AMAZON.COM INC AMZN
December 17, 2011 - 1:51pm EST by
trev62
2011 2012
Price: 181.26 EPS $0.00 $0.00
Shares Out. (in M): 455 P/E 0.0x 0.0x
Market Cap (in $M): 82,429 P/FCF 37.3x 28.1x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 76,103 TEV/EBIT 67.0x 42.8x

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  • High Barriers to Entry, Moat
  • Internet
  • GARP
  • Jeff Bezos
  • Ecommerce
 

Description

I believe Amazon is an extremely attractive long position for any investor with a 5+ year time horizon (possibly few and far between!).  The company is misunderstood by many investors who focus on its short term earnings, despite the fact that CEO Jeff Bezos has been clear in his intentions to sacrifice near-term earnings for the sake of long-term free cash flow generation and the deepening of the company’s competitive advantage.  Amazon’s moat is wide and growing, and the company is well positioned to take advantage of global internet growth and the resulting migration of retail sales to the internet, one of the most powerful trends of our generation.  10 years from now I believe that 1) the leading online retailer globally will be amongst the largest retailers in the world, 2) that company will be amongst the most valuable of all companies in the world, and 3) Amazon is likely to be that company.  If that is true the stock should appreciate meaningfully from its current $76 B enterprise value, despite the high current P/E that scares most value investors away.

 

Wait, Doesn’t This Trade at 95x Earnings?

Let me start with the valuation discussion since I’m sure this will generate a healthy debate.  The key point I want to get across is that Amazon’s current earnings are not reflective of its true earnings power, and therefore I don’t believe they should be the primary metric used when valuing the company.  This is because Amazon’s strategy from day one has been to take the profits generated from its scale and superior business model and give some of those profits back to its customers through lower prices.  The idea is that this will lead to higher cash flow generation in the long run given the massive efficiencies of scale in online retail (large fixed costs spread across a larger base and less variable costs than brick and mortar retail).  As Amazon grows its business model gets more and more attractive, and therefore its customers benefit as well (through lower prices).  It’s a true virtuous cycle, and one Bezos has been clear about in his annual letters:

“When forced to choose between optimizing the appearance of our GAAP accounting and maximizing the present value of future cash flows, we'll take the cash flows” – 1997

“Eliminating defects, improving productivity, and passing the resulting cost savings back to customers in the form of lower prices is a long-term decision…Our pricing strategy does not attempt to maximize margin percentages, but instead seeks to drive maximum value for customers, and thereby create a much larger bottom line – in the long-term.” – 2003

“Our judgment is that relentlessly returning efficiency improvements and scale economies to customers in the form of lower prices creates a virtuous cycle that leads over the long term to a much larger dollar amount of free cash flow, and thereby to a much more valuable Amazon.com. We’ve made similar judgments around Free Super Saver Shipping and Amazon Prime, both of which are expensive in the short term and—we believe—important and valuable in the long term.” – 2005

While this is a rather unique model, there are examples of this working successfully – Costco is one of the best, but I’d throw in segments of Berkshire as well (Geico, Nebraska Furniture Mart).  This model is one of the main reasons Charlie Munger thinks so highly of Costco: 

 “I just can't say enough about my admiration for Costco. More of you should look at Costco…It has a frantic desire to serve customers a little better every year.  When other companies find ways to save money, they turn it into profit.  (CEO) Sinegal passes it on to customers.  It’s almost a religious duty.  He’s sacrificing short-term profits for long-term success...Generally speaking, I believe Costco does more for civilization than the Rockefeller Foundation” – Charlie Munger, July 2011, http://money.msn.com/investment-advice/article.aspx?post=7f0e084a-3473-41cc-b7e9-f4353e0deeb3

I believe that exact same argument can be made for Amazon.  It’s also worth noting that in addition to sharing profits with its customers, Amazon also invests aggressively in its systems and infrastructure to further grow its main retail business, and also to fund new areas such as cloud computing and the Kindle, which further cuts into current earnings.  Also, free cash flow is consistently higher than net income given the company’s high inventory turns and resulting negative working capital cycle (in 2010 FCF was $2.5 B versus $1.2 B net income).  So to value Amazon properly, there are several reasons why you need to look beyond current earnings, and in my opinion need to think ahead to where the company will be several years down the line.   

 

Overview

Bezos started Amazon in 1994, leaving a promising Wall Street career at DE Shaw with the idea to start an online book store.  He was ambitious from the beginning, getting the site launched by 1995, raising $8 mm from Kleiner Perkins in 1996 and listing publicly in 1997, which raised an additional $54 mm and valued the company at $429 mm.  I’d highly recommend reading his shareholder letters (the first of which, in 1997, was titled “It’s All About the Long-Term”) which are available at: http://phx.corporate-ir.net/phoenix.zhtml?c=97664&p=irol-reportsannual.  In short he has many admirable qualities for a CEO – he’s obsessed with serving his customers, only takes an $82 K salary, is focused on long-term free cash flow generation, has proven to have incredible foresight into his industry, is only 47 years old, and has even quoted Ben Graham in his letters.  He’s consistently taken a truly long-term view of his company, down to what now seem like obvious things such as allowing customer reviews of products on the site starting in 1995.  Many merchants thought this was crazy at the time, since negative reviews could hurt sales of certain products, but Bezos knew that in the long run customers would like the service and it has obviously become the norm in the industry since.   

Amazon is now the largest online retailer by a wide margin.  Its sales are estimated to be around $49 B this year, while Costco, Target, and Wal-Mart combined will have under $8 B in online sales.  45% of its business is now outside of the US, with online stores in the UK, Germany, France, Japan, Canada, China, and Italy.  It now sells just about everything online, with 18 main product categories, and it grows its selection every year.  It’s a leader in cloud computing and other related internet services, with groups such as Netflix, NASA, ESPN, The New York Times, and Twitter all tapping into its massive technology infrastructure for a fee.  It has developed several innovative programs over the years, including one-click shopping (which it has trademarked), Amazon Prime, Amazon Marketplace (now 33% of sales), the Kindle, and the Subscription business (where you can sign up to have any product delivered on a regular schedule in exchange for a discount – I highly recommend this for anyone who doesn’t like to shop!) all of which have been focused on improving both its customer experience and the long-term competitive advantage of the business. 

 

Massive Tailwinds

This won’t come as a surprise to anyone but I think it’s important to reflect on just how big of a theme global internet growth is.  Despite the tech bubble bursting in 2000, the # of internet users globally has grown more than 5x over that time:

Global Internet Users (mm)

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Jun-11

361

513

587

719

817

1,018

1,093

1,319

1,574

1,802

1,971

2,110

*www.internetworldstats.com

             

Because of continually dropping costs thanks to Moore’s law and other technological advances such as mobile, this trend will almost certainly continue regardless of what happens to the global economy.  I believe the best-positioned companies to take advantage of this trend are those that provide a service to their customers yet also have some degree of pricing power, as it’s tough to compete on the hardware side of things given the consistent price deflation of those products.  I believe internet retail fits this nicely given that it’s a service business that is enhanced by the increasing ease of use and declining costs of technology broadly, while at the same time offering large efficiencies of scale that should act as a competitive barrier.   

