Author Topic: AMZN - Amazon.com Inc.  (Read 631662 times)

Grenville

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Re: AMZN - Amazon.com Inc.
« Reply #380 on: May 13, 2014, 08:31:30 PM »
I didn't realize the Diapers.com/Quidsi founders had left Amazon. The other founders of acquired companies are still there.

Diapers.com co-founder quietly working on new startup called Jet
http://tech.fortune.cnn.com/2014/05/13/diapers-com-founder-startup/

Amazonís Quidsi Sees Founders Depart to Work on New Projects
http://www.bloomberg.com/news/2013-07-08/amazon-s-quidsi-sees-founders-depart-to-work-on-new-projects.html


JAllen

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Re: AMZN - Amazon.com Inc.
« Reply #381 on: May 21, 2014, 11:45:49 AM »


Here are some thoughts I wrote in an email a while back.  I hope it spurs more AMZN discussion.


"
  • Amazon's margin history is the most misunderstood aspect of the company, in my opinion, and suggests that the company trades at an EV/FCF multiple of 20-25.  For instance, AMZN generated a 12% FCF margin in 2009, just prior to the massive, greater-than-sales-growth-rate infrastructure expansion the company embarked on (2010-2012 57% square footage growth against 20% average square footage growth 2002-2009)
  • Comparing AMZN's historical operating expense margin to Walmart's is instructive.  AMZN's opex margin was mid-teens prior to its massive spending ramp in 2010 compared to ~19% now, compared with Walmart's stable 18% opex margin.  I believe that it's likely Amazon's long-term opex margins will be less than Walmart because AMZN doesn't have expensive retail real estate, and this is corroborated by AMZN's prior-to-2010 opex margin history - mid-teens opex margins noted above.
  • AMZN's gross margins have expanded materially to 28% for 2013 compared with ~22% prior to 2011.  When combined with mid-teens opex margins noted above, there's the possibility AMZN may have long term operating margin/FCF margins (which aren't perfect substitutes over short periods of time due to various non-cash expenses like stock comp. etc. but should approximate one another ex-taxes and interest) into the double-digits, which I doubt the market has considered (although Skzutak mentions the potential double-digit margins in a CC).
Generally the market seems to believe AMZN has no pricing power and is making zero profit.  But we haven't seen anyone analyze the company's historical margins thoroughly and considered where they might go.  Even using AMZN's current gross margin - 28% - and WMT's opex margin of  ~18% gets us to 10% operating margins for AMZN (Walmart's operating profit margin are very reliably 6% so I think of 6% as a base for AMZN long-term).  I personally believe that AMZN's North American operations are running at least 8% underlying operating margin now, excluding massive non-revenue generating expenses like digital video licensing (~$1B/year); crazy things like Amazon Fresh and hardware development with non-trivial expenses (e.g. hundreds of Silicon Valley employees and dozens of Fresh trucks and employees).  The 8% North American operating margin is also supported by the fact that the N.A. operating margin is already 4% despite the fact that AMZN books all stock-comp in N.A., does so using an accelerated method which results in >1% of N.A. revenue being expensed prematurely (in 10-K), and almost surely has most R&D type expenses booked here (which makes perfect sense to do in your highest corporate tax jurisdiction, doesn't it?). 


Another thing that AMZN does well is to invest using expenses, not always capex, which as you know are immediately tax-deductible and help maximize long-term cash flows by minimizing taxes (remarkably similar to John Malone's modus operandi actually), the only thing Bezos cares about.  So the market thinks AMZN's underlying operations aren't profitable at all when in reality the profit is being obscured by the company's massive growth expenses, much of which are growth expenses.  A great example is the significant sum AMZN is now spending on HBO shows.

