Amazon Stock's Expensive Unless Free Cash Flow Doubles

Shares of Amazon.com (AMZN) have gained 70% since April, hitting new seven-year highs along the way, and adding more than $10 billion in market value due to one quarterly report alone. Investors were happy to overlook the fact that the first quarter's surprise increase in net income was mostly thanks to a much lower tax rate, and when you consider the company's true free cash flow, which isn't influenced by taxes, the results came in flat year-over-year.

Take a look...

Amazon.com's trailing twelve-month free cash flow, measured to the end of 3/2007:

• True Free Cash Flow [TFCF]: $521 million, exactly flat year-over-year
• Structural Free Cash Flow [SFCF]: $273 million, up more than 50% year-over-year, aided by tax rates

True free cash flow doesn't consider taxes. Structural free cash flow does, with a starting base of net income after taxes. It increased. But true free cash flow did not.

Now let's consider other moving parts to get a valuation to free cash flow, again compared year-over-year to the end of March:

• Diluted shares outstanding: 420 million, down 6 million due to Amazon's share buyback program, which so far has been an excellent investment
• Cash, investments & equivalents: $1.42 billion, still down 29%
• Long-term debt: $1.25 billion, flat

With these numbers and the $70 share price, we find that Amazon has an enterprise value, or EV, of over $29 billion. So, we have EV/FCF multiples of:

• EV/TFCF: 55.6
• EV/SFCF: 106

These multiples compare to average free cash flow prices in the low-20s for large-cap stocks today. eBay (EBAY) trades at 25 times true free cash flow and 31 times structural, less than half of Amazon's price in both cases.

These valuations suggest that Amazon is expensive unless free cash flow is going to double or much more the next year, which does not appear likely. The share price looks especially expensive when you consider Amazon's rock-bottom profit margins. So is today's price sustainable, let alone attractive for new buyers?

Today's price seems to offer limited upside potential the next few years against meaningful downside risk. 

Disclosure: Author has a short position in AMZN

AMZN 1-yr chart:

Comments

[karpodiem:]

Agreed. Time to short.

2007 Jun 20 03:09 PM

[Kris Tuttle:]

I agree with your analysis and stock opinion. However I wonder what drove the stock higher over the month post the huge pop on Q1 results? I can guess that technical types may have seen the move from 45 to 60 as a huge breakout on heavy volume and this helped the stock follow through from 60 to almost 75.

But does anyone see any real fundamental change in the story to support buying stock above $60? I have not been able to figure it out. I'm a major Amazon customer and love the company, think they get Web 2.0 and all that but the valuation relative to the current core business is difficult to fathom.

2007 Jun 20 06:26 PM

[Yaser Anwar:]

There had been a considerable amount of short interest as well which just added fuel to the fire.

2007 Jun 22 09:44 PM