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Summary

  • Despite its stock price and growing revenues Amazon is in desperate need of a stable cash flow.
  • Amazon's cash flow has been going up and down like a roller coaster and it has been getting worse.
  • eBay's experience with PayPal shows that payments are the way for an online company to generate cash flow.

The reason Amazon.com (AMZN) has decided to enter the online payments business is a simple one: the company desperately needs a stable rate of free cash flow.

Chart watchers know that Amazon's revenues have been rising steadily for years but its free cash flow has been going up and down like a roller coaster. Every year Amazon reports a huge free cash flow in December during the Christmas shopping frenzy that falls to a dismal low in the spring.

Amazon.com's Free Cash Roller Coaster

This year the figures were particularly bad; Amazon.com reported a free cash flow of $4.699 billion (a record high) in December 2013 and -$3.582 billion (a record low) just three months later in March 2014. That's a difference of $8.27 billion in one quarter, and charts seem to indicate it has been getting worse for the past few years.

In March 2013, Amazon.com reported a free cash flow figure of -$3.04 billion in contrast to a figure of $3.055 billion in December 2012. In March 2011, Amazon.com reported a free cash flow figure of -$1.88 billion and in December 2010 a free cash flow figure of $3.16 billion.

Unstable does not begin to describe Amazon.com's free cash flow; volatile might be a better term. Amazon.com has a serious free cash flow problem, and it is getting worse each year. The company needed to do something about this, and it has; it has started imitating eBay Inc. (EBAY).

eBay's Cash Machine

Unlike Amazon.com, eBay has not reported a negative free cash flow figure in the past five years. In fact, its free cash flow remained fairly steady until March 2012, when it dropped to $289 million.

Then it rose to $1.089 billion in December 2012, fell to $638 billion in March 2013, rose to $1.432 billion in December 2013, and fell to $968 million in March 2014. The charts clearly show why eBay's cash flow is fairly steady and growing: PayPal.

TechCrunch reported that PayPal's revenues increased by 19% in the final quarter of 2013. It also reported that PayPal gained 5.2 million new users in that quarter. That means there are now 143 million PayPal Users. PayPal processed $27 billion in payments in 2013, and its mobile commerce use grew by 14 million, according to eBay CEO John Donahoe in a March earnings statement.

PayPal provides eBay with a steady flow of cash that's increasing. The flow rises at Christmas, but it comes in all year round, and it is money that bolsters PayPal's bottom line.

Amazon.com Wants and Needs Float

The numbers indicate that PayPal and eBay have what Warren Buffett likes to describe as "float." Float is "collect now pay later money" from customers that can be effectively used as an interest free loan by a company. Buffett likes to describe the money in insurance policies as float, but we can think of at least some of the payments processed through PayPal the same way.

Amazon is hoping that it can use its role as a middleman in transactions to generate float by managing subscription payments from other companies. Around 40% of its sales come from third party sellers. The third party sellers generate float for Amazon.com because as sellers like myself know, the company holds their payments for around two weeks.

By concentrating on subscriptions, Amazon.com is trying to create a lot of float. A steady source of cash can be used for projects like Mr. Bezos's famed drones, the smartphone, movie and TV production, and the expansion of services like Amazon Prime.

A subscription service fits in nicely with Amazon.com's business model. People used to making regular Amazon Prime or music subscription payments won't think twice. Rising bank fees and the growing number of under-banked Americans provide for lots of potential customers for Amazon.com's service.

Wal-Mart Wants Float Too

Amazon.com is not the only company hoping to use financial services to generate float. Wal-Mart Stores Inc. (WMT), which has been plagued by falling revenues, launched a money transfer service called Walmart 2 Walmart. Wal-Mart hopes the money being transferred will work like float.

Wal-Mart has also launched a business to business e-commerce platform in India that sounds a lot like Amazon.com. That's another way to generate float.

So will Amazon.com's attempt to generate float and stable free cash flow succeed? Most likely yes; the company already has vast numbers of loyal customers and a reputation for integrity and convenience. Tens of millions of people already trust cash with Amazon.com and pay its subscriptions every day.

My guess is that Amazon.com Payments will work and provide some much needed float, but they won't be a direct challenge to PayPal. Instead, Amazon.com will go after one market subscription and bill payments, leaving PayPal to dominate direct payments. Either way, Amazon.com payments will boost Amazon.com's bottom line and possibly stabilize its cash flow.

Disclosure: The author is long EBAY. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. The author runs an e-commerce business that conducts retail sales through both eBay and Amazon.com.

Source: Why Amazon.com Has Entered The Payments Business: Cash Flow