Regarding size of Walmart now compared with AMZN's eventual size.  I've generally thought of AMZN's current addressable U.S. retail sales at ~$4T, which is less than $5T, primarily because it excludes fuel sales but includes groceries now (pretty sure retail + groceries is ~$4T).  But  yes, I believe AMZN will eventually be larger than WMT as a percentage of the U.S. economy (WMT is now ~10-11% of U.S. retail sales) because AMZN is now in four large businesses and sells 100X+ (WMT Supercenters are ~150,000 SKUs compared with Prime at 15M+) the number of products WMT sells and is not limited in the sectors it can participate in because it doesn't rely on the physical retail infrastructure Walmart relies upon (think AMZN art + cars with no physical capital required).


Regarding raising prices: aside from the proposed Prime price increase, I've seen a couple of potential price increases anecdotally.  I ordered something a few weeks ago on a Thursday evening.  They offered me one-day shipping for Saturday  - for $8.99, instead of the usual $3.99 - but for almost 48 hours later, not one day shipping really.  The free shipping date was the following Tuesday - a full 3+ shipping days after my order.  So not sure what that's about but it could be a shortage of that particular product (computer cord), a large shipping price increase, or some combination thereof.


Bezos has mentioned the need to "check in and make sure we can still make a profit" (this is not verbatim and I can't remember where he said this) a few times.  They may be doing this now, but I'm not sure.  But the Prime price increase suggests they believe they have pricing power with Prime, which I imagine they do.


Anyways, I'm happy to discuss AMZN more.  It's our second largest position at the moment and I hope to hold it for a decade or two.  I believe it will be the largest U.S. company by revenues and market cap in 10+ years or so.


One last thing I just remembered: the market focuses on sales growth.  This is wrong for AMZN because their gross profit is growing much faster - 34% in 2013 - than sales - 24%. This is because of the third-party retail commission growth (that should have much higher than normal retail gross margins of ~24%) and the shift to digital sales.  It's a little hard to explain, but the gist is that if AMZN were selling all of the third-party products themselves and not selling more digital products, sales growth would be closer to gross profit growth instead of sales growing at about two-thirds the rate of gross profit growth.  So AMZN in effect is generating the gross profit from sales growth equal to gross profit growth because it's capturing the profit with lower revenue, higher margin commissions, if that makes sense.  So I think of AMZN being a 30+% grower instead of 23%, which is a totally different story from a long-term shareholder return perspective.


I agree about your ROIC type calculations, although I've been using FCF for AMZN ( OCF - CAPEX and normalizing that for historic times when they were expanding less) instead of EBITDA.    This is primarily because OCF fully deducts taxes and interest (there aren't much of either though) and you've got a conservative pre-capex FCF number there.  Also, Bezos focuses on the cash flow statement - the operating cash flows (it's listed first in the reports; can either of you recall another company doing that?).  You can pick your FCF or whatever margin.  I think of it as high single digits now for OCF, which is less than what they were doing before they ramped spending in 2010 as I noted above and is only 2% of revenues more than what the income statement shows - 7.4% OCF margin for 2013.  I use 2% for the capex margin, because their capex as a percent of revenues was a very steady 1-2% until 2010 when they massively ramped spending (see above chart again).  So I get mid to high single-digit FCF margin. As far as invested capital for the ROIC denominator, AMZN's tangible invested capital is about $10B (leaving nearly all of the cash as invested which is probably conservative).  If you look at OCF/tangible capital it's quite attractive at ~55%. I realize this doesn't include any capex, I'm just using numbers that we know for certain to ballpark FCF ROIC numbers: OCF and balance sheet numbers."


Maintenance capex is of course the wild card here, and I don't know what % of revenues it will average.  I would love to read others' arguments why it will be substantially greater than the ~2-3% it averaged for seven years prior to the massive spending ramp in 2010.  If we use 3% as maintenance capex margin and operating margin of ~10% we get to 7% FCF margin which is entirely possible and would result in an approximate 50% FCF/ROIC

Liberty

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Re: AMZN - Amazon.com Inc.
« Reply #382 on: May 21, 2014, 11:57:11 AM »
Excellent post, JAllen. Thanks! The Malone comparison when it comes to avoiding taxes is very apt, IMO. Better to spend that money to invest in growth than to pay it in taxes, even if it makes GAAP earnings look horrible.
« Last Edit: May 21, 2014, 12:10:44 PM by Liberty »
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Palantir

