Amazon: Dirty Little Secrets Persist

If you read some of the notes listed in Amazon’s (AMZN) 10K, your confidence level could be severely hampered, especially if you read between the lines.

The company has grown its infrastructure exponentially. It now resembles more of a brick and mortar operation than a pure e-tailer, as its fixed costs have skyrocketed . It now has fulfillment/warehouse facilities in 36% of the fifty states (12 million square feet) as well as nine foreign countries (5.3 million square feet). Annual lease expenses approximate a hefty $160 million.

May 1997 IPO: AMZN went public in May of 1997, selling 3 million shares at $18 per share to raise over $54 million. In the last twelve years, AMZN has built shareholders' equity to $2.67 billion or $6.18 per share. Tangible book value is $2.2 billion or $5.09 per share when subtracting $438 million worth of good will. Remember, If you do the math, AMZN’s net worth (book or shareholder’s value) increased an under-impressive $216 million per year or about 50 cents per annum. AMZN didn’t payout any cash dividends. Where did all the money go? It sure didn’t seem to fall into the retained earnings column. The company’s book value is practically nonexistent for an enterprise with a staggering market cap of almost $33 billion. You almost have to be a CPA to understand AMZN’s complex accounting maneuvers.

Dilution through more shares: Even though AMZN has authorized a $1 billion stock repurchase program (the company has repurchased $600 million so far) its share count has been steadily increasing primarily due to the award of employee incentive options and the cost of acquisitions. In 2008, AMZN’s outstanding shares increased 2% from 424 million shares to 432 million shares. I thought share repurchase programs were intended to reduce a company’s outstanding shares, not increase them. There are an additional 16.7 million shares available for purchase through incentive options with an average exercise price of $25 per share. It is troubling that AMZN is so eager to go to the printing press over and over again without regard to the negative impact of dilution.

Lawsuits a plenty: AMZN seems to have more lawsuits than Carter has pills. The company is currently faced with six separate lawsuits, as well as a US Postal Service investigation probing compliance with postal service rules. I guess everybody comes out of the woodwork looking for ‘fast money ‘, when you are on a roll. The list includes a June 2001 filing against AMZN’s Audible subsidiary, a May 2004 suit from Toys R Us, a Dec 2005 legal proceeding from Registrar Systems, a Aug 2006 legal challenge from Cordance Corp, a Oct 2007 lawsuit filed by Digital Reg of Texas and finally a Dec. 2008 lawsuit by Quito Enterprises. A recent ruling in the Toys R Us case, by a New Jersey appeals court, could pave the way for a $65 million award to the toy retailer. The 10K stresses that negative outcomes to one or more of these legal proceedings could adversely impact the company’s financial performance (well Duh!) .

Be careful on this one. Although the company seems to be firing on all cylinders and optimism about Kindle and Cloud Computing have many analysts in giddy moods, the shares are still too risky. The fact is, the company’s gross profit margins have been steadily deteriorating. Its stock price could be, “priced for perfection “and then some. The company’s upside potential is about $20, while its downside risk is more than double that—not a very compelling risk reward scenario in my opinion.

Disclosure: Short.

Comments

[Augustus:]

I particularly like the analysis that they have always reported making money, paid no dividend, yet have very little book value. Where did the money go, indeed. However much people may like to believe in the AMZN operation, I just don't see the justification for the share price. Nothing in it for the shareholder, IMHO. Dilution has been just terrible.

Apr 08 09:07 AM

[HTHTFH:]

Whats it trading at now? 40 times earnings? And as so many consumers are up to their butts in credit card debt, the Amazon purchases will taper off the average family budget over the next several months. Not a great short term outlook (and no, the Kindle doesn't count for much).

Apr 08 09:07 AM

[bill9300:]

Mark you should also think about what they are calling FCF.


seekingalpha.com/artic...

Apr 08 09:45 AM

[optionboy:]

The valuation on this company is absurd 52 times 2009 earnings, PEG of 2.5 and 11 times book. Their growth in 2009 is estimated to be negative 1%. Besides the things above their accounting is distorted by unusual items, The non-cash sale of a DVD unit for more than its was worth, the tweaking of tax rates when necessary and other items to make the bottom line look better. Reality is Amazon can sell, bu their hard pressed to make money. This stock is all pure hype on hopes for the future. The company is constantly putting out PR to boost their stock. We are in a deep recession and numbers yesterday showed that the consumer is cutting back on using plastic. In this environment do you think its rational to pay over 50 times earnings for a retailer ?

Apr 08 09:52 AM

[raytayzmd:]

...Mark, Mark, Mark -- you've been dissing Amazon since, what, January 4:

seekingalpha.com/artic...

...and, gosh, it's almost doubled since you recommended shorting it!...now, I understand how that would cause sufficient rectal sphincter tension to make defecation near impossible...I guess that explains why you're so FOS!...HAW!...good one, huh?!...but one bright point I see is that you replaced your sorry mug with an ever so much more attractive pug!

Apr 08 09:57 AM

[Optionsforme:]

Huge growth ? EPS growth in 2009 is supposed to be -1%, sales grow but profits don't.


