Tag Archives: AMZN

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.

 

security monitoring services–another thought on Amazon (AMZN)

April 30, 2014 By in Industry Analysis, secuirty monitoring firms Tags: , , , , , 1 Comment

Security monitoring services have an interesting financial structure.  They wire up your home with anti-intrusion devices, which they monitor from a remote location.  They may charge an installation fee, which typically covers half or less of the actual installation cost.  And they charge a periodic, usually monthly, monitoring fee.

These companies have operating leverage in two ways:  a few employees can equally well monitor one or thousands of homes; and the company can charge for add-on services (like fire or medical monitoring) that cost almost nothing to provide.

A contract with a homeowner will work something like this (I’m making these numbers up):

–installation costs $2,000, of which the client pays $1,000

–the client signs a three-year contract to pay a monitoring fee of $50 a month

–monitoring expense (rent + equipment + salaries) is $10 a month.

On these figures, it takes the monitoring company about two years to recover its initial investment.  After that, a waterfall of money rains down into the monitoring company’s bank account.

This is a fabulous business to own, even though the initial negative cash flow may be daunting.

For the stock of a company like this,  however, it may not be the dream investment it may seem.

How so?

It isn’t that the early years look ugly from a profit and cash flow perspective.  It isn’t the issue of how to finance the initial investment in monitoring equipment.  Liberal accounting technique can pretty up the financials a bit, but–I believe–most holders see through this to understand the actual cash in/cash out relatively clearly.

Instead, investors concentrate on the asset value created by each new customer.  Let’s say a typical customer retains the monitoring service for 15 years (again, a made up number).  If so, and if both revenues and costs remain constant, each new customer adds something like $6,000 to the firm’s asset value.

For investors, then, the more new customers who sign up, the better.  The more existing customers who sign up for new services, increasing their asset value, the better.  That’s even though the more new customers, the uglier the near-term losses and negative cash flow will get.

Here’s the kicker:

–the fastest way for a company like this to show stellar earnings growth is to stop signing up new customers.  But that’s also the kiss of death–because it means the firm has gone ex-growth!!

…the stock fall apart.  Maybe it doesn’t go down in flames all at once.  But it suddenly looks an awful lot like a bond.  So PE contraction offsets the better earnings.

This is not how a startup works.  Usually incremental customers are profitable right out of the gate; the issue is getting enough of them to cover infrastructure costs.

It isn’t quite AMZN, either, which seems to require massive infrastructure spending just to tread water.  But I think holders take the large amount of spending on infrastructure as a proxy for future growth–just as holders of alarm companies do.

I wonder what would happen if AMZN suddenly entered the waterfall-of-money phase of its life that presumably owners are waiting for.  My guess is they wouldn’t find it as enjoyable as they thing they would.

 

 

 

 

 

thinking about Amazon (AMZN)–and concept stocks in general

April 29, 2014 By in Current Market Thoughts, Portfolio management, Recent Market Action Tags: , , , , , , , 1 Comment

I’ve watched AMZN since its inception, although I’ve never owned the stock.  What I find especially fascinating is that it has been a “concept” stock–one where the possibility of spectacular earnings growth is always there, but the reality seems to somehow always be just around the next bend–for close to two decades.

I think the stock has particular significance for investors in general–owners or not–at present, for two reasons:

–Yesterday afternoon I happened to be home and noticed a small crossover SUV I didn’t recognize parked outside our house.  After a while, an unmarked white panel truck drove up.  The driver came to our door, rang the bell and left.  It was a package from AMZN, containing–unusually for AMZN–a bunch of different stuff (gummi bears and two kinds of SD card, if you have to know) in one box.

The driver then opened up the back of the truck and began transferring packages to the crossover.  Welcome to  the newest wrinkle in AMZN’s logistics system.  No uniforms, no big trucks, no handheld package control computers.  Just guys with cars stitched together into a (low-cost) delivery network.  I’d been seeing the panel truck for months.  This is the first on-the-fly transfer I witnessed, though.

I read this as AMZN’s response to the successful campaign by bricks-and-mortar retailers to have states enforce the sales tax laws with AMZN.  I don’t think this has helped the b&m people at all.  I think it’s been a windfall for smaller online retailers, though, and for companies that use AMZN for distribution, two groups that are so far flying under the sales tax radar.

AMZN’s competitive response has been to reduce delivery costs, with (presumably negative, if it’s successful) implications for the post office, Fedex and UPS.

–More important for me, AMZN shares fall into the group of “story” stocks that have been sold off very heavily since February.  So I think we can draw conclusions about the whole group by examining AMZN (not a rock solid premise, but, I think, the best we’re going to be able to do).

Two features stand out to me.

First, nothing much has changed with the company, even though the stock has lost a quarter of its value in the selloff.

Second, the list of major holders consists of the most prominent institutional money managers in the country. So the selloff is not being induced by a small bunch of crazy, risk-prone hedge funds.  In addition, most of the big names (ex Fidelity) had already been lightening their positions late last year.

As far as trying to figure out how far the selloff might go, we can look at a fundamental component and an emotional one.  On the fundamental side, pre-Great Recession AMZN shares tended to trade at about 30x cash flow.  In recent years, that figure has been closer to 50x.  A return to 30x cash flow would imply a price of around $300, or about where we are now.  Personally, I don’t see why I should pay 30x cash flow for anything but a startup.  But arguably most of the air has already been taken out of the AMZN balloon.

The emotional side is where looking at price charts and volumes traded comes in.  In the case of AMZN, there has been a sharp pickup in volume over the past couple of days,  That’s usually an indicator of the panicky selling that marks a bottom.

From my own perspective, the selloff has gone on longer, and has been deeper, than I would have thought.  But that’s par for the course for me.  And I’m not feeling very uneasy about stocks in general–which is my go-to indicator that I should be starting to buy.  Of course, this may be because the overall market has been holding up very well. Selling has been confined to a relatively small subset of stocks.

For now, my strategy remains to ride out the storm, not buying in a big way but not selling either.  To my mind, it’s way too late for me to do the latter.  But I’d like more confirmation before becoming more aggressive.