I wrote an email to a PM friend of mine in February telling him AMZN was a short. I wrote this before they reported Q1 and the onset of the tech wreck. Bottom Line: The Meme on AMZN is changing. In AMZN’s case Bezos has done a masterful job of convincing the Street and Investors that he is a wizard. The former Meme was: AMZN is taking huge share from traditional B&M retailers, the TAM is huge and they need to invest to take that share, hence we are a top line growth story. Here is the new Meme (now pay attention Large Cap Growth PM’s!): Competition is stiff, revenues are decelerating and profits are collapsing. This is a variable cost model not a fixed cost model and operating margins will always be low. Revenue growth since 2010 has been of a very low quality. Since they don’t disclose much in the way of numbers it is a classic trust me story. The market is not in a trusting mode.
I think it is hysterical that the sell side lets them get away with such poor disclosure. Sell side estimates have been getting revised down since the middle of August 2012-I don’t suspect that trend to subside anytime soon but its just now that the investment community has noticed because the stock is down.
Now I am not telling you to go out and short this tomorrow. We are currently in bounce mode and the stock has lost 100 points in four months. However, what i am telling you is this is a classic deceleration large cap growth story and we are in the process of the new Meme getting worked into the multiple. This will take time and this has become a short the rally story rather than a buy the dip story.
Here is my email to my friend:
Let me start by saying that I was a huge AMZN bull pre-financial crisis and post financial crisis up until 2011. The thesis as you know is pretty simple. They are the premier online retailer taking share from the B&M retailers. The TAM is huge! The service is fantastic and the website is easy to use. Early on I was a big believer in the investment meme of investing for growth and deferring profits. However, that was predicated on the fact that I thought the business model was primarily a fixed cost model that would produce good margins down the road. I have come to believe that the model is a variable cost model and the returns promised are largely non-existent. In other words, the revenue growth is unprofitable and will never deliver the returns that are currently being imputed in the current share price. Interestingly enough the ROI, profit and free cash flow have all deteriorated since 2010. What has happened since 2010? They have started to invest in businesses with lower returns i.e. the kindle, video streaming, AWS, prime customers etc.
The street has been giving the company a pass on the profitability and free cash flow issue because of the promise of future profits. I think what has been lost on the street is that this is a brutally competitive space and AMZN does not have the competitive moat that many think it does. It has been starting to show up in the numbers.
What has happened since 2010 when reveneue growth and returns started to decline?
1) The sales tax advantage has basically been removed in most states. I believe this was a huge competitive advantage that AMZN had for years and it is now gone.
2) The B&M (TGT, WMT, BBY) are fighting back and finally have credible online and price matching strategies.
3) Revenue growth has matched opex growth. No leverage, why? They are not making any money on incremental revenues. The street will counter that they are investing but that does not make any sense because capex is capitalized and amortized over many years thus the hit to current period earnings would not be as extreme as the street thinks. The only logical answer is that the revenue growth since 2010 has been of low non-profitable quality.
4) Web sites exist that allow people to put an item in the search bar and it ranks the online retailers with the best prices. More and more people are searching these engines to search other sites.
5) The revenue mix has shifted from Media towards EGM which is lower margin.
As you know the disclosure from this company is atrocious. Additionally, they changed their accounting of ebook revenues in Q2 of last year from agency to wholesale. The agency revenue recognition is 30% of the wholesale revenue. This has had the effect of adding several percentage points of growth the last three quarters. In other words, revenue growth would have decelerated more over the last three quarters if not for this change.
Cash flow quality is not sustainable. The largest contributors to operating cash flow are A/P and stock option expense. The negative cash conversion cycle works as long as revenue growth continues at a nice clip. Essentially AMZN has been borrowing money from its suppliers at zero interest. It would be better if their cash flow was coming from actually making a profit. The young marketing savvy sell siders think all cash flow is created equal. The point is that this amazing cash flow is just float from their suppliers and not from actually turning a profit. What kind of a multiple do you put on that? Not 2x sales.
I think it is likely that AMZN will have to come to market and float a bond or convert to shore up the balance sheet as the float from their suppliers decreases due to a slowing of the revenues. The cash on the balance sheet is eventually owed to suppliers. I am sure that AMZN will have some BS story about investing in drones which was dropped into our laps during CYBER Sunday on Sixty Minutes. But the real reason will be that the float is decreasing due to slowing growth and that they don’t make any money on their low quality revenue growth.
Since June of 2012, both the revenue numbers and the eps numbers have come down but the stock has gone up 60%. Clearly this negative call has been wrong up until the last quarter. I believe that their admission that they need to raise Prime pricing is a tell that their cash flow is becoming a concern. I have always suspected they lose money on prime customers and they basically just admitted it. If they raise price they risk losing customers and slowing revs. Classic catch 22. This is an emperor has no clothes story. Investors suspend belief in traditional measures like profits in return for market share and revenue growth. The belief is that we are investing for the future. What if the future never comes. I believe AMZN is going to try and change their story as internal financing of low quality growth becomes an issue. The question is will the street buy this change. I doubt it. Fundamentals have been deteriorating for about a year and the stock has been a five bagger since 2009. Time to move on and ring the cash registrar.
Costco has $100 billion in revs, 185k employees and a $50 billion market cap. AMZN has $74 billion in revs, 111k employees (an additional 70k at Christmas) and a $170 billion market cap. I agree that AMZN is growing faster but where is the scale of efficiencies. This looks like a B&M to me. If I had to bet, one of these valuations is not correct.
On a side note Bezos has dumped $1billion in stock since August. He dumped a 1 million shares in February.