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Paulo Santos, Think Finance (377 clicks)
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Yesterday, based on Amazon.com's (AMZN) earnings release, I commented on several negative and positive developments that were already evident. Most were negative and related to large drops in earnings, revenue guidance, earnings guidance, operating cash flow, free cash flow and cash. I did leave the door open for a more detailed analysis once I got the latest 10-Q. With the 10-Q in hand, I can now comment further on a couple of important things. I'll start with the net shipping costs.

Net shipping costs

One of two positive developments that happened in this quarter related to how the long-standing unfavorable trend on net shipping costs seemed to turn and how shipping revenue seemed to accelerate, which was in line with the thesis that the Kindle fire would bring in a lot of new Prime memberships. The relevant part of the 10-Q seeming to bear this out is this:

(click charts to enlarge)

We see shipping revenue accelerating from 33% last year, same quarter, to 40% right now. Shipping revenue amounting to 3.5% of revenue, versus 3.3% before, and as a consequence, net shipping cost coming in at 5.1% versus 5.4% in Q4 2011. But look at the table again.

Are we measuring the same thing as last year? The last note seems to indicate that there are additional values considered on shipping revenue over and above what was included last year. It's impossible to know if there's a change in perimeter or not, but it's weird that the note would clearly specify that it's only including something "for the three months ended March 31, 2012." This same note did not exist during 2011, though the second note said it included some amounts from FBA. We are left with the doubt about whether the included values are the same or were expanded.

The one-time gain

I had already said yesterday that Amazon.com's beat was entirely due to a one-time gain. Today, based on the 10-Q we can expand further on that. Not only was the beat entirely due to a one-time gain, but the gain was entirely fiction. The gain had two components.

The first was Amazon.com's share of LivingSocial's income. LivingSocial's earnings report is summarized in the 10-Q:

This is where it gets interesting. How does a $92 million operating loss turn into $156 million net income? This happened by means of hocus-pocus accounting. LivingSocial accounted for gains in acquisitions it made in the quarter, where it already held an equity position. So, as it bought out minorities at valuations greater than what it had those equities for in the books, it registered entirely imaginary gains! And AMZN, having a 29% share on LivingSocial, accounted for its share of those imaginary gains. Now, this was not a minor thing. Without the hocus-pocus, Amazon.com would have accounted for 29% of $92 million in losses, so -$26.7 million. Instead, it ended up writing up 29% of $156 million in imaginary gains, so +$45.2 million. Just here, Amazon.com got a $71.9 million imaginary gain, or $0.155 per share.

But that was not all. Amazon.com also registered a further $36 million due to having seen its LivingSocial position diluted. Another $0.078 per share. This means these imaginary, accounting, non-cash, "earning" increased Amazon.com's EPS by a full $0.232 per share, or more than the entire "earnings beat."

Cash position

Due to the huge drop in free cash flow, together with the massive buying of its own shares, we already knew that Amazon.com had seen its cash balances fall around $1.2 billion when compared with the same quarter the year before. But there's another interesting tidbit regarding the cash. It's now almost all held in foreign accounts! This might have consequences if Amazon.com tries bringing it back into the U.S., or might lead to Amazon.com actually having to issue some debt down the road. Here, we should keep in mind that the cash balances still don't account for the Kiva acquisition, which will cost $775 million cash. The relevant paragraph on the 10-Q that shows the dwindling U.S. cash position is this one (if you net out the $3.0 billion in foreign currencies, you notice that what remains is just $2.7 billion):

Our principal sources of liquidity are cash flows generated from operations and our cash, cash equivalents, and marketable securities balances, which, at fair value, were $5.7 billion and $9.6 billion at March 31, 2012, and December 31, 2011. Amounts held in foreign currencies were $3.0 billion and $4.1 billion at March 31, 2012, and December 31, 2011, and were primarily Euros, British Pounds and Japanese Yen.

Media numbers

Finally, something that has been known for a while but I've never commented on. Over time, Amazon.com has been turning mostly into an online electronics retailer with all the consequences that entails. Indeed, in this earnings release Amazon.com already puts the mix at 60% electronics, 36% media, 4% other. This, too, is misleading. Amazon.com is, even now, a lot more geared toward electronics than it seems. The reason is simple and can be confirmed by reading the earnings call transcript: gaming consoles are considered media as well, when obviously, they should be electronics. It's hard to say, given the lack of transparency, exactly what else is being classified this way or even moving from one category to another.

Consoles are media, but really, electronics. So the mix is even more electronics than it seems:

Sure. I'll take the second one first on North American media. I just mentioned that a little bit in one of the previous questions. But certainly, our digital media growth has been great and certainly it's helping that. One other color just to keep in mind, in Q4, I had mentioned that video games, including video game consoles, the consoles are part of North America media, that's a seasonal business that was bringing down growth in Q4. So it's also something to keep in mind.

Final considerations

Not only were Amazon.com's earnings rife with negative developments, but there was also a considerable amount of misleading or absent information in them. The lack of transparency that Amazon.com displays is not compatible with incredible valuation premiums. The major positive on the earnings release was due to operating earnings above deeply lowered valuations and still showing year-on-year decreases. These operating earnings were driven by a gross margin improvement that Amazon.com never explained clearly - it could be increased pricing, for all we know. The drop in payables and days' sales outstanding on those payables could be consistent with a quarter that went well at the start and slowed down massively in the end. This would also be consistent with the lowered revenue and earnings guidance.

All in all, this is not an earnings report compatible with the incredible buying frenzy the market is displaying.

Source: Amazon.com, The 10-Q Surprises