Stop and ask yourself two questions: what do you think internet retail will be as a proportion of total global retail sales in 10 years, and what do you think that number was last year?  In several informal polls I’ve found most people think the current #’s are a lot higher than they really are (I also recommend anyone under the age of 25 what % of their purchases are made online): 

Global ecommerce as % of Total Retail

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011E

2012E

0.6%

0.7%

0.9%

1.1%

1.3%

1.6%

1.9%

2.1%

2.2%

2.4%

2.7%

3.0%

3.2%

*Goldman Sachs

                   

While the level in 10 years is impossible to predict with any precision (10%, 15%?) it will clearly by much, much higher and only growing from there as well.  Incredibly not only has Amazon been taking share of this rapidly growing pie, it’s actually done so at an increasing rate every year since 2005:

AMZN Stats

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011E

2012E

Revenues ($B)

2.7

3.1

3.9

5.3

6.9

8.5

10.7

14.8

19.2

24.5

34.2

49.3

65.6

% of global e-commerce

7.0%

6.5%

6.2%

6.2%

6.2%

5.9%

5.9%

6.7%

7.6%

9.1%

10.8%

13.4%

15.8%

Change in share (bps)

 

(48)

(36)

3

-6

-22

1

73

91

148

173

258

239

*Goldman Sachs

                       

 

Amazon’s Ever Widening Moat

Of all the major internet and technology companies, I believe Amazon has the best chance of still being around 10, 20, 50, etc. years down the line.  It passes the simple Buffett test with flying colors in my opinion (could a new, well-funded competitor compete with the business?) given its massive distribution infrastructure that took years to build and required large amounts of upfront investment to get to necessary scale (Amazon racked up $3 B of losses between 1995-2003).  Morgan Stanley estimates that the company will end 2011 with 40 mm square feet of “one-to-one, multi-node fulfillment infrastructure” (in others words, very sophisticated warehouses and logistics) and notes “No other company in the world has such an infrastructure, including offline retailers with much larger revenue bases”.  Replicating that would take many years and billions and billions of dollars.   

Internet retail has several advantages over brick and mortar retail, which give a company like Amazon cost, selection, convenience, and availability advantages over the competition.  As one example let’s compare Amazon to Best Buy since they have similar revenue levels ($52 B vs. $49 B expected in 2011).  Amazon has 33,700 employees while Best Buy has 180,000.  If you assume each of the 146 thousand additional employees that Best Buy has on staff gets paid $25 K on average, that’s $3.7 B of additional costs, or 7% of Best Buy’s total sales!  In a low margin business like retail that is an enormous advantage for Amazon.    It doesn’t stop there though - in addition to requiring more employees, Best Buy’s business model also has significantly higher rent expense than Amazon (more than 3x as a % of sales).  Despite the lean staffing and physical presence, Amazon is able to carry more than 10 times the # of TVs and laptops that Best Buy does, turns its inventory over more rapidly each year (10.6 vs. 7.3 turns/year), and is open for business more than twice the hours of Best Buy.  Simply put, Amazon has a far superior business model to brick and mortar retailers, and yet the migration of sales to the internet remains at an early stage (Best Buy still has more than 4x the market share in US consumer electronics as Amazon, for example).      

For more reading on Amazon’s moat and business in general, this presentation has some good additional detail: http://www.slideshare.net/faberNovel/amazoncom-the-hidden-empire


Truly Long-Term Focus and Customer Obsession

In Bezos’s 1998 letter to shareholders, he wrote “We intend to build the world’s most customer-centric company”.  While that was a particularly bold statement coming from a 3-year old company that had just lost $125 mm that year, incredibly Amazon has become just that.  This table shows Amazon’s scores in the American Customer Satisfaction Index versus several well regarded retail and internet peers.  Not only has Amazon scored the highest rating of any service related business in the history of the index, but it has had or tied for the best score each year since 2000: 

American Customer Satisfaction Index*

 

00

01

02

03

04

05

06

07

08

09

10

Amazon

84

84

88

88

84

87

87

88

86

86

87

eBay

80

82

82

84

80

81

80

81

78

79

81

Nike

78

74

76

76

78

75

72

75

78

79

80

CNN.com

   

72

72

74

72

74

73

73

71

73

Google

   

80

82

82

82

81

78

86

86

80

Yahoo

74

73

76

78

78

80

76

79

77

77

76

Wal-Mart

73

76

74

75

73

72

72

68

70

71

73

Target

73

77

78

77

75

78

77

77

77

80

78

Sears

73

76

75

73

74

73

73

72

72

74

75

Microsoft

           

73

70

69

70

76

Costco

77

76

79

80

79

79

81

81

83

81

82

Best Buy

     

72

72

71

76

74

74

74

77

Sam's Club

74

78

77

77

75

76

78

77

79

79

78

Staples

             

77

76

77

81

Lowe's

 

75

76

77

76

78

74

75

76

79

77

*www.theacsi.org

                     

Amazon has delighted its customer base for over a decade, building trust and further widening its moat along the way.  Despite minimal marketing the customer base has grown from 20 million to 137 million over that span and the scores remained consistently high.

 

So, What is it Worth?

I believe there is a reasonably high chance that Amazon will become the largest retailer and one of the most valuable companies in the world.  Obviously that’s not certain and will take time, but given its massive tailwinds and huge competitive advantage I think it’s more likely than not to occur.  The average market cap of the 10 largest companies in the world is $253 B (at a seemingly reasonable 12x P/E I might add), so if I’m right there is clearly room for Amazon’s $82 B market cap to grow.  Comparing Amazon’s valuation to its peers in the internet/tech and retail space also helps put things in perspective and shows the amount of market cap available for AMZN to eat into:

Internet/Tech

Retail

Company

Market Cap ($ B)

Company

Market Cap ($ B)

Apple

$354

Wal-Mart

$202

Microsoft

$219

CVS Caremark

$50

Google

$204

Tesco

$50

Facebook

$82 (est.)

Costco

$37

eBay

$41

Target

$36

 

 

Walgreen

$30

For some actual metrics, current street consensus has Amazon generating $6.2 B in free cash flow in 2015.  At its current price that would be just over 12x EV/FCF, and I believe that the free cash flow could be meaningfully higher by then and that the true earnings/cash flow power of the company is even higher still.  The nice part of the Amazon story is that the company truly does get stronger as it grows, which compared to a company like Apple (which has to create new innovative devices every year just to keep up) is a huge long-term advantage. 

Another way of thinking about Amazon’s valuation is to estimate the % of retail sales that will be online in the future, the share of ecommerce Amazon has, and the company’s resulting margins.  While this is obviously a guessing game, for one example if total global retail sales grow 4% a year from current levels, 10% of those sales move online by 2021, Amazon has 15% share of that market, and net income margins match Wal-Mart’s current level of 3.6% (despite an inherently better business model), Amazon would generate ~$10 B in net income in 2021.  I believe something along those lines is a reasonably conservative outcome, and remember free cash flow would be even higher and the company’s growth prospects would remain bright at that time as the migration of retail sales to the internet will continue (eventually I could see half of retail moving online, but that could be very far off in the future).     

Another reason for my conviction in AMZN is the team’s consistent track record of innovation and likelihood of building additional earnings streams in the future (the analysis in the previous paragraph only focused on the core retail business, for example).  The company’s effort in cloud computing with Amazon Web Services is a great example – it has become the leader in yet another business in which there are large benefits to scale and significant growth coming in the future.  Goldman estimates that AWS will grow 50% per annum through 2015 and will generate $4 B of revenue at that time.  During Amazon’s May 2010 shareholder meeting Bezos claimed “It has the potential to be as big as our retail business”.  The Kindle has been a great success as well, revolutionizing the e-book market and generating additional book sales for Amazon.  While these segments are difficult to predict they demonstrate Bezos and his team’s creativity and focus on innovation.  Every year Amazon adds new categories to its main retail business, looks to buy small competitors who dominate a niche of online retail who would benefit from Amazon’s infrastructure (Diapers.com, Soap.com, Zappos, etc.), and enters new areas that have the potential to be significant as well (recent ventures include book publishing and grocery delivery, for example).      

