Category Archives: Amazon

Amazon’s no-show profits

July 29, 2014 By in Amazon, Current Market Thoughts, earnings conference calls, Industry Analysis, internet, Stock ideas Tags: , , , , , , 2 Comments

Amazon’s 2Q14 results

When Amazon (AMZN) reported 2Q14 results last Thursday, not only did the company post a bigger operating loss than anticipated but it said that the 3Q14 red ink would dwarf the 2Q14 actuals.

The news came as a surprise  …and not one that Wall Street took favorably.  The stock dropped 11% in Friday trading.

At the same time, the news media were filled with red-faced portfolio managers and analysts complaining that Jeff Bezos should be more sensitive to their need for more robust profits, which–allegedly–would make the stock go up.

To me, this is a case of being careful what you wish for.

Let’s do some back of the envelope calculations to see why…

is AMZN’s valuation reasonable?

The analyst consensus is that AMZN will earn around $2 a share in 2015.  That’s a forward PE of 160x.  How could anyone pay that price to own a share of any company?  For someone who holds AMZN, he must be thinking something like this:

–the company consists of a US business that makes a considerable profit and a foreign one that is flirting with breakeven.  If we assume that foreign operations can equal the US in size and profits at some point, then that $2 a share will sooner or later become $4 a share at some point.  On this basis, the multiple is “only” 80x.

–the company spends a lot of money on computer software.  In a very real sense, this is capital spending.  That is to say, as is the case with any capital asset, the expenditure on software should arguably be registered on the balance sheet and written off bit by bit against revenue over the lifetime of the programs.  Because of past accounting abuses, however, programming costs are recognized as expenses immediately, even though the programs may last a long time.  This depresses current income.

AMZN also writes off startup expenses for new ventures right away. This is a conservative approach, but it also depresses current income.

To pluck a figure out of the air, if AMZN were less conservative and if it could treat software costs as capital items, $4 would be $8–and the future PE multiple is a “mere” 40x.  That’s too rich for my blood, but it’s not absolutely crazy, provided AMZN continues to grow.

what will likely happen if/when AMZN’s profits start to surge

What would it mean if AMZN began to show large amounts of current income?

The most likely scenario–and the one pms and analysts are calling for–would be that the company is no longer incurring software creation expense and  hefty startup costs for new ventures.

…in other words, it would imply that AMZN had run out of growth opportunities!  Surging profits imply AMZN is going ex-growth.

In my experience, there are few things worse, in stock market terms, than holding a growth stock that has suddenly gone ex growth.

In my judgment, a +30% increase in earnings by AMZN would be accompanied by a gigantic price earnings multiple contraction.  A halving of the PE would be my best guess.  If that’s anywhere near correct, the end result would be a loss of a third of AMZN’s market value.

As I said above, be careful what you wish for.  It also strikes me that the Wall Street complainers have no clue about the kind of stock they’re dealing with.

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Kindle Unlimited: publishers as collateral damage?

July 25, 2014 By in Amazon, e-readers, Industry Analysis, internet, Publishing, Retail Tags: , , , , , , , 2 Comments

At one time there was only the Kindle.

Then came the Kindle Fire and Amazon Prime.  Now there’s the Fire phone and Kindle Unlimited–all five programs (along with a bunch of smaller ones) launched by Amazon (AMZN) to bind customers ever closer to the shopping service and get them to buy more stuff through it.

For AMZN, it’s not that important that any of these be moneymakers straight out of the box.  That can always be straightened out later, when the customer has been transformed from a buyer of X who happens to use AMZN to an AMZN customer who happens to want to buy X.

Kindle Unlimited, the just introduced subscription service for e-books and audio-books, is a particularly interesting instance.  That’s because it may end up being the tipping point in AMZN’s favor in its long-running battle with the five big publishing houses for control of the English-language book reader.

Another intriguing aspect of Kindle Unlimited is that AMZN has more relevant information, I think, than any other party at the table–but it isn’t talking.  So analysts, both the Wall Street kind and the planners inside the publishing companies, have less than normal to work from as they create their castles in the air.

Here’s how I view the situation:

1.  For $9.99 a month–about $120 a year–Kindle Unlimited lets subscribers read as many e-books as they want, from a collection of over 600,000, as well as to listen to as many Audible audiobooks, from a list of “thousands.”

No titles from the big five publishing houses are included, although, for example, all the Harry Potter books are.

The rollout of KU suggests that the very public spat between AMZN and Hachette, the smallest of the big five, may have been aimed at persuading Hachette to take part.

2.  Most industries exhibit a “heavy half.”   The idea is that, say, 20% of the purchasers buy a huge amount, usually put at 80%, of the stuff.  For e-books, only AMZN knows what the exact proportions are.  My guess is that heavy users easily spend $50 a month ($100+?) on e-books.  For them, signing up for KU is a no-brainer.

