Amazon: Is 'Free Cash Flow' More Important Than Net Income? 17 comments
-
Font Size:
-
Print
- TweetThis
Questions:
Is it fair to consider short-term cash available because of delayed payment terms of Amazon's (AMZN) A/Ps as Free Cash Flow? Most of their “FCF” from 2007 vanished in the March 2008 Quarter.
How much does the "FCF" from the increase in Accounts Payable benefit Amazon, aside from investment income earned on the float?
What is the quality of Amazon's FCF?
It seems that some analyzing Amazon are ignoring Net Income and using FCF to justify its valuation or a target price. There is no clear consensus on the definition of FCF; this can lead to confusion on what is the most meaningful definition and for the formula to use for its computation..
Free Cash Flow, strictly speaking, is the amount of money left over from the operations of a company that is available for distribution to the owners of the capital employed in the company.
There are various formulas to compute FCF. Whatever method is used, adjustments can be made to get a quality figure. In evaluating a company, analysts use various definitions of FCF, including "True Free Cash Flow", "Structural Free Cash Flow", "Maintenance Structural Free Cash", etc.
Below are two methods to compute Amazon's FCF. Formula 1 is very popular with analysts and liked by the company. It includes, in FCF, short-term cash received from customer sales in one quarter that was paid to suppliers in the following quarter. The second Formula is based on earnings, and ignores that short-term cash. Also listed is FCF, based on Formula 1 for the Quarter ended March 31, 2008, showing FCF at a negative $(706)ml.
Two methods of computing Amazon's FCF for 2007
1) Cash Flow From Operations...........$1.405 bn.
- Less Capital Expenditure.................224
- Free Cash Flow......................................$1.181bn
2) Net Income............................................$476ml
- Plus Depreciation...............................246
- Less Capital Expenditures................-224
- Free Cash Flow.........................................$496 ml
Difference between the formulas .....................................$685 million
Free Cash Flow (Negative) March 31, 2008
3) Cash Flow From Operations.....................$(645) ml.
- Less Capital Expenditure...........................-61
- Free Cash Flow(Negative)...............................$(706)ml
Amazon is a company that has been in business for over 14 years and still has an Accumulated Deficit in Retained Earnings of $(1.2) bn, as total net losses exceeded their net Income. For 2007, they had earnings of $476ml; at the current stock price of $81m, they have a P/E ratio of 68. For the past 6 years they had total earnings of $1.5bn, which is extremely low for a company with a valuation of $34 billion.
Amazon has had good growth in sales, but with their history of no or low earnings, slim profit margins and a high P/E, some analysts and the company had to come up a ways to help justify their valuation. One method was to tout their FCF alleging that FCF is more important than earnings.
Some in the investing media feel that earnings per share and P/E ratio may be misleading. They state that FCF is the only true way to measure a firm’s cash generating ability and is a more useful metric of investment attractiveness than earnings. This argument begs several questions, including the definition of FCF, the quality of the FCF and what should be included in the computation.
Many analysts reported $1.181bn as Amazon’s FCF for the year 2007; how meaningful is that number? Why does it differ greatly from the computation in example 2 above? Examining the Statement of Cash Flow it can be seen that over $800 ml of the $1.181bn is derived from a net change in working capital, most from the $1.2 bn year over year increase in liabilities. Cash did increase as did Accounts Payable.
Cash increased $1.1bn for the Y/E 12/07 over 12/06, mainly from the increase in A/Ps that would be paid to suppliers after 12/31/07 which decreased cash by $1bn at March 31, 2008.
Current Liabilities-Year ended 12/31
2007...$3.7bn
2006.....2.5
Increase...... ............... $1.2bn
Total Debt-
3/31/08…$4.4bn
Y/E 12/31-
2007....5.3 bn
2006... 3.9
2005....3.5
2004....3.5
2003... 3.2
2002... 3.3
Cash and ShortTerm Investments-
3/31/08…$2.1bn
Y/E 12/31-
2007.... 3.1bn
2006..... 2.0
2005......2.0
2004......1.8
2003......1.4
2002......1.3
Amazon had Net Earnings of $476ml for the year, all of which belongs to the shareholders. How much does the “FCF” from this short-term cash mean to the shareholders? It seems only the investment income Amazon is earning on the float.