On Apr 08 06:12 AM Cetin Hakimoglu wrote:

> yea, but the stock keeps surging because of huge growth and it;s
> immune to the supposed financial crisis and recession. That makes
> it a huge buy.

Apr 08 10:10 AM

[raytayzmd:]

...HAW!...going back to a article written over a year ago is pretty desperate, don't you think?!


On Apr 08 09:45 AM bill9300 wrote:

> Mark you should also think about what they are calling FCF.
>
>
> seekingalpha.com/artic...

Apr 08 10:15 AM

[sdt993:]

First, who uses book value to measure a growth stock, or any stock for that matter these days? With all the write offs and accounting changes over the years, book value is generally meaningless outside the financial sector where you need regulatory capital. The value of a stock is the NPV of future free cash flows. BV looks backward, not forward. Second, AMZN may have gone public in 1997, but it lost money on a GAAP basis every year until 2003, as you might expect with what was then a start up operation. BV bottomed at -$1.4B in 2002 and has since grown to +$2.7, up $4.1B in the 6 years since it has been profitable. Third, share count has risen from 403 in 2003 to 436 at year end, up 8% over the period. Hardly a disaster. Where did the cash go? Gee, lets check the cash flow statement and balance sheet. Debt down from $1.945B to $.4B so thats $1.5 of debt paydown since 2003, Cash/Short term investments have gone from $1.3B to $3.7B, up $2.4B. SHare repo - just $.6B, not very much. Total CAPX since 2003 is just $1.1B and acquisitions about $.7B. So, total CFFO since 2003 is $5.5B, and i've just accounted for $5.6B. There's the answer to your big mystery. Your comments on fixed costs are borderline insane. AMZN turns its fixed assets 23.5X per year ($20B sales/.850 fixed assets) vs. 4.3X for WMT and 2.6X for TGT. There IS a short case to be made on AMZN, but this article is pure sophistry.

Apr 08 11:02 AM

[Mark Krieger:]

Nice analysis....you made some very compelling points..I realize at times my arguement is a bit farfetched. mark


On Apr 08 11:02 AM sdt993 wrote:

> First, who uses book value to measure a growth stock, or any stock
> for that matter these days? With all the write offs and accounting
> changes over the years, book value is generally meaningless outside
> the financial sector where you need regulatory capital. The value
> of a stock is the NPV of future free cash flows. BV looks backward,
> not forward. Second, AMZN may have gone public in 1997, but it lost
> money on a GAAP basis every year until 2003, as you might expect
> with what was then a start up operation. BV bottomed at -$1.4B in
> 2002 and has since grown to +$2.7, up $4.1B in the 6 years since
> it has been profitable. Third, share count has risen from 403 in
> 2003 to 436 at year end, up 8% over the period. Hardly a disaster.
> Where did the cash go? Gee, lets check the cash flow statement and
> balance sheet. Debt down from $1.945B to $.4B so thats $1.5 of debt
> paydown since 2003, Cash/Short term investments have gone from $1.3B
> to $3.7B, up $2.4B. SHare repo - just $.6B, not very much. Total
> CAPX since 2003 is just $1.1B and acquisitions about $.7B. So, total
> CFFO since 2003 is $5.5B, and i've just accounted for $5.6B. There's
> the answer to your big mystery. Your comments on fixed costs are
> borderline insane. AMZN turns its fixed assets 23.5X per year ($20B
> sales/.850 fixed assets) vs. 4.3X for WMT and 2.6X for TGT. There
> IS a short case to be made on AMZN, but this article is pure sophistry.

Apr 08 11:09 AM

[Hedge Fund ...:]

Good stuff. I like the word "sophistry." And AMZN is still probably overvalued.


On Apr 08 11:02 AM sdt993 wrote:

> First, who uses book value to measure a growth stock, or any stock
> for that matter these days? With all the write offs and accounting
> changes over the years, book value is generally meaningless outside
> the financial sector where you need regulatory capital. The value
> of a stock is the NPV of future free cash flows. BV looks backward,
> not forward. Second, AMZN may have gone public in 1997, but it lost
> money on a GAAP basis every year until 2003, as you might expect
> with what was then a start up operation. BV bottomed at -$1.4B in
> 2002 and has since grown to +$2.7, up $4.1B in the 6 years since
> it has been profitable. Third, share count has risen from 403 in
> 2003 to 436 at year end, up 8% over the period. Hardly a disaster.
> Where did the cash go? Gee, lets check the cash flow statement and
> balance sheet. Debt down from $1.945B to $.4B so thats $1.5 of debt
> paydown since 2003, Cash/Short term investments have gone from $1.3B
> to $3.7B, up $2.4B. SHare repo - just $.6B, not very much. Total
> CAPX since 2003 is just $1.1B and acquisitions about $.7B. So, total
> CFFO since 2003 is $5.5B, and i've just accounted for $5.6B. There's
> the answer to your big mystery. Your comments on fixed costs are
> borderline insane. AMZN turns its fixed assets 23.5X per year ($20B
> sales/.850 fixed assets) vs. 4.3X for WMT and 2.6X for TGT. There
> IS a short case to be made on AMZN, but this article is pure sophistry.