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Re: AMZN - Amazon.com Inc.
« Reply #383 on: May 21, 2014, 12:03:32 PM »
JAllen - what adjustments are you making to OCF to get the true "economic" OCF? I assume your argument is that economic FCF is far higher than what the statement shows, so just wondering where to look to find adjustments.
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JAllen

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Re: AMZN - Amazon.com Inc.
« Reply #384 on: May 21, 2014, 12:38:04 PM »
JAllen - what adjustments are you making to OCF to get the true "economic" OCF? I assume your argument is that economic FCF is far higher than what the statement shows, so just wondering where to look to find adjustments.


For now, I'm using actual OCF as a floor that no one can argue with on its own (except for what I discuss below).  AMZN does have growth expenses as I mentioned, and these do reduce OCF as well as income, so your intimation that OCF is probably understated is correct, IMO.  OCF is just a number that is better than GAAP operating income to work with because op. income is being intentionally minimized.


There are some major expenses OCF excludes in addition to not deducting anything for maintenance capex (which I do deduct for FCF in my discussion above as perhaps 3% of revenues), the biggest one being stock-comp. expense (which is itself overstated - see below), so I think OCF is a very rough proxy for current operating margins after subtracting growth expenses.  We would need to adjust OCF downward for stock-comp, by something like .4-.5% of revenues (actual stock-comp. expense is ~2% of revenues but AMZN's vesting schedule is not 50% the first year of grants which is how they expense stock-comp[1]; it is 5%-15%-40%-40%) but adjust it upwards for all of the cash growth expenses and benefits that are thrown at customers but aren't charged for like the Prime benefits, Amazon Fresh, digital video (this is a huge tax-deductible expense, probably something like 1-1.5% of revenues now), other general expansion and whatever else they are spending money on that we have no clue about


So the moral of the story is that much of AMZN's growth spending is not capex but are tax-deductible expenses.  It makes perfect sense to target growth expenses if you are truly concerned about long-term FCF like Bezos is. 


Would you rather give 39% of your income to the Federal Govt. and get zero benefit or throw your OCF at customers to make them happier, more loyal, build trust, gain a larger percentage of their annual retail spending and drive your taxable income to essentially zero?  If you're not concerned about current years EPS, which Bezos is so clearly not, this is exactly what you would do.  And then Buffett would say you're essentially the best American CEO.


[1] We utilize the accelerated method, rather than the straight-line method, for recognizing compensation expense. For example, over 50% of the compensation cost related to an award vesting ratably over four years is expensed in the first year. If forfeited early in the life of an award, the compensation expense adjustment is much greater under an accelerated method than under a straight-line method. (pg. 19 in 10-K)
« Last Edit: May 21, 2014, 12:39:59 PM by JAllen »

PatientCheetah

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Re: AMZN - Amazon.com Inc.
« Reply #385 on: May 21, 2014, 03:58:26 PM »
Excellent analysis, it took me a few years to finally understand the AMZN story and I blame myself for reading too many bearish thesis. The steady increase in price and my own personal dependency on AMZN should've tipped me off a long time ago.
« Last Edit: May 21, 2014, 04:37:24 PM by PatientCheetah »
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dwy000

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Re: AMZN - Amazon.com Inc.
« Reply #386 on: May 21, 2014, 09:16:31 PM »
Great analysis JAllen.  Good summary and it's tough to argue with any of the math.

At the end of the day though I just struggle with the concept that Amazon has always been an investment I justify by starting with "when they finally start to...." or "when they stop doing.....".  The sales growth has unquestionably been fantastic but I always come back to the fact that free cash flow over the past 5 years has been steadily declining: 
    2009  - $2920
    2010  - $2516
    2011  - $2092
    2012  - $ 395
    2013  - $2031
All while sales have grown from $24bn to $74bn (and other than 2012 the share count has continued to increase).