While some investors and analysts are beginning to realize what an incredible business model Amazon has, I believe that even those who understand it have a hard time buying the stock given the headline valuation #’s.  It’s not a simple story, and the model of sharing earnings with your customers to increase long-term value is not common.  Imagine your average hedge fund analyst pitching his portfolio manager: “I want to buy Amazon at 100x earnings”.  We are all wired to prefer things that appear statistically cheap, even if the true intrinsic value of certain companies requires looking beyond near-term P/E’s.  During its growth phase in the 70’s and 80’s Wal-Mart never appeared statistically cheap, but in hindsight it was clearly undervalued and ended up as one of the best performing stocks of all time.    You can see this hesitation in recent sell-side opinions for example:

 “We view AMZN’s approach as the right decision for the long run, given AMZN’s attractive prospects and high ROIC…we await a more attractive entry point” - Credit Suisse 10/25/2011 (neutral)

“We require a better entry point, however, as we await follow-through on margin expansion before we can get more firmly positive on Amazon” - Barclays 11/28/2011 (Equal Weight)

“Long-term profit potential could exceed expectations…await a better entry point to take advantage of our multi-year thesis”- Goldman Sachs 12/13/2011 (Neutral)

 

Risks and Conclusion

Potential change in sales tax law is one risk, as Amazon has clearly benefited from most if its customers not having to pay sales taxes.  The company has stated that it would be comfortable with online sales being taxed at the federal level as long as it was fair, and in the end Amazon will maintain a large cost advantage over its competition because of its scale and superior business model.  There would also be some benefits to the company from being able to build more distribution centers around the country and make its delivery service even faster (as one example I believe they will deliver groceries with same day service to most major cities in the future, but would need more facilities around the country to do so). 

Competition is another risk, as clearly Wal-Mart and other brick and mortar retailers will try to move more sales online over time.  At the end of the day online retail and brick and mortar retail are very different businesses, and Amazon’s large and growing lead over the competition will make it tough to beat.  I believe the odds of Amazon having a larger share of online retail in the future are much higher than the odds of them having less.  I do think there will be several country-specific internet retailers started in other countries that could become quite valuable over time, and while it’s unlikely they would penetrate Amazon’s existing markets, they could dampen the company’s ability to grow in certain fast growing markets (360Buy in China and Flipkart in India are two good examples).   

There are other short term risks such as currency exposure (some risk to the USD going up) and the ongoing mess in Europe, but they shouldn’t get in the way of the long-term success of the business.  Stock price volatility is clearly a risk given the high headline valuation and the historic shifts in sentiment about the company, which can be significant.  I’m comfortable with that risk because the end point for Amazon is likely to be the same given it’s extremely long run way that is protected by a wide moat.  If an investor takes a truly long-term view, or would be prepared (or indeed, thrilled) to buy more if the stock falls, than I believe this is an attractive entry point into one of the world’s best businesses. 

Catalyst

Continued growth of the internet and ecommerce globally
Continued domination of that market by Amazon and widening of the company's moat
Continued innovation by Bezos and his team
Free cash flow growth from superior business model
 
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    Description

    I believe Amazon is an extremely attractive long position for any investor with a 5+ year time horizon (possibly few and far between!).  The company is misunderstood by many investors who focus on its short term earnings, despite the fact that CEO Jeff Bezos has been clear in his intentions to sacrifice near-term earnings for the sake of long-term free cash flow generation and the deepening of the company’s competitive advantage.  Amazon’s moat is wide and growing, and the company is well positioned to take advantage of global internet growth and the resulting migration of retail sales to the internet, one of the most powerful trends of our generation.  10 years from now I believe that 1) the leading online retailer globally will be amongst the largest retailers in the world, 2) that company will be amongst the most valuable of all companies in the world, and 3) Amazon is likely to be that company.  If that is true the stock should appreciate meaningfully from its current $76 B enterprise value, despite the high current P/E that scares most value investors away.

     

    Wait, Doesn’t This Trade at 95x Earnings?

    Let me start with the valuation discussion since I’m sure this will generate a healthy debate.  The key point I want to get across is that Amazon’s current earnings are not reflective of its true earnings power, and therefore I don’t believe they should be the primary metric used when valuing the company.  This is because Amazon’s strategy from day one has been to take the profits generated from its scale and superior business model and give some of those profits back to its customers through lower prices.  The idea is that this will lead to higher cash flow generation in the long run given the massive efficiencies of scale in online retail (large fixed costs spread across a larger base and less variable costs than brick and mortar retail).  As Amazon grows its business model gets more and more attractive, and therefore its customers benefit as well (through lower prices).  It’s a true virtuous cycle, and one Bezos has been clear about in his annual letters:

    “When forced to choose between optimizing the appearance of our GAAP accounting and maximizing the present value of future cash flows, we'll take the cash flows” – 1997

    “Eliminating defects, improving productivity, and passing the resulting cost savings back to customers in the form of lower prices is a long-term decision…Our pricing strategy does not attempt to maximize margin percentages, but instead seeks to drive maximum value for customers, and thereby create a much larger bottom line – in the long-term.” – 2003

    “Our judgment is that relentlessly returning efficiency improvements and scale economies to customers in the form of lower prices creates a virtuous cycle that leads over the long term to a much larger dollar amount of free cash flow, and thereby to a much more valuable Amazon.com. We’ve made similar judgments around Free Super Saver Shipping and Amazon Prime, both of which are expensive in the short term and—we believe—important and valuable in the long term.” – 2005

    While this is a rather unique model, there are examples of this working successfully – Costco is one of the best, but I’d throw in segments of Berkshire as well (Geico, Nebraska Furniture Mart).  This model is one of the main reasons Charlie Munger thinks so highly of Costco: 

     “I just can't say enough about my admiration for Costco. More of you should look at Costco…It has a frantic desire to serve customers a little better every year.  When other companies find ways to save money, they turn it into profit.  (CEO) Sinegal passes it on to customers.  It’s almost a religious duty.  He’s sacrificing short-term profits for long-term success...Generally speaking, I believe Costco does more for civilization than the Rockefeller Foundation” – Charlie Munger, July 2011, http://money.msn.com/investment-advice/article.aspx?post=7f0e084a-3473-41cc-b7e9-f4353e0deeb3

    I believe that exact same argument can be made for Amazon.  It’s also worth noting that in addition to sharing profits with its customers, Amazon also invests aggressively in its systems and infrastructure to further grow its main retail business, and also to fund new areas such as cloud computing and the Kindle, which further cuts into current earnings.  Also, free cash flow is consistently higher than net income given the company’s high inventory turns and resulting negative working capital cycle (in 2010 FCF was $2.5 B versus $1.2 B net income).  So to value Amazon properly, there are several reasons why you need to look beyond current earnings, and in my opinion need to think ahead to where the company will be several years down the line.   

     

    Overview

    Bezos started Amazon in 1994, leaving a promising Wall Street career at DE Shaw with the idea to start an online book store.  He was ambitious from the beginning, getting the site launched by 1995, raising $8 mm from Kleiner Perkins in 1996 and listing publicly in 1997, which raised an additional $54 mm and valued the company at $429 mm.  I’d highly recommend reading his shareholder letters (the first of which, in 1997, was titled “It’s All About the Long-Term”) which are available at: http://phx.corporate-ir.net/phoenix.zhtml?c=97664&p=irol-reportsannual.  In short he has many admirable qualities for a CEO – he’s obsessed with serving his customers, only takes an $82 K salary, is focused on long-term free cash flow generation, has proven to have incredible foresight into his industry, is only 47 years old, and has even quoted Ben Graham in his letters.  He’s consistently taken a truly long-term view of his company, down to what now seem like obvious things such as allowing customer reviews of products on the site starting in 1995.  Many merchants thought this was crazy at the time, since negative reviews could hurt sales of certain products, but Bezos knew that in the long run customers would like the service and it has obviously become the norm in the industry since.   

