In an article out today by Rocco Pendola, he chastises the shorts or would-be shorts for shorting Amazon.com (NASDAQ:AMZN) just on valuation. He goes to great lengths in showing how Netflix (NASDAQ:NFLX) was different when it headed to $300 and then plunged. How there it was never about valuation alone:
Folks who shorted Netflix as it ran to $300 in 2011 absolutely did not do it on the basis of valuation and valuation alone. In fact, for the shorts who made the most compelling cases, it rarely came back to valuation. It came down to the business model, a doomed international expansion, uncertain market opportunity and the low likelihood that Netflix could leverage it without missteps.
It was much easier to talk the talk and walk the walk with Netflix because you had factors other than valuation -- such as incompetent management and tons of competent competition -- driving the core of the short case.
Rocco implies that anyone can see the 3000 TTM P/E on Amazon.com and thus reflexively shorts it.
There's just one problem with this thesis. The problem is that it is false. The reasons to short Amazon.com go well beyond Amazon.com being overpriced by every metric on relative terms (relative to the market, to history, etc). Sure, the TTM P/E makes for a pretty obvious picture, if you pull up an historic AMZN chart such as the one below:
But how did the TTM P/E get up there in the 3000s? It didn't get up there just by AMZN going up. It got there mostly by Amazon.com's earnings falling down. That's the first true reason to short Amazon.com: because its earnings are imploding faster than every other large capitalization stock out there. The chart below makes it pretty obvious.
But it's not just earnings that have been plunging. Estimates have been plunging as well. Just 2 years ago, Amazon.com was expected to earn around $5.50 during 2012. Right now the expectation has plunged all the way to -$0.01, that's a loss for the full year, by the way. And it was not just 2012 that got the treatment, even 2013 is now down to $1.75. Just think about it, it was supposed to earn $5.50 on 2012 two years ago, and now even 2013's estimates are just for $1.75! Plus, this would mark around 9 years of no earnings growth for Amazon.com. One has to ask if this is the stock that warrants the largest multiple among all the large capitalization stocks. Also, deep plunges in estimates are associated with stock underperformance, so that's true reason number two.
Sure, this one has been beaten to death, but Amazon.com started collecting sales taxes in Texas during July and in California during September, and over time will probably collect everywhere else. Sales taxes eliminate one of Amazon.com's pricing advantages and force it to either take a revenue growth hit or a further margin hit. Either way, it's negative and it's another true reason for shorting it given its huge valuation which implies no challenges whatsoever.
Change in digital distribution paradigm
Amazon.com managed to control the physical book market. It also had a good business going in physical media such as CDs, DVDs, etc. But the problem is that this market is now shifting into digital distribution. While Amazon.com initially managed to control eBooks through its Kindle franchise, now even that lead is being eaten away. The problem here is that the digital distribution paradigm is shifting towards digital media being sold in OS-integrated stores such as Apple's (NASDAQ:AAPL) iTunes or Google's (NASDAQ:GOOG) Google Play.
Amazon.com has no way to displace this reality. Its own Amazon App Store is orders of magnitude smaller than either iTunes or Google Play, and even its Kindle franchise pales in comparison to the hundreds of millions of iOS and Android devices. So this is basically another huge challenge to Amazon.com's business model, and another true reason to short it.
Apple selling digital media, apps (software) and even books. Google selling digital media, apps (software) and also books, and increasingly selling product ads as well. Google thinking of ways to connect sellers to consumers. Ebay (NASDAQ:EBAY) is doing the same. Wal-mart (NYSE:WMT), Target (NYSE:TGT), Costco (NASDAQ:COST), are all facing Amazon.com directly.
In fact, Amazon.com seems to be going against every powerhouse there is. And ALL of those large competitors are better capitalized, have unique advantages over Amazon.com, or have cost advantages over Amazon.com. Amazon.com's sole weapon is to lower selling prices while not leading on cost. Does that look like a sustainable model? That's another powerful reason to short Amazon.com.
Liquidity, Debt, Mismanagement, Adverse selection, you name it …
The reasons don't stop at earnings, estimates, sales taxes, changing digital paradigm and competition. Weird as it is for the company trading at the absolute highest multiple valuation among large capitalizations, Amazon.com presents several other sets of red flags. It starts with liquidity, which along with earnings has been falling since 2010, as seen below in the current ratio.
Then, since liquidity is getting worse, Amazon.com is now taking on debt, issuing $3 billion of it, but even that understates the true extent of debt usage by Amazon.com, after all it's still expanding its operating leases strongly, and those are now up to $4.7 billion in the latest quarter.
Although all of the earnings and liquidity situation is put down to Amazon.com investing in the future, there are clear signs of mismanagement as well, such as:
- Being a jack of all trades, master of none, by spreading itself to tens of different market segments at once, facing powerful entrenched competitors in many of them simultaneously;
- Expanding offerings in such a way that it compromises warehouse efficiency, especially taking into account that Amazon.com's warehouses are truly low-tech;
- Competing on price while not leading on cost. It's basically an unsustainable strategy. This can be seen when comparing Wal-mart or Costco operating costs to Amazon.com's;
- Offering free video even to existing Prime members. This created an instantaneous large cost with huge earnings impact while not bringing any new revenues;
- Investing heavily in the most unprofitable areas of its business. Research points out that 3P sales are the most profitable for Amazon.com, yet the area consuming truly large amounts of capital is 1P, since 3P sales mostly don't need fulfillment capacity.
Not only are these signs of mismanagement, but also there are many signs of Amazon.com exposing itself to adverse selection and seemingly not even taking notice of it. One of the things that leads me to believe this is the famous thought that Amazon.com Prime members buy three times more from Amazon.com. Nobody seems to stop and think that perhaps the heaviest users elect to be prime members because it nets out positive for them. Other examples of adverse selection are found in free shipping of expensive-to-ship goods, AWS for peak loads, books and apps on promotion, etc.
All in all, these are several further reasons for shorting Amazon.com over and beyond earnings, estimates, sales taxes, changing digital paradigm and competition.
Far from valuation being the only reason to short Amazon.com, it's easy to see that there are many more reasons for doing so. These extend to plunging earnings, plunging estimates, sales tax collection, the changing digital paradigm, powerful competition, the liquidity and debt situation, mismanagement and God knows what else. All of this packaged into the equity that has the largest multiple valuation in the Street, trading at 143 times 2013 estimates (which will probably be slashed further), 3000 times TTM earnings and a $115 billion market capitalization, a full 1/5th of Apple, a company growing as fast, growing earnings, and being 50-500 times more profitable than Amazon.com.