3.  It seems to me that KU users will dig deeper into “free” content in the 600,000 titles instead of buying expensive bestsellers launched by the big five.  Presumably, AMZN has surveyed the heavy half, and maybe even run small tests to figure out what will likely happen.  Certainly AMZN must believe that KU will redirect a lot of e-book use away from the big five and toward AMZN self-published content, or content from smaller presses that may sign up.

4.  Until yesterday, I hadn’t looked at AMZN’s financials for years.  From my perusal, I’ve decided, for no particularly good reason, that AMZN makes $60 million in operating profit per quarter from e-books in the US.  The company could easily let that drop to zero, as sales of high-priced best sellers wane. However, AMZN seems to be indicating–who knows whether bluster or not–that it is willing to go deep into the red to get KU off the ground (remember, AMZN is generates about $5 billion in yearly cash flow, so it can afford to lose money on KU for a l-o-o-ng time).  Last night it guided to a possible operating loss of over $800 million for the coming quarter.

5.  The big five could be squeezed in a number of ways.  KU users switch away from them, constricting their cash flow.  Fewer pre-orders from KU users would mean new titles fall off the bestseller lists, hurting sales further.  Authors complain about diminished royalty payments and ponder self-publishing through AMZN themselves, where, for sales in the US, the author receives 70% of the sales price vs. 25% from the big five.

6.  AMZN has lots of customer information; the publishers probably have much less.  Therefore, this negative money cycle may end up being much larger than the big five anticipate.  One or more may break ranks.

It will be interesting to see how this plays out.

 

 

once more on Amazon (AMZN)

May 6, 2014 By in Amazon, Current Market Thoughts, Industry Analysis, internet, Portfolio management, Recent Market Action, Stock ideas Tags: , , , , , , , Leave a comment

I’ve been doing a lot of thinking/daydreaming/musing about AMZN lately.  I don’t know quite why, since I’m probably not going to buy the stock.  But my mind apparently doesn’t want to let go.

The latest thing to pop into my head is something I’d seen on the Value Line page for the stock but hadn’t paid much attention to.  It’s that:

–during the bounceback from the 2000 collapse of the Internet Bubble, AMZN shares tended to trade at about 30x cash flow.  In the recovery from the Great Recession, its cash flow multiple expanded to 50x.  Both are mind-boggling figures, to be sure-the second more so.

What could cause this gigantic multiple expansion, particularly during a period when investors were scared out of their wits and therefore more cautious than usual?

…possibly a better appreciation of the transformative nature of the internet and AMZN’s premier position as online merchant.  Cash generation from operations continues to grow at about 25% a year, virtually the same as before the GR, despite the company’s larger size.  That’s both a plus and a minus.  It’s an heroic achievement to maintain growth in the face of ballooning size.  But that’s usually something that keeps the multiple from contracting, not that causes it to expand by 60%.

…so I can’t help thinking that a lot of the favorable move is due to the Fed’s super-accommodative money policy.

Which gets me to my point.

Let’s assume that the economy’s release from intensive care and a return to normal money policy cause AMZN’s cash flow multiple to shrink to a “mere” 30x.  In simple terms, this means the stock should lose 40% of its value–maybe not all at once, but ultimately.  Continuing relentless growth in cash flow could cushion the fall somewhat.

Since the end of January, when the Fed made it clear it would continue baby steps toward normal despite weakening economic indicators, AMZN shares have pretty much made the entire reverse movement already–they’ve lost 25% of their value in a flat market.  They haven’t been alone, either.  Every other story stock has fallen this much–or more.

This thought makes me want to speed up my efforts to dig through the rubble.

 

rent vs. buy: digital goods

April 8, 2014 By in Amazon, Current Market Thoughts, e-readers, Entertainment, Facebook, internet, Publishing Tags: , , , , , , Leave a comment

My daughter, who’s very interested in digital goods, suggested that I write about them.

Why?

They’re new, and they’re different.  Also, Laura supplied a lot of the information in this post.

Part of the difference between the digital goods we have now and their physical counterparts is in the nature of the beast(s).  Part, however, comes the desire of sellers–particularly Apple–to recreate the AOL-style “walled garden” that tethers the buyer to a given seller’s product line and secures fat profits for the retailer.

Some examples:

Generally speaking, for digital goods like e-books, or songs or movies, you don’t really own the digital copy you download.  You only have a license to use it.  Kindle owners found this out early on.  Amazon was inadvertently distributing 1984 without having bought the digital rights.  When the company found out–presumably when the rights holder called asking for money–Amazon simply went “Poof!” and made the book disappear from all the Kindles it had appeared on.  Apparently very few of the shocked Orwell fans had read the fine print in the Kindle service agreement.  It is kind of funny, though.