This short-term cash should not be considered Quality FCF and it is not equivalent to Net Earnings, which belongs to the shareholders. According to example 3 above Amazon had a negative $(706ml) for the March quarter, or 40% of the $1.181bn FCF that many claim Amazon had for the year.
Is the 2007 FCF of $1.181bn, that many are touting, meaningful when in the following quarter their FCF came out to a negative $(706)ml? How much is that “FCF” really worth to the valuation of the company, except for the relatively small amount of investment income they earn on it? It seems many are trying to equate “FCF” (relating to A/P) to Net Income, which it is not. This cash was temporary, vanished the following quarter and does not belong to the shareholders. Some analysts have increased target prices and target market valuations equivalent to tens of billions of dollars on this temporary “FCF”.
Warren Buffett, when analyzing a company and its FCF, uses computation #2 (above) it begins with Net Income. When valuing a business he would not consider the short-term cash held to pay liabilities as FCF and he would not pay multiples for it. FCF does not equal Earnings; it can be easily manipulated-increased by stretching out payment terms, as the below Goldman comment mentions.
Goldman Sachs' recent recommendation mentions FCF and increasing it by obtaining longer payment terms in their attempt to help justify a target price, they completely ignored earnings. (Goldman owned 7.5 ml AMZN shares at March 31, 2008).
...Trading at around 20X 2009E free cash flow, Goldman believes Amazon stock can outperform on rising revenue if margins are only flat; RAPID REVENUE GROWTH ASSISTS FREE CASH FLOW BECAUSE AMAZON USES ITS IMPROVING CATEGORY SHARE TO NEGOTIATE LONGER PAYMENT TO SUPPLIERS in categories such as books...
In certain companies, FCF can be very important as it gives the company access to cash for expansion without borrowing. With Amazon, this benefit is not that great; they have substantial cash and even have enough to repurchase $100s of million of their own stock. Amazon’s FCF is not consistent, using their definition; they showed FCF of $1.181bn for the year ended December 31, 2007 and for the March 2008 quarter a negative $(706) ml.
Remember Free Cash Flow is not equal to Net Income. The quality of the FCF is very important in valuing a company. Earnings and Cash Flow differences occur because of timing; over the long these two measures must converge
Disclosure: Author holds a short position in AMZN
Related Articles
|
Find People on SA
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largest
increase in followers
in the last 7 days-
1
David Fry
-
2
Philip Davis
-
3
Bill Gross
-
4
Tyler Durden
-
5
TraderMark
Fastest Climbers » -
1
-
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most activeSee all
Instabloggers.
Top Instabloggers » -
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
This article has 17 comments:
As an aside, I would indicate that much of the success of Berkshire was due to the fact that Buffett recognized the value of that float and increased it over time via investing. That is where most of Berkshire’s wealth comes from, but that is Buffett and this is a totally different animal…
Anyway, moving on – It looks like there are two levels of disagreement here. First, should we value based on earnings or on some measure of free cash flow? Second, if it is free cash, how should we define it?
On the first question, I don’t know that there is an objective answer and we could descend into some no-win argument. For whatever it's worth, I tend to think that free cash is the best way to look at it, since earnings are an opinion (determined by industry convention, management estimates or fictions, and FASB), but cash is a fact (or at least much closer to it). You can’t take your earnings and buy a warehouse, expand your factories, pay a dividend or buy back shares. You need cash to do that – and earnings are just a shorthand way of approximating free cash (not the other way around). If you disagree and are set on earnings as the real driver, at this point, we must part ways.