    Amazon is now the largest online retailer by a wide margin.  Its sales are estimated to be around $49 B this year, while Costco, Target, and Wal-Mart combined will have under $8 B in online sales.  45% of its business is now outside of the US, with online stores in the UK, Germany, France, Japan, Canada, China, and Italy.  It now sells just about everything online, with 18 main product categories, and it grows its selection every year.  It’s a leader in cloud computing and other related internet services, with groups such as Netflix, NASA, ESPN, The New York Times, and Twitter all tapping into its massive technology infrastructure for a fee.  It has developed several innovative programs over the years, including one-click shopping (which it has trademarked), Amazon Prime, Amazon Marketplace (now 33% of sales), the Kindle, and the Subscription business (where you can sign up to have any product delivered on a regular schedule in exchange for a discount – I highly recommend this for anyone who doesn’t like to shop!) all of which have been focused on improving both its customer experience and the long-term competitive advantage of the business. 

     

    Massive Tailwinds

    This won’t come as a surprise to anyone but I think it’s important to reflect on just how big of a theme global internet growth is.  Despite the tech bubble bursting in 2000, the # of internet users globally has grown more than 5x over that time:

    Global Internet Users (mm)

    2000

    2001

    2002

    2003

    2004

    2005

    2006

    2007

    2008

    2009

    2010

    Jun-11

    361

    513

    587

    719

    817

    1,018

    1,093

    1,319

    1,574

    1,802

    1,971

    2,110

    *www.internetworldstats.com

                 

    Because of continually dropping costs thanks to Moore’s law and other technological advances such as mobile, this trend will almost certainly continue regardless of what happens to the global economy.  I believe the best-positioned companies to take advantage of this trend are those that provide a service to their customers yet also have some degree of pricing power, as it’s tough to compete on the hardware side of things given the consistent price deflation of those products.  I believe internet retail fits this nicely given that it’s a service business that is enhanced by the increasing ease of use and declining costs of technology broadly, while at the same time offering large efficiencies of scale that should act as a competitive barrier.   

    Stop and ask yourself two questions: what do you think internet retail will be as a proportion of total global retail sales in 10 years, and what do you think that number was last year?  In several informal polls I’ve found most people think the current #’s are a lot higher than they really are (I also recommend anyone under the age of 25 what % of their purchases are made online): 

    Global ecommerce as % of Total Retail

    2000

    2001

    2002

    2003

    2004

    2005

    2006

    2007

    2008

    2009

    2010

    2011E

    2012E

    0.6%

    0.7%

    0.9%

    1.1%

    1.3%

    1.6%

    1.9%

    2.1%

    2.2%

    2.4%

    2.7%

    3.0%

    3.2%

    *Goldman Sachs

                       

    While the level in 10 years is impossible to predict with any precision (10%, 15%?) it will clearly by much, much higher and only growing from there as well.  Incredibly not only has Amazon been taking share of this rapidly growing pie, it’s actually done so at an increasing rate every year since 2005:

    AMZN Stats

    2000

    2001

    2002

    2003

    2004

    2005

    2006

    2007

    2008

    2009

    2010

    2011E

    2012E

    Revenues ($B)

    2.7

    3.1

    3.9

    5.3

    6.9

    8.5

    10.7

    14.8

    19.2

    24.5

    34.2

    49.3

    65.6

    % of global e-commerce

    7.0%

    6.5%

    6.2%

    6.2%

    6.2%

    5.9%

    5.9%

    6.7%

    7.6%

    9.1%

    10.8%

    13.4%

    15.8%

    Change in share (bps)

     

    (48)

    (36)

    3

    -6

    -22

    1

    73

    91

    148

    173

    258

    239

    *Goldman Sachs

                           

     

    Amazon’s Ever Widening Moat

    Of all the major internet and technology companies, I believe Amazon has the best chance of still being around 10, 20, 50, etc. years down the line.  It passes the simple Buffett test with flying colors in my opinion (could a new, well-funded competitor compete with the business?) given its massive distribution infrastructure that took years to build and required large amounts of upfront investment to get to necessary scale (Amazon racked up $3 B of losses between 1995-2003).  Morgan Stanley estimates that the company will end 2011 with 40 mm square feet of “one-to-one, multi-node fulfillment infrastructure” (in others words, very sophisticated warehouses and logistics) and notes “No other company in the world has such an infrastructure, including offline retailers with much larger revenue bases”.  Replicating that would take many years and billions and billions of dollars.   

    Internet retail has several advantages over brick and mortar retail, which give a company like Amazon cost, selection, convenience, and availability advantages over the competition.  As one example let’s compare Amazon to Best Buy since they have similar revenue levels ($52 B vs. $49 B expected in 2011).  Amazon has 33,700 employees while Best Buy has 180,000.  If you assume each of the 146 thousand additional employees that Best Buy has on staff gets paid $25 K on average, that’s $3.7 B of additional costs, or 7% of Best Buy’s total sales!  In a low margin business like retail that is an enormous advantage for Amazon.    It doesn’t stop there though - in addition to requiring more employees, Best Buy’s business model also has significantly higher rent expense than Amazon (more than 3x as a % of sales).  Despite the lean staffing and physical presence, Amazon is able to carry more than 10 times the # of TVs and laptops that Best Buy does, turns its inventory over more rapidly each year (10.6 vs. 7.3 turns/year), and is open for business more than twice the hours of Best Buy.  Simply put, Amazon has a far superior business model to brick and mortar retailers, and yet the migration of sales to the internet remains at an early stage (Best Buy still has more than 4x the market share in US consumer electronics as Amazon, for example).      

    For more reading on Amazon’s moat and business in general, this presentation has some good additional detail: http://www.slideshare.net/faberNovel/amazoncom-the-hidden-empire


    Truly Long-Term Focus and Customer Obsession

    In Bezos’s 1998 letter to shareholders, he wrote “We intend to build the world’s most customer-centric company”.  While that was a particularly bold statement coming from a 3-year old company that had just lost $125 mm that year, incredibly Amazon has become just that.  This table shows Amazon’s scores in the American Customer Satisfaction Index versus several well regarded retail and internet peers.  Not only has Amazon scored the highest rating of any service related business in the history of the index, but it has had or tied for the best score each year since 2000: 

    American Customer Satisfaction Index*

     

    00

    01

    02

    03

    04

    05

    06

    07

    08

    09

    10

    Amazon

    84

    84

    88

    88

    84

    87

    87

    88

    86

    86

    87

    eBay

    80

    82

    82

    84

    80

    81

    80

    81

    78

    79

    81

    Nike

    78

    74

    76

    76

    78

    75

    72

    75

    78

    79

    80

    CNN.com

       

    72

    72

    74

    72

    74

    73

    73

    71

    73

    Google

       

    80

    82

    82

    82

    81

    78

    86

    86

    80

    Yahoo

    74

    73

    76

    78

    78

    80

    76

    79

    77

    77

    76

    Wal-Mart

    73

    76

    74

    75

    73

    72

    72

    68

    70

    71

    73

    Target

    73

    77

    78

    77

    75

    78

    77

    77

    77

    80

    78

    Sears

    73

    76

    75

    73

    74

    73

    73

    72

    72

    74

    75

    Microsoft

               

    73

    70

    69

    70

    76

    Costco

    77

    76

    79

    80

    79

    79

    81

    81

    83

    81

    82

    Best Buy

         

    72

    72

    71

    76

    74

    74

    74

    77

    Sam's Club

    74

    78

    77

    77

    75

    76

    78

    77

    79

    79

    78

    Staples

                 

    77

    76

    77

    81

    Lowe's

     

    75

    76

    77

    76

    78

    74

    75

    76

    79

    77

    *www.theacsi.org

                         

    Amazon has delighted its customer base for over a decade, building trust and further widening its moat along the way.  Despite minimal marketing the customer base has grown from 20 million to 137 million over that span and the scores remained consistently high.