Apr 08 11:27 AM

[dowbuys:]

If you're long the stock you could use a trailing stop of $71.73. Technically it's a healthy looking stock at this time but approaching overbought territory on weekly and monthly charts (a rarity these days). Alternatively, you could short below $71.73.

Apr 08 11:34 AM

[Mark Krieger:]

great word --"sophistry"--one of my dad's favorite words!!!


On Apr 08 11:27 AM Hedge Fund Invest wrote:

> Good stuff. I like the word "sophistry." And AMZN is still probably
> overvalued.

Apr 08 11:53 AM

[ideas2sell:]

One thing's for sure. After AMZN announces its results on 4/23, the stock price will either go up or down!

Apr 08 02:12 PM

[Optionsforme:]

Ok so you think its fairly valued at 52 times 2009 earnings and a PEG of 2.5 ? Yes they paid their long term debt, but look at how accounts payable have ballooned. Their have not growth in 2009, so what multiple will you pay for zero growth ?


On Apr 08 11:02 AM sdt993 wrote:

> First, who uses book value to measure a growth stock, or any stock
> for that matter these days? With all the write offs and accounting
> changes over the years, book value is generally meaningless outside
> the financial sector where you need regulatory capital. The value
> of a stock is the NPV of future free cash flows. BV looks backward,
> not forward. Second, AMZN may have gone public in 1997, but it lost
> money on a GAAP basis every year until 2003, as you might expect
> with what was then a start up operation. BV bottomed at -$1.4B in
> 2002 and has since grown to +$2.7, up $4.1B in the 6 years since
> it has been profitable. Third, share count has risen from 403 in
> 2003 to 436 at year end, up 8% over the period. Hardly a disaster.
> Where did the cash go? Gee, lets check the cash flow statement and
> balance sheet. Debt down from $1.945B to $.4B so thats $1.5 of debt
> paydown since 2003, Cash/Short term investments have gone from $1.3B
> to $3.7B, up $2.4B. SHare repo - just $.6B, not very much. Total
> CAPX since 2003 is just $1.1B and acquisitions about $.7B. So, total
> CFFO since 2003 is $5.5B, and i've just accounted for $5.6B. There's
> the answer to your big mystery. Your comments on fixed costs are
> borderline insane. AMZN turns its fixed assets 23.5X per year ($20B
> sales/.850 fixed assets) vs. 4.3X for WMT and 2.6X for TGT. There
> IS a short case to be made on AMZN, but this article is pure sophistry.

Apr 08 02:36 PM

[sdt993:]

My guess is that the stock is probably ahead of itself in the short term, but longer term there is no denying the power of this franchise. One point I would make is that the bears always throw out the P/E on GAAP earnings and declare the valuation ridiculous. Markets generally aren't stupid for extended periods of time on large cap stocks. Thus, I would suggest that many people add back non-cash expenses such as FAS 123 to their estimates to get a truer picture of earnings. This adds about .40 to .45/share to reported GAAP. Second, the company has a unique cash flow cycle in which AP days are greater than A/R and Inventory days combined. Thus, they GENERATE large quantities of cash from working capital, which is highly unusual. Somebody above said the story was pure "hype", effectively dismissing a global retailer generating $20B in sales as hype. Here's the long term story: Global retail is over $13Trillion. Retail ecommerce is about $400B this year or just barely 3% of total retail. ecommerce has been growing at 4X the rate of global retail since 2006 (faster before). AMZN is about $20B/400 or just 5% of ecommerce. Thus, while it is by far the dominant e-retailer, it is still a tiny fraction of total retail. Moreover, ebay is dead in the water. They can't compete with AMZN and they have just announced they are going to stop trying. WMT is a $400+B revenue company. That is the opportunity for AMZN. There is no practical reason why they couldnt do hundreds of $B in sales per year if you look out past the next earnings report. And yes, they do make money in spite of what some comments above say. Coincidentally enough, their operating margins on a GAAP basis are very close to WMT and on non-GAAP they are closer to where TGT is in a good year.

Apr 08 02:57 PM

[TekGems:]

yes, shopping will slow down for all businesses, including amazon, but since amazon offers great customer service, those who have money to spend will go with a reputable company before risking their money with an unknown.

Apr 10 04:02 PM

[seattleite:]

Mark
I think your article is flawed. If you are wondering where the cash is, then clearly you are writing this article because of personal vendetta ( I think you shorted the stock at around 50 and I commented on your article that you will cover at 80 and we are almost there) and not because of any financial analysis. You have not done the most basic thing, read the financial statements. If you would have, you would have seen that debt is down almost 1.5 bn and investments are up. Thats where the cash is.

I have nothing for or against Amazon but I hate the fact that people are using seekingalpha to pump/crap their own holdings. This should not be allowed.

Mark, cover your shorts and stop putting down AMZN every 3rd week especially when its going up.

Apr 19 02:25 AM