On the second question, it looks like you don’t accept the argument that working capital changes should be accounted for in the definition of free cash flow. Most of the time, companies need to invest in inventories, etc… and only get paid later (they have a positive cash conversion cycle, which results in a negative value as you go down the statement of cash flows (i.e., it is a use of cash). But a negative cash conversion cycle (provided it is structural and not anomalous) is valuable – not kinda, sorta, maybe, but real, cash in the bank valuable. Overall, a negative cash conversion cycle means you get paid before you have to pay everybody else. A private buyer would get his hands on that cash, and relatively active markets for corporate control keep public companies in some reasonable approximation of that private market value.
So, is AMZN’s negative CCC consistent (indicating something structural rather than fleeting)? Every year since 1995, AMZN’s working capital has been a source of cash – less to borrow from the bank or raise in a secondary, more to expand or buy back stock, etc… It is always good to have a negative CCC (not just sometimes) – that is the reason they don’t have a lot of debt and have been able to buy back their stock (not the inverse, as you seem to indicate, that it is not valuable because they have tons of cash).
Another way to look at it – Buffett says (and I agree, just to give it some extra credibility) that the value of a business over time is how much cash you can take out of it. To me, that seems clear as day, it’s just CFFO – CFFI. You can set up a simple DCF and you will see that a swing from a positive CCC to a negative one can have massive implications on the value of the stock. The caveat is that the company has to be growing at some level (at 0% growth, there will be no change in WC balances and no source/use of cash).
Finally, on the quarterly issue, this is due to the nature of their business – in Q4 they sell books and gifts for the holidays (lots of cash in) and in the new year, they pay the publishers. Every Q1, CFFO falls dramatically for that reason. It’s just seasonality – nothing more.
How much market valuation is that FCF worth?
Company makes very little profit, a total of $1.5bn in the past 6 years
P/E 67- very high
Market Valuation $33bn
Their Total Debt has been increasing every year,
FCF seems to be a way to pump up or support the stock price
You said Berkshire recognized the valued that float, he used a more meaningful definition to measure it, as was mentioned in the article.
The way some analysts, Amazon, FCF it can be easily manupulated.
For example in the December quarter, if they obtained better terms on $100ml of A/Ps and delayed payment until January their "FCF" (their definition) would have been $100ml higher, $1.281bn rather than $1.181bn.
Would that add'l $100ml be meaningful? (except for some investment income)?
I have already described why I believed GAAP earnings to be relatively unimportant. Besides, I already conceded that it’s a bit pricey for my blood. My point in writing was to delve into this issue of why FCF would not be better than earnings.
2) “Their Total Debt has been increasing every year”
Debt load appears to be very manageable at more than 10X covered.
3) “FCF seems to be a way to pump up or support the stock price”
I think it is much harder to manipulate FCF than it is to manipulate earnings. Furthermore, price manipulations can work in the short-run, but in the long-run, the economics always win. Bezos, as owner ¼ of the equity, would appear to be in it for the long haul.
4) “You said Berkshire recognized the valued that float, he used a more meaningful definition to measure it, as was mentioned in the article.”
I think the definition you offered is sufficient in most circumstances of low/steady growth companies where you don’t have a negative CCC. In those cases, it just doesn’t move the needle much. I don’t know of Buffett offering the precise definition you cite (I don’t doubt it either), but I do know the ironclad one he has discussed is the present value of the cash that the owner can extract over the life of the business. From there, I use my judgment as to what can be extracted. A structural negative CCC represents extractable cash, and I have seen no argument why it isn't.
5) “The way some analysts, Amazon, FCF it can be easily manupulated. For example in the December quarter, if they obtained better terms on $100ml of A/Ps and delayed payment until January their "FCF" (their definition) would have been $100ml higher, $1.281bn rather than $1.181bn. Would that add'l $100ml be meaningful? (except for some investment income)?”
This is why I previously indicated that it must be structural issue and not just shifting between time periods. If it is a one-off thing where they were able to push out payables a bit longer this once and we don’t expect that to happen again, then that $100mm is not meaningful from a valuation standpoint. If, however, the business model is such that they are able to consistently generate cash from working capital, then an appropriate valuation should reflect that. When you talk about manipulation, I would also just say that getting better terms from suppliers seems more like a sound business practice that adds value than manipulation. And contrary to your claim, it is not easily done – by extending terms (i.e., Amazon wants 60 days to pay, rather than 30, or whatever the numbers are), Amazon would be extracting cash from its suppliers, who probably wouldn’t like it and would push back as much as possible.