     

    So, What is it Worth?

    I believe there is a reasonably high chance that Amazon will become the largest retailer and one of the most valuable companies in the world.  Obviously that’s not certain and will take time, but given its massive tailwinds and huge competitive advantage I think it’s more likely than not to occur.  The average market cap of the 10 largest companies in the world is $253 B (at a seemingly reasonable 12x P/E I might add), so if I’m right there is clearly room for Amazon’s $82 B market cap to grow.  Comparing Amazon’s valuation to its peers in the internet/tech and retail space also helps put things in perspective and shows the amount of market cap available for AMZN to eat into:

    Internet/Tech

    Retail

    Company

    Market Cap ($ B)

    Company

    Market Cap ($ B)

    Apple

    $354

    Wal-Mart

    $202

    Microsoft

    $219

    CVS Caremark

    $50

    Google

    $204

    Tesco

    $50

    Facebook

    $82 (est.)

    Costco

    $37

    eBay

    $41

    Target

    $36

     

     

    Walgreen

    $30

    For some actual metrics, current street consensus has Amazon generating $6.2 B in free cash flow in 2015.  At its current price that would be just over 12x EV/FCF, and I believe that the free cash flow could be meaningfully higher by then and that the true earnings/cash flow power of the company is even higher still.  The nice part of the Amazon story is that the company truly does get stronger as it grows, which compared to a company like Apple (which has to create new innovative devices every year just to keep up) is a huge long-term advantage. 

    Another way of thinking about Amazon’s valuation is to estimate the % of retail sales that will be online in the future, the share of ecommerce Amazon has, and the company’s resulting margins.  While this is obviously a guessing game, for one example if total global retail sales grow 4% a year from current levels, 10% of those sales move online by 2021, Amazon has 15% share of that market, and net income margins match Wal-Mart’s current level of 3.6% (despite an inherently better business model), Amazon would generate ~$10 B in net income in 2021.  I believe something along those lines is a reasonably conservative outcome, and remember free cash flow would be even higher and the company’s growth prospects would remain bright at that time as the migration of retail sales to the internet will continue (eventually I could see half of retail moving online, but that could be very far off in the future).     

    Another reason for my conviction in AMZN is the team’s consistent track record of innovation and likelihood of building additional earnings streams in the future (the analysis in the previous paragraph only focused on the core retail business, for example).  The company’s effort in cloud computing with Amazon Web Services is a great example – it has become the leader in yet another business in which there are large benefits to scale and significant growth coming in the future.  Goldman estimates that AWS will grow 50% per annum through 2015 and will generate $4 B of revenue at that time.  During Amazon’s May 2010 shareholder meeting Bezos claimed “It has the potential to be as big as our retail business”.  The Kindle has been a great success as well, revolutionizing the e-book market and generating additional book sales for Amazon.  While these segments are difficult to predict they demonstrate Bezos and his team’s creativity and focus on innovation.  Every year Amazon adds new categories to its main retail business, looks to buy small competitors who dominate a niche of online retail who would benefit from Amazon’s infrastructure (Diapers.com, Soap.com, Zappos, etc.), and enters new areas that have the potential to be significant as well (recent ventures include book publishing and grocery delivery, for example).      

    While some investors and analysts are beginning to realize what an incredible business model Amazon has, I believe that even those who understand it have a hard time buying the stock given the headline valuation #’s.  It’s not a simple story, and the model of sharing earnings with your customers to increase long-term value is not common.  Imagine your average hedge fund analyst pitching his portfolio manager: “I want to buy Amazon at 100x earnings”.  We are all wired to prefer things that appear statistically cheap, even if the true intrinsic value of certain companies requires looking beyond near-term P/E’s.  During its growth phase in the 70’s and 80’s Wal-Mart never appeared statistically cheap, but in hindsight it was clearly undervalued and ended up as one of the best performing stocks of all time.    You can see this hesitation in recent sell-side opinions for example:

     “We view AMZN’s approach as the right decision for the long run, given AMZN’s attractive prospects and high ROIC…we await a more attractive entry point” - Credit Suisse 10/25/2011 (neutral)

    “We require a better entry point, however, as we await follow-through on margin expansion before we can get more firmly positive on Amazon” - Barclays 11/28/2011 (Equal Weight)

    “Long-term profit potential could exceed expectations…await a better entry point to take advantage of our multi-year thesis”- Goldman Sachs 12/13/2011 (Neutral)

     

    Risks and Conclusion

    Potential change in sales tax law is one risk, as Amazon has clearly benefited from most if its customers not having to pay sales taxes.  The company has stated that it would be comfortable with online sales being taxed at the federal level as long as it was fair, and in the end Amazon will maintain a large cost advantage over its competition because of its scale and superior business model.  There would also be some benefits to the company from being able to build more distribution centers around the country and make its delivery service even faster (as one example I believe they will deliver groceries with same day service to most major cities in the future, but would need more facilities around the country to do so). 

    Competition is another risk, as clearly Wal-Mart and other brick and mortar retailers will try to move more sales online over time.  At the end of the day online retail and brick and mortar retail are very different businesses, and Amazon’s large and growing lead over the competition will make it tough to beat.  I believe the odds of Amazon having a larger share of online retail in the future are much higher than the odds of them having less.  I do think there will be several country-specific internet retailers started in other countries that could become quite valuable over time, and while it’s unlikely they would penetrate Amazon’s existing markets, they could dampen the company’s ability to grow in certain fast growing markets (360Buy in China and Flipkart in India are two good examples).   

    There are other short term risks such as currency exposure (some risk to the USD going up) and the ongoing mess in Europe, but they shouldn’t get in the way of the long-term success of the business.  Stock price volatility is clearly a risk given the high headline valuation and the historic shifts in sentiment about the company, which can be significant.  I’m comfortable with that risk because the end point for Amazon is likely to be the same given it’s extremely long run way that is protected by a wide moat.  If an investor takes a truly long-term view, or would be prepared (or indeed, thrilled) to buy more if the stock falls, than I believe this is an attractive entry point into one of the world’s best businesses. 

    Catalyst

    Continued growth of the internet and ecommerce globally
    Continued domination of that market by Amazon and widening of the company's moat
    Continued innovation by Bezos and his team
    Free cash flow growth from superior business model
     

    Messages


    Subjecttax advantage + shipping gimmick is all I see
    Entry12/19/2011 01:34 AM
    Membersurf1680
    From my perspective, saving state sales tax and their shipping gimmicks are their primary competitive advantage.  If either of those change I don't know what will keep me around.  I get no pleasure by shopping at Amazon over eBay, or whatever google feeds me, but I do get pleasure from shopping at Whole Foods instead of Albertsons.  For buying tech, CNET has a clever tool that routes me to the cheapest seller, including cost of shipping and sales tax.  Amazon doesn't win very often.
     
    Part of your thesis is that earnings really should be higher because they're investing so much more in the future to drive down prices, benefit the consumer, etc.  That investment should be captured on the R&D line, which is nearly $6/share.  So add that to their existing earnings and you're still under $8/share for earnings, making the share price still expensive for such a big company.
     
