would not bet against Bezos.

[Liberty]

https://blog.twitch.tv/twitchprime-458a537a3ae1#.efqu17s6l

 

Twitch Prime, comes bundled with Amazon Prime.

[Liberty]

http://www.newyorker.com/culture/sarah-larson/yelling-at-alexa-amazon-echo

[Spekulatius]

I wonder when AMZN is going to get hit by lawsuits for counterfeit goods that are being sold on their website with impunity. I got aware of this when looking for genuine replacement batteries for my Samsung S4. It seems that based on users comments and other reports, 95% of all the "genuine" batteries sold are knockoffs. I don't think a major retailer like AMZN can get away with enabling some vendor to simply sell their counterfeits on Amazon, possibly even under the "prime" label.

 

Same is true for many luxury goods (handbags, watches). At some point, this is going to be blow up big time in their face, as it will be apparent that AMZN enables those vendors. Just imagine what happens, if one of those products turns out to be unsafe and starts to hurt people. The lawsuits will go after the company with the money, not the shady vendor in Hongkong or who knows where. Once investigations start, it will be clear that AMZN knew  about this and did nothing about it apparently.

 

 

I don't know what and when it will happen, but I think it is a tail risk that AMZN investors should be aware of. I like AMZN prime, but I have started to switch purchases of some goods to websites, where I think I will get genuine goods, not knowoffs.

[Ballinvarosig Investors]

Ebay have gotten away with it for years....

[KCLarkin]

They are also selling dangerous products. The vendors ship direct from China so they are likely immune to product liabilities.

 

If Amazon isn't liable for 3rd party items, the law needs to change.

[DeepSouth]

I wonder when AMZN is going to get hit by lawsuits for counterfeit goods that are being sold on their website with impunity. I got aware of this when looking for genuine replacement batteries for my Samsung S4. It seems that based on users comments and other reports, 95% of all the "genuine" batteries sold are knockoffs. I don't think a major retailer like AMZN can get away with enabling some vendor to simply sell their counterfeits on Amazon, possibly even under the "prime" label.

 

Same is true for many luxury goods (handbags, watches). At some point, this is going to be blow up big time in their face, as it will be apparent that AMZN enables those vendors. Just imagine what happens, if one of those products turns out to be unsafe and starts to hurt people. The lawsuits will go after the company with the money, not the shady vendor in Hongkong or who knows where. Once investigations start, it will be clear that AMZN knew  about this and did nothing about it apparently.

 

 

I don't know what and when it will happen, but I think it is a tail risk that AMZN investors should be aware of. I like AMZN prime, but I have started to switch purchases of some goods to websites, where I think I will get genuine goods, not knowoffs.

 

The lawsuits have already begun. Apple sued them last week.