Consider two fictional companies – AverageCo and RichCo:
AverageCo RichCo RichCo*
NI $100 $100 $100
D&A $40 $40 $40
Change in WC ($20) $20 $15*
CFFO $120 $160 $155
CFFI (incl Capex) ($40) ($40) ($40)
FCF $80 $120 $115
Value of firm at 10X $800 $1,200 $1,150
* Adjusted for $5mm of unsustainably extended terms
NI, D&A, CFFI are identical. The only point of difference is that AverageCo (like most companies) has a positive CCC (and WC is therefore a use of $20mm cash), while RichCo has a negative CCC (and WC is therefore a source of $20mm cash). The situation you present, a presumably unsustainable extension of terms with suppliers, would make RichCo’s change in WC of $20mm unsustainably high. So maybe it’s only a $15mm source of cash – that doesn’t make the $15mm irrelevant. I just slapped a simple multiple on it to make things easy, but if you DCF it, you get to the same place. If you accept the premise that FCF is a superior measure of value than GAAP profits (for reasons I discussed in my previous post), the valuation difference between AverageCo and RichCo is substantial (50% greater). Adjusting for the unsustainably extended terms decreases the valuation from $1,200 to $1,150, but it does not make them $800 (AverageCo's value) or $1,000 (10X the $100 accounting profit).
Using AMZN’s method of computing FCF: it appears they had a $393ml reduction in FCF for the 12 mos ended 3/31/08 compared to 12/31/07. It was mostly from the $-366ml difference between
March 31, 08 and 07s, Cash from Operating Activities. (2008) $-645ml - $-279= $-366ml). This was because of the large increase in A/Ps of
$1.2bn 2007/ 2006, with the Short-Term Cash from December Q sales paid to
suppliers in the March Q. (HOW CAN YOU CONSIDER THAT FCF?)
Instead of using fictional companies, why don’t you look at the numbers that Amazon issued in their Statements of Cash Flow. As I said putting billions of $s of valuation on their “FCF” is wrong, meaningless, and I repeat Warren Buffett would not consider the “FCF” from A/P as FCF. The company has little profit and is trying to justify their valuation of $33bn by use of this “FCF”.
finance.google.com/fin...
FCF, for the 12 months ending March 31, 2008
Cash from Operating Activities
3/31/08........-645ml
12/31/07.....1,148
9/30/07..........237
6/30/07..........299
Total....................
Less Cap Exp.......-251
FCF-12 Mos ended 3/31/08.........$788ml
FCF-12 Mos ended12/31/07...... ..1,181ml
Decrease in FCF......................
Above is their method of calculation, beginning with CF from operations.
One analyst projected $1.5bn in FCF for the year, I think he should re-evaluate his projection and thinking.
Using AMZN’s method of computing FCF it appears they had a $393ml reduction in FCF for
the 12 mos ended 3/31/08 compared to 12/31/07.
finance.google.com/fin...
FCF, for the 12 months ending march 31, 2008
Cash from Operating Activities
3/31/08........-645ml
12/31/07.... 1,148
9/30/07.........237
6/30/07..........299
Total.................... 1.039bn
Less Cap Exp....... -251
FCF-12 Mos/End 3/31/08.........$788ml
FCF-12 Mos end 12/31/07........1,181m...
Decrease in FCF...................... $393ml
Is AMZN’s FCF from Short-term Cash held from Customers' Sales December Q, paid to suppliers in the March 2008 Q worth $16bn in Market Valuation??? Remember this FCF, as many classify it, is not Net Income.
Goldman put a 20 X 2009 estimated FCF, to try to justify Amazon's valuation of $34bn. (2009?)