     
     
     
     
     

    SubjectAMZN one of the best companies
    Entry12/20/2011 10:47 PM
    Membercharlie479

    I think Amazon is one of the most admirable companies in the world.  It has the expense advantages in rent and labor over B&M retailers that you mention, and it has cost advantages over other internet retailers as well.  The massive sales volume makes the fixed cost percentages very low, and the inventory turnover in many products is so high that it can accept lower gross margins and still generate higher ROIC than competitors who charge a larger markup.  The lower markup attracts more customers and generates more volume, which only reinforces the edge.  It is the higher-turn/lower-markup Borsheim's dynamic that Buffett describes.  

    The advantages aren't limited to cost either.  The high turnover also allows them to carry a huge number of SKUs at adequate ROIC, so they can offer customers the widest selection in many categories.  For certain categories, after I browse Amazon and then Walmart, I'll come away feeling that Walmart doesn't have much of a selection.  It's hard to make Walmart look narrow.  Amazon is the first/last place many people shop because they know it has the widest selection and it's likely to have that selection in stock.

    Another non-price advantage is that they're the most trusted internet retailer.  I actually think those customer satisfaction ratings might be understating the difference.  Their return policy and customer service is great.  Even if a product is available from discountworldxyz.com at a slightly cheaper price, I'll pay more to get it through Amazon because I know it'll be the product I ordered, or else I'll be able to return it.  Who wants to deal with negotiating shipping costs or return policies with anyone else?  I don't think this is simply Amazon being more generous than discountworldxyz.com.  They have the low cost structure described in paragraph #1 that allows them to accept higher return costs while still generating better ROICs.  I also suspect that their extensive review database reduces some of the likelihood of returns.

    I think many retailers like Best Buy are at such a severe selection and cost disadvantage (even adjusting for sales tax) that their businesses are in trouble in the long term.  I even worry about beloved Costco.  I no longer have no-price-comparison-needed-let's-just-buy faith when walking down the aisles at Costco because Amazon has better prices frequently enough to make me doubt.  More broadly, as someone who is cheering for the Costcos (no financial rooting interest, I just root for them because I admire them), I worry that Amazon will get to such scale one day that it'll be a more efficient overall system for one UPS guy to drive from the Amazon warehouse and cruise through your neighborhood dropping off everything you and your neighbors need for the week.  That might sound crazy but the current system of having you and all your neighbors separately drive SUVs 15-20 minutes to Costco to each walk through the aisles hand-picking and then checking out, doesn't sound that efficient by comparison.   I haven't read anything about Bezos explicitly saying that's his endgame but I wouldn't be surprised if that's in the 10 year wish list.  If they end up with the cheapest and widest pipeline, there might not be much need for other pipelines. 


    SubjectRE: AMZN one of the best companies
    Entry12/20/2011 11:25 PM
    Membercharlie479
    I forgot to say that I chuckled thinking about the analyst making the "I want to buy Amazon at 100x earnings" pitch.  I suppose that doesn't necessarily make it mispriced but the earnings power is certainly higher than current GAAP net income.  I think they could easily raise their prices by $0.63 per each $25 order (not exactly the same thing, but if Super Saver shipping was $0.63 instead of free, would that really change shopper behavior?).  If they managed the business to maximize current profits like this, that $0.63 increase per $25 would double earnings. If sales grow like they did the past 12 months then suddenly the multiple isn't looking so crazy.  I'm not saying this makes AMZN one of the top half dozen stock investments in the world but the p/e might not be awful if your thesis is right.
     
    I've occasionally wondered if someone could beat Amazon if they had $80 billion.  I don't think they could take over the #1 spot but I do think they could become competitive in a lot of areas.  I would probably use the $80 billion to start several category-specific internet retailers, develop a large selection within that category, and drive turnover by capturing mindshare as the expert in that category and as the lowest price seller, initially at losses.  This is more or less the Amazon playbook, and companies like Diapers.com (before being bought), Newegg, and Blue Nile have managed to carve out niches.  I bet there will be more.  I think if VCs or public markets are willing to lose enough money for awhile, it isn't that hard to replicate the warehouse network and other logistical moats.
     
    Another reason to temper the who-needs-another-pipeline thought I posed in the previous comment is that consumers sometimes choose retailers for reasons other than price and selection.  Certain bricks and mortar retailers will always have an advantage in terms of convenience (e.g. convenience stores, insightful eh?).  And customers like to touch and try on certain products, like clothes, so I don't see Amazon getting anything close to 50% share in those categories.  Freshness matters, too, so it's not clear grocery can be effectively penetrated by Amazon, and I bet that is a large portion of the Global Retail sales denominator.  So, perhaps the current internet retail number at 3% is lower than what most people think, but maybe the maximum theoretical internet retail percentage is also lower than what most people think.

    SubjectRE: RE: RE: AMZN one of the best companies
    Entry12/21/2011 02:55 AM
    Membercharlie479
    skimmer610,
     
    Maybe Sears/Kmart.  I don't know that company well but I think I'd be scared to play that hand versus Amazon's price and selection advantages in overlapping categories.  I'm not sure that the sales declines in recent years is solely attributable to management voluntarily excising unprofitable sales.  I suspect competitors like Amazon have had an impact on erosion.  I am not endorsing a long AMZN / short SHLD trade because that's not my game, and because I don't know at least one of these companies well enough, but by inserting the phrase "long AMZN / short SHLD" on this unwarranted basis, maybe we'll trigger a VIC battle royale not seen since Freddy vs Jason.
     
    Maybe Walmart.  I used to think nobody could cross Walmart's price/selection moat but now I think I might have been wrong.  I believe Walmart's US division (including online) has been declining the last few years.  If anyone's studied the impact of Amazon on this, I'd be curious to hear the analysis.
     
     
     
    majic06,
     
    Most of my comments were solely about how great a business it is, so I agree with you that that doesn't automatically make it a good investment.  I gave my $0.63 per $25 price increase example mainly to illustrate that GAAP earnings might not be the best measure of true earnings power.
     
    I happen to think that they could easily raise prices by 2.5% across the board.  Maybe I am wrong.  But, when you do your next Amazon purchase, see if you can find that item elsewhere for the same price (sales tax adjusted), and then ask yourself if you'd move your sale over for 63 cents (per $25).  I don't think I would, and I am sort of a miser.
     
    Btw, I think McDonald's has successfully raised their prices by 5 cents (and more) across the board many many times during their history.  Still billions served and counting.

    SubjectRE: RE: RE: AMZN one of the best companies
    Entry12/21/2011 08:11 AM
    Memberjwright44
    Barnes & Noble (BKS) would be the most obvious short idea in view of the Amazon moat/brand/logistics. The Nook is proving to be a huge R&D sink and Apple has not even released a "reader" oriented device yet.  
     
    I was visiting a quality independent book store yesterday. The owners were bragging that they have more staff on the floor than BKS. Since 47% of BKS leases expire after 2015, I still don't see how they will escape the bricks and mortar business fast enough to survive. Their digital business could have value if there were any way to isolate that biz from the real estate. 

    SubjectRE: AMZN one of the best companies
    Entry12/21/2011 11:09 AM
    Memberdr123
    I’m not sure the long-term viability of the digital segment has been adequately addressed:  Even granting that the existing business is more than a play on sales tax arbitrage and the average shopper’s unfamiliarity with product search engines, why is AMZN at this stage any different from other companies that have built an enviable and defensible franchise in one area (online sales of physical goods) but had to struggle to re-invent the company when material parts of the business were facing existential threats (media from digital distribution in the ST and the sale of plastic crap and electronics from distributed manufacturing/”3D printing” in the far more distant future)?