There are a ton of adjustments you can make that suggest the FCF potential is enormous but it always seems to be just that, potential.  The higher capex to build out fulfillment centers has hurt the past few years but I can't see that stopping any time soon if they want to keep growing the top line and taking delivery down to same or next day.  It will also increase the ongoing fulfillment opex as they operate all these new and larger facilities.  If you assume growth slows they lose the cash flow benefit of the operating cycle (working capital) as well as the direct cash generated by unearned revenue growth ($400M of FCF in 2013).

Would love to get your view on a couple of items:
 - what's your thoughts on the impact of them having to start charging state sales tax in the next year or two?  I haven't done the homework but it would seem that for the states this has been implemented they took a pretty sharp hit to revenues (probably one time and then resumed growing);
- the price declines in AWS services have been significant over the past year.  Microsoft, Google and IBM have all dropped prices hugely (over 40% I think) in just the past year and have stated they will match any price.  This is high margin, sticky business for AMZN.
- they don't really buy back shares but they certainly expense them (your point on timing is a good one but over a longer term this will even out).  The share count hasn't gotten out of hand over the past few years but it certainly isn't helping from a FCF/share perspective.

In buying this stock I worry very much about the reaction you saw after the 1Q earnings and outlook.  People seem to be pricing it off of the potential FCF it can earn in the future.  But at the FCF multiples it trades at today there's a big risk of the Microsoft situation - i.e. the stock is dead money for 10 years while the cash flow and earnings grow into the stock price as the multiple comes down.





dwy000

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Re: AMZN - Amazon.com Inc.
« Reply #387 on: May 21, 2014, 09:39:12 PM »
sorry for droning on but I forgot to add a couple of other points:

- The gross margins are strong and growing but I really think it makes sense to adjust those for the technology and content spend which is also growing rapidly, given they are including AWS in the sales number but there aren't many COGS expenses for this as it is largely a fixed cost business and we don't know what support costs for AWS are in COGS vs tech & content.

- on a similar vein, again, they don't break it out but a good portion of the capex growth over the past 2 years has to be related to AWS.  And that's a business that will require a lot of additional capex (both facilities and hardware) to support growth.  The hardware would likely need to be replaced every 3-5 years.

- Google shopping now offers same day delivery here (San Fran) on items purchased from major stores.  It's free for the first 6 months.  Who knows how they'll price it long term or if it takes off (I think it will die a quiet death at the next downturn much like all those delivery businesses in the internet bubble) but it's a deep pocketed competitor aiming directly at the Amazon core.

Laxputs

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Re: AMZN - Amazon.com Inc.
« Reply #388 on: May 21, 2014, 09:56:36 PM »
I'm curious on the investment argument: how do you price in the future growth given your hurdle rate?. I never do DCF analysis, I usually buy companies priced at very attractive earnings yield, with growth not necessary for the investment. So supposing this is 25x normalized earnings, what kind of minimum return are you expecting when accounting for growth? I'm hoping a few examples and the math involved can be offered.

It's interesting that multiple contraction is not really an issue with this stock, if the math of your assumptions is roughly correct. It means the company is currently trading at the multiple some anitcipate it will contract to.

Also, JAllen, what is your largest holding?

Thanks.

JAllen

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Re: AMZN - Amazon.com Inc.
« Reply #389 on: May 22, 2014, 12:03:11 AM »
Great analysis JAllen.  Good summary and it's tough to argue with any of the math.

At the end of the day though I just struggle with the concept that Amazon has always been an investment I justify by starting with "when they finally start to...." or "when they stop doing.....".  The sales growth has unquestionably been fantastic but I always come back to the fact that free cash flow over the past 5 years has been steadily declining: 
    2009  - $2920
    2010  - $2516
    2011  - $2092
    2012  - $ 395
    2013  - $2031
All while sales have grown from $24bn to $74bn (and other than 2012 the share count has continued to increase).