Amazon a company that earned $1.5bn in the past 6 years, a 2007 profit of $476ml and a P/E of 60+) How can "FCF" (aside from earnings) most of which is of POOR QUALITY be given such a outrageous valuation (20X).
From the Goldman recommendation-in the article-
"Trading at around 20X 2009E free cash flow, Goldman believes Amazon stock can outperform on rising revenue if margins are only flat; RAPID REVENUE GROWTH ASSISTS FREE CASH FLOW BECAUSE AMAZON USES ITS IMPROVING CATEGORY SHARE TO NEGOTIATE LONGER PAYMENT TO SUPPLIERS in categories such as books..."
"FCF" for 2007 according to their definition (computation 1- in the article) came out to $1.181bn, as compared to (computation 2) the FCF beginning with Net Income , of $496ml a difference of $685ml.
Do you feel it is proper or fair to value this $685ml at $13bn, ($685ml x 20 = $13.7bn?) when it all vanished in the following quarter?
Two methods of computing Amazon's FCF for 2007
1) Cash Flow From Operations...........$... bn.
Less Capital Expenditure..............
Free Cash Flow.....................
2) Net Income...................
Plus Depreciation.............
Less Capital Expenditures.............
Free Cash Flow..................... ml
Difference between the formulas ......................... million
Is AMZN’s FCF from Short-term Cash held from Customers' Sales December Q, paid to suppliers in the March 2008 Q WORTH $16bn in Market Valuation??? Remember this FCF, as many classify it, is not Net Income.
Goldman put a 20 X 2009 estimated FCF, to try to justify Amazon's valuation of $34bn. (2009?)
Amazon a company that earned $1.5bn in the past 6 years, a 2007 profit of $476ml and a P/E of 60+) How can "FCF" (aside from earnings) most of which is of POOR QUALITY be given such a outrageous valuation (20X).
From the Goldman recommendation-in the article-
"Trading at around 20X 2009E free cash flow, Goldman believes Amazon stock can outperform on rising revenue if margins are only flat; RAPID REVENUE GROWTH ASSISTS FREE CASH FLOW BECAUSE AMAZON USES ITS IMPROVING CATEGORY SHARE TO NEGOTIATE LONGER PAYMENT TO SUPPLIERS in categories such as books..."
"FCF" for 2007 according to their definition (computation 1- in the article) came out to $1.181bn, as compared to (computation 2) the FCF beginning with Net Income , of $496ml a difference of $685ml.
Do you feel it is proper or fair to value this $685ml at $13bn, ($685ml x 20 = $13.7bn?) when it all vanished in the following quarter?
Two methods of computing Amazon's FCF for 2007
1) Cash Flow From Operations...........$... bn.
Less Capital Expenditure..............
Free Cash Flow.....................
2) Net Income...................
Plus Depreciation.............
Less Capital Expenditures.............
Free Cash Flow..................... ml
Is AMZN’s FCF from Short-term Cash held from Customers' Sales December Q, paid to suppliers in the March 2008 Q WORTH $16bn in Market Valuation??? Remember this FCF, as many classify it, is not Net Income.
Goldman put a 20 X 2009 estimated FCF, to try to justify Amazon's valuation of $34bn. (2009?)
Amazon a company that earned $1.5bn in the past 6 years, a 2007 profit of $476ml and a P/E of 60+) How can "FCF" (aside from earnings) most of which is of POOR QUALITY be given such a outrageous valuation (20X).
From the Goldman recommendation-in the article-
"Trading at around 20X 2009E free cash flow, Goldman believes Amazon stock can outperform on rising revenue if margins are only flat; RAPID REVENUE GROWTH ASSISTS FREE CASH FLOW BECAUSE AMAZON USES ITS IMPROVING CATEGORY SHARE TO NEGOTIATE LONGER PAYMENT TO SUPPLIERS in categories such as books..."
"FCF" for 2007 according to their definition (computation 1- in the article) came out to $1.181bn, as compared to (computation 2) the FCF beginning with Net Income , of $496ml a difference of $685ml.
Do you feel it is proper or fair to value this $685ml