    At the very least you may want to split off the media segment and value it separately from the “electronics and other” using a multiple comparable to the peers in this highly competitive and dynamic space.  For an observer with no involvement in the stock, the risk of dis-intermediation in the hands of GOOG, AAPL, and the content owners seems entirely plausible.  I personally don’t know many folks from the techie/early adopter crowd who buy games or music on AMZN anymore and many, myself included, have been moving digital subscriptions from Kindle to Android apps for general UI considerations.  The barriers to digital content distribution via apps seem quite low.  While not exactly a classic case of Innovator’s Dilemma, Kindle Fire still demonstrates trade-offs that undermined the viability of the product so as not to cannibalize the core business (lack of memory expansion, “walled garden” experience).  The current trend for AMZN in digital would make me uncomfortable as a long and if I knew how to time the fade of optimism for this business I would probably be short the stock.


    SubjectNo-growth margins
    Entry12/22/2011 12:28 AM
    Memberotaa212
    Trev et al--I found this write up and discussion fascinating, thanks. Have you actually tried to guess what AMZN's no-growth margins might be?

    Subject$2 computer dongle & free 2-day shipping
    Entry08/08/2012 11:57 AM
    Membernha855
    I just ordered a $2 computer dongle & got free 2-day shipping. Remind me again how this company make money.

    SubjectRE: RE: $2 computer dongle & free 2-day shipping
    Entry08/08/2012 12:09 PM
    Membernha855
    I'm an Amazon Mom member = $0 annual fee & free shipping

    Subjectamazon mom
    Entry08/08/2012 12:21 PM
    Memberjgalt
    My understanding is you need to be a prime member to get that:

    SubjectRE: RE: RE: amazon mom
    Entry08/08/2012 01:11 PM
    Membercam121
    Amazon Mom only gives free prime for a year.  You might be able to change credit cards/email addresses and get it again, but it's a hassle.  They also have a student deal that gives free prime for a while.
     
    Once my Amazon Mom ran out, I went without prime for a while and then signed back up...

    SubjectRE: Would love to hear others thoughts ?
    Entry10/25/2012 09:28 PM
    Membernha855
    I bought a stylus for about $1.50 from them and had it shipped for free. Can't understand how they make money.

    SubjectRE: RE: RE: bottom line
    Entry10/26/2012 04:09 PM
    Memberspecialk992
    At this point Amazon stock is like a religion, to own it requires a faith-based belief in a glorious future much different from the ugly realities of the here-and-now

    SubjectRE: RE: RE: RE: RE: bottom line
    Entry10/28/2012 10:41 PM
    Membertyler939
    So the end game is to kill brick and mortar and then raise prices, or is there more to it?

    SubjectRE: RE: RE: RE: RE: RE: RE: bottom line
    Entry10/28/2012 11:43 PM
    Membertyler939
    Trev, from the bull's perspective, do they ever stop the money losing small dollar 2 day deliveries? Also, which retailers survive long term?  I assume bbby and dks are done, but what about the shopping malls and dollar stores? Are the mall and strip reits shorts?  Are Costco, Walmart and Target permanently impaired?  I assume amzn does not pose a threat to luxury retailers ( coh, tif, etc.). Do you concur?

    SubjectRE: RE: RE: RE: Amazon vs. an insurance company
    Entry10/31/2012 03:31 PM
    Membernha855
    YCombinator - I thought you and Utah were partners? Can't believe that hate/resentment has set in this quickly? Or am I confused?

    Subjectbigger picture
    Entry10/31/2012 04:17 PM
    Memberspecialk992
    You guys are basically arguing over whether Amazon is below breakeven or modestly profitable. To me, a more interesting question is when Amazon is going to generate economic FCF (calculated after paying employees with stock) commensurate with its market cap? If there is anything I have learned in the last 15 years, it's that every company, no matter how sexy its business may appear at the time, eventually trades at a double digit free cash flow yield. To make the math easy, call Amazon a $100B market cap company with $1B in annual SBC. When is AMZN going to generate $11B in OCF less capex? By my metric, they did $302M ($3,336M in OCF less $756M in SBC and $2,310 in capex) in the trailing twelve months before considering acquisitions. And that's just to justify the current stock price. And remember, when growth slows down, they will lose a decent portion of the working capital cash flow benefit (even if it never goes in reverse) and will have to generate the FCF from old fashioned profit, not getting more working capital to invest in marginally profitable retail sales and other initiatives that generate more "float".
     
    To me, Amazon (and a few other growth stocks like it) are economic creatures unique to our public markets, sort of analagous to Ponzi schemes. They work well if and only if people believe in the stock and don't care about the company generating an economic profit on the market value of their investment. While the stock goes up, shareholders are happy because they are making money on paper, employees are (relatively) happy because they are well paid partially with stock that doesn't count against the company's profitability to Wall St. and customers are happy because they are serviced at zero or negative profit. If for whatever reason shareholders stop believing the whole thing falls apart. I really doubt anyone would run a private business this way.
     
    I actually think one of the worst things for the stock at this point would be for the company to focus on profitability. That would only serve to make investors realize how meager these profits are actually likely to be, and apply a realistic multiple to them. So you could have a $100B revenue company with 7% FCF margins and the stock would be lower than it is today desipte more than a doubling of sales and an enormous increase in cash flow.
     
    If you plot MSFT and CSCO's stocks against their earnings over the last 9 years you get some idea of what I am talking about. And these companies have much higher operating leverage businesses than AMZN.
     
    I actually think that many of AMZN's businesses suck or are likely to be as big a flops as the A9 search engine. Is selling hardware at zero or negative profit hoping to make it up on digital content sales viable? Apple's results (which last quarter feature roughly $10B of gross profit from iPhone, iPad and iPod and only $3B of *revenue* from the "other music products" and "software & other" lines) tell me otherewise. Is on-demand cloud computing going to be fabulously profitable? Thinking about this business suggests that it has all the characteristics of a value-destroying bad business, including high capital costs, fixed capacity, low barriers to entry and high competitive intensity. To boot, given the excitement around it and the wide variety of providers jumping in, it is almost certain to have significant over-investment as a sector at some point. And physical retail e-commerce has never been shown to be a high margin business either, although arguably this is largely because of Amazon itself.
     
    I am not short Amazon (altough I may be someday when I sense the love affair with Wall St. is souring). I like buying from them. I get that they generate decent returns on capital and are investing back in their business, perhaps even at decent returns when you look at the long term. I just think the math will eventually break down for long-terminvestors paying 14x book value today. I realize you could have made this argument five years ago, and yet the stock is so much higher today. But I almost guarantee if you pulled up an analyst model from five years ago and compared the estimated 2012 CF, the model from five years ago would be much higher than the reality today. The stock appreciation has largely been from investors paying higher and higher multiples when they trade the stock, and this cannot go on indefinitely.
     
    That post ended up up being a lot longer than I thought it would be, but there it is. Maybe I am dead wrong and 5 years from now Amazon will be a $150B company with 15% FCF margins and AMZN investors will be laughing all the way to the bank.

    SubjectRE: RE: Amazon vs. an insurance company
    Entry10/31/2012 08:16 PM
    Memberbafana901

    Assets = Debt + Equity

     

    If one focuses on the cash flow statement one finds that AMZN has spent $10bil on assets between Jan2003 and Dec2011. (The total of all investment activities)

     

    Of the $10bil spent on assets $7bil was funded by "positive working capital" also from cash flow statements.

     

    The earnings power of the assets using 2011 EBITDA is $2bil. This means that AMZN is able to generate a 20% return on the $10bil investment which beats the yield on treasuries. 