AMZN is for me and Bezos a very long-term stockholding, so I'm really not overly concerned about what the company is earning now.  If you don't view AMZN as a long-term hold and focus on what it will earn in five to ten years, it just doesn't work, because it's not cheap on a current FCF basis.  That point is inarguable. Since the vast majority of us will be alive in 10-20 years, why not have a holding period perspective that long?  There's the great hockey quote that applies in droves here: skate where the puck is going, not where it is.  So I believe that when the massive spending ramp (again from 20% growth to 57% growth - this is huge!) cools back down to sales or gross margin growth, we will see growth in operating income and free cash flow, but I have no idea when that will happen.  If one has a VERY long-term perspective, you hope this doesn't happen for a very long time, as that would mean AMZN has run out of places to invest its capital.  This won't even begin to be a problem for AMZN for a number of years though, at least ten I'm guessing.


There are a ton of adjustments you can make that suggest the FCF potential is enormous but it always seems to be just that, potential.  The higher capex to build out fulfillment centers has hurt the past few years but I can't see that stopping any time soon if they want to keep growing the top line and taking delivery down to same or next day.  It will also increase the ongoing fulfillment opex as they operate all these new and larger facilities.  If you assume growth slows they lose the cash flow benefit of the operating cycle (working capital) as well as the direct cash generated by unearned revenue growth ($400M of FCF in 2013).

Again, this comes down to a difference in time-horizon.  I'm viewing AMZN as a semi-permanent shareholder, not as 1-2 year shareholders.

Regarding the operating cycle, I expect that to continue due to Prime + Prime Fresh and AWS 1 and 3 year reserved instances (that are quite attractively priced) revenues.  I don't expect growth to slow anytime soon because of the virtuous cycle caused by having the best selection, prices, and service/convenience.  AMZN has by far the most momentum in very important industries that are the future of how humans do business and consume.  This should not be overlooked.  It can be easy to miss the forest for a tree.  AMZN having great momentum, first mover advantage, scale and the best management in very large businesses while still being tiny in the grand scheme of things is the forest (AMZN's North American revenue is still just 1% of addressable sales).  Being concerned with how much FCF the company is currently generating is a tree.

Would love to get your view on a couple of items:
 - what's your thoughts on the impact of them having to start charging state sales tax in the next year or two?  I haven't done the homework but it would seem that for the states this has been implemented they took a pretty sharp hit to revenues (probably one time and then resumed growing);

The sales tax cost advantage was just one attraction from a consumer's perspective.  AMZN started charging sales tax in CA, which is almost surely its highest revenue state at least a couple of years ago.  When they do start charging in a new state, they can lower shipping expenses building warehouses closer to population centers.  For SF, packages used to come from Reno and Las Vegas, 4.5 and many hours away respectively.  Reno was over the Sierra Mountains, which I'm sure was risky and sometimes treacherous due to snow for four months of the year.  Now there are two warehouses 1.5 hours away.  That cuts down on costs so AMZN can lower prices.  The sales tax advantage was always an impermanent advantage and everyone knew it was going away.  This is an anecdote, but I probably spend 2X with AMZN compared with when they started charging sales tax.  It was a bummer the first time I saw I was going to pay sales tax, but that didn't once cause me to even consider driving to Wal-mart or walking to Best Buy! People love AMZN for lower prices that they still have, convenience, selection, reviews, great customer service (I regularly complain for things like massive price drops right after I purchase things and they'll give me money back no questions asked - this is the right way to build trust and loyalty).  Don't forget that now the field is level from a sales tax perspective, but since AMZN has lower op ex. costs, because they're more software-focused, automated and don't operate retail real estate, they can still charge lower prices.  Also, driving to stores is a huge pain and WMT.  I'm 30+ minutes from a WMT (SF).  That's another mark against WMT relative to AMZN - driving to a store, finding what you're looking for, and waiting in line sucks!

I will respond more tomorrow.  It's late here now.  I'm really glad there's more discussion about AMZN now!