Usually, you can’t give your download to someone else.  You may be able to lend it for a short period of time, but maybe not.

The digital good may appear on all of your devices.   …or it may appear just on all your Android devices but not Apple, or vice versa.

 

The most peculiar aspect of digital goods, to my mind, is what happens with e-books in (if that’s the right word) libraries.  Many authors or imprints won’t sell e-books to libraries, so the selection is limited.  At least some sellers place counters in the downloads, so that the copy disappears after a certain number of borrowings.  It isn’t a quality control issue–a worry that the digital copy has somehow degraded;  it’s to mimic what happens to physical books, which eventually fall apart after repeated use.   In other words, it’s to force the library to pay again after a certain number of uses.

 

investment significance?

Maybe there’s none.

On the other hand, I think we’ve got to distinguish carefully between essential characteristics of digital goods and those that are a function of sellers’ desire to create closed “ecosystems.”  After all, the AOL walled garden lost any allure it had (I never got it) when people discovered there was a big wide world outside the AOL server farms that AOL got in the way of people experiencing.

I suspect the same will eventually happen with Apple–personally, I think this might be happening already.  As/when this occurs, I’d expect the price of digital goods in general to fall (maybe a lot).  A sharp separation will probably also emerge between high-quality content, whose unit sales will increase (again, maybe by a lot), and me-too content, which will disappear.

 

 

 

 

 

the SEC investigates store chains’ internet sales claims

August 30, 2013 By in Amazon, Industry Analysis, internet, Retail Tags: , , , , , Leave a comment

the SEC questions internet sales hype

According to the Wall Street Journal, the SEC recently sent inquiry letters to a bunch of retailers asking them to quantify claims managements were making in quarterly earnings conference calls about internet sales and internet sales growth.  Fifth & Pacific (Kate Spade, Juicy Couture…), for example, told investors it had a “ravenously growing” web business.  Others tossed around numbers like up 30%.

On the other hand, while online sales in the US may be growing faster than revenues from bricks-and-mortar operations, they’re still only in posting increases in (low) double digits, and make up less than 6% of total retail.  So the SEC was concerned that the company talk might be more hype than reality.  Why no disclosure of internet sales as a percentage of total sales?

The SEC got two types of reply:

—equivocation.  Some retailers said they don’t disclose the size of online sales because they’re “omnichannel” firms.  An individual customer may sometimes visit a store, sometimes order from a desktop at work, sometimes buy from a smartphone on the train going home in the evening.  It’s the total customer relationship that counts, they said, not the way someone may buy any particular item.  Translation:  online sales are almost non-existent, but we know shareholders will react badly if we say so.

—confession, sort of.  Others said that online sales were “immaterial,” meaning no more than a couple of percentage points of total sales.

there’s information here

Why not just say so?

…because it sounds bad.

Why bring up internet sales in the first place?

…because we have no other good things to say.

look at the income statement

I could have told you that, just from taking a quick look at company income statements.

Here’s my reasoning:

–if a company’s internet sales are growing at, say, 20% and comprise 10% of total sales, then they’ll contribute 2% to overall sales growth.  Because online sales are free of many of the costs of bricks-and-mortar stores, like salespeoples’ salaries and rent, they should carry (much) higher margins than sales in physical stores.  Therefore, if internet sales are big, we should see accelerating sales growth and rising margins.

Take Target (TGT) as an example.  Aggregate sales are growing at about a 3% annual rate with no signs of acceleration.  Operating margins are flat to down.  If online sales contributed 2/3 of total growth, TGT would have to disclose that  …and margins would be heading up noticeably. Therefore, internet sales can’t be anything close to 10%–or even 5%–of TGT’s business.

By the way,  TGT’s response to the SEC was that its internet sales are immaterial.

why the SEC investigation?

Every company is going to try to spin the facts of its performance in a favorable way.  Just take a look at the 10-K, where management can go to jail if disclosure is incomplete or counterfactual.  It’s chock full of dire warnings of what might go wrong.  It’s also in dense print with no pictures.  Compare that with the annual report, where every page is glossy, every face is smiling and the skies are always blue.

Also, retailers are marketers, after all, so we should expect an unusually rosy portrayal of results and prospects from them.

Still, there are limits.  Even if the border line is a bit fuzzy, there comes a point where  positive spin becomes deception, where touting the fantastic prospects of a currently minuscule business becomes fraud–especially if it’s in an area like online where Wall Street is intensely interested.

I interpret the SEC letters a warnings to the companies involved that they have been treading dangerously close to that line, and may even have stepped over it.  Expect a much more 10-K-ish assessment from now on.