     

    The cost of the $7bil is probably the loss of early settlement discounts. 

     

    Instead of calculating the pv(yield on the float - cost of the float) I would rather say that AMZN only needed  $3bil of capital to generate EBITDA of $2bil. I am still unsure how much I would be prepared to pay for the business as I struggle to value asset light operations which essentially require very little capital to double in size. I always seem to find them too expensive and usually leave lots of money on the table. Any ideas???

     

    Insurance companies on the other hand are capital intensive and usually require gobs of capital to double in size. Further, the returns on the assets are lower as the business is competitive and commoditised. Companies with lower yields need to focus intensively on their WACC so whenWarrenfinds  free/cheap capital he celebrates. In commoditised capital intensive businesses it is often the guy with the lowest cost of capital who wins.

     

     


    SubjectRE: RE: RE: Amazon vs. an insurance company
    Entry11/01/2012 09:25 AM
    Memberspecialk992
    Urban, your scenario sounds semi-plausible, but we really have no idea if it is achievable. I'd also observe that this probably optimistic scenario in terms of growth, margins and multiple would give an investor a 10 year CAGR of about 12% (maybe 10-11% after SBC dilution). If that's your upside- and it depends on AMZN having a better moat than MSFT and on par with KO- it seems uncompelling relative to the downside.
     
    Honestly, do we really believe they have better moats than MSFT, one of the all time great network effects high moat businesses with a near zero marginal product cost? I always thought a moat was evidenced by a company generating enormous returns on capital yet no competitor could break in. AMZN seems to be missing the enormous returns on capital part (although arguably the returns on its core retail business are at least decent). And like I said, I don't think there is really any reason to believe they will have huge moats in all the numerous businesses they enter like tablets, cloud computing, video streaming etc. unless you define a moat as being willing to live with extremely low margins- which to me defeats the purpose of a moat in the first place.
     
    To me, a lot depends on the price paid. Even KO gave the investors who paid the late 90's bubble multiples a decade of negative returns. I think AMZN could be setting up similarly even if it succeeds over time. It  also seems virtually certain that we will have at least one (probably more than one) bear market in the next 10 years. When that happens, given its momentum and extreme valuation, AMZN is almost certain to trade lower than where it is today. I know we are not supposed to time the market, but it seems highly unlikely to me that investors won't have a better chance to own AMZN in the future.

    SubjectRE: RE: RE: RE: Amazon vs. an insurance company
    Entry11/01/2012 12:59 PM
    Membernha855
    Majic - 10-Ks are really tough. Is there a sell-side report you can post on scribd and then post a link? Also, can you make it an abbreviated link so it's easier for me? Thanks

    Subjectno moat, no buyback
    Entry11/01/2012 02:34 PM
    Membersurf1680
    How can Amazon ever raise their prices?  They are already expensive (which may be justified by the convenience/familiarity factor).  It takes me 10 seconds to skim Ebay, Google, Cnet and Bing.  How can that be compared to Coke at a restaurant?   Quickly skimming other sites is not as convenient as buying it all on Amazon but it's not like I'm driving around town.  I just type it in the little google box at the top of my browser and 10 seconds later I save  $$.  Whatever I buy arrives by the same distribution network Amazon uses (UPS).
     
    My wife wants a new camera - Canon 5d costs $500 more on Amazon than eBay, and $300 more on Amazon than reputable dealers that CNET points me to. 
     
    It being election season- I need a can of spraypaint.  My Walmart (physical) has them for $.97 vs. $3.70 on Amazon.  These days, I'm finding stuff at Walmart (physical) is signficantly cheaper than Amazon.
     
    Amazon's buyback sound great in headlines but this is not how buybacks look:
     
      Amazon shares
    2005 412
    2006 416
    2007 413
    2008 423
    2009 433
    2010 447
    2011 453
    2012 452
     
     
     

    SubjectRE: RE: 10-15 year horizons
    Entry11/01/2012 02:36 PM
    Memberspecialk992
    It depends on how your calculate the EV, and it's actually relevent to the AMZN discussion. If you consider the financing receivables equivalent to cash and investments and don't consider the negative working capital debt, then the EV/EBITDA is 1.1x on the January 2013 FY. If you do deduct the negative working capital as debt, then the number is 2.3x. Dell's negative WC is about $6.5B as of the end of this year by my model, and while it might go slightly in reverse as their sales stangate and get concentrated in higher working capital intensive enterprise sales it does seem to be a permanent part of their capital structure.
     

    SubjectFulfillment Partners
    Entry11/05/2012 04:08 PM
    Memberyellowhouse
    We're considering a short position on a discount online retailer. 
     
    Have any of you done work on the competitive landscape for fulfillment partners? It surprises me that the online storefronts can pick up high teens margin for simply listing a product on their website and handling product returns. I would think that competition from Amazon and increased use of Google Shopping would significantly diminish the real estate value of certain retail domain names.
     
     

    SubjectRE: RE: RE: RE: RE: roic
    Entry11/16/2012 04:38 PM
    MemberYCOMBINATOR
    xanadu, I'll take you second question first.
     
    1) The difference between DEC/Compaq and FedEx is that FedEx invested in building its moat. DEC/Compaq just rode two growth waves, minicomputers and PCs, without building a long-term defensible moat. I think AMZN is clearly building a giant moat.
     
    2) As to your first question, I would argue that one of AMZN's key competitive advantages is that it needs almost no capital to grow. I do not know how you compete against someone who needs no capital to grow because its operations generate float.
     
    From FY2004 to FY2012, TGT sales increased by $26.5b ($43.4b to $69.9b), but capital increased by $12.7b ($20.6b to $33.bb), with $6.3b of that coming from new debt issuance.
     
    Over the same time period, AMZN sales increased by $41.1b ($6.9b to $48b), but capital increased by $6b ($1b to $7b), with $1.8b of debt paydown.
     
    My view is that AMZN needs pretty much no incremental capital to grow. This makes my head hurt when I think this through to its logical conclusion.

    SubjectRE: RE: RE: RE: RE: RE: RE: RE: roic
    Entry11/16/2012 07:15 PM
    MemberYCOMBINATOR
    finn, otaa articulated my point well. One small example, if AMZN wants to move into a new geography it opens website and a DC, all funded internally. TGT has to open a store, stock inventory, possibly get external funding, etc...
     
    AMZN can simply move faster, in a way that no B&M can replicate because that can't replicate AMZN's capital model. The upper limit of AMZN's growth rate is multiples of its competitors and the global retail market is gigantic. That seems like a solid moat to me.

    SubjectUpdated thoughts?
    Entry05/01/2013 12:20 PM
    Membertyler939
    In particular have any of the bulls changed their mind post earnings?  Thanks.

    SubjectRe: Trev - Prop Bet
    Entry01/08/2016 03:59 PM
    Membertrev62

    You're on.  My only condition is that the payout is distributed via these Warren Buffett coins purchased, of course, on Amazon:

    http://www.amazon.com/WARREN-BUFFETT-Successful-Investor-Century/dp/B00GWRJYB6


    SubjectRe: Trev - Prop Bet
    Entry01/08/2016 04:14 PM
    Membershoobity

    That would be Buffett's largest ever initial investment (not purchase of a business) or maybe you are saying it will come and he will buy. Should be fun to see if it occurs. 

    Utah why do you think it would be now for him? Would think he would have had a pretty good idea about the business for a long time. 


    SubjectRe: Re: Trev - Prop Bet
    Entry01/08/2016 04:44 PM
    Memberutah1009

    Done. Coins must be delivered by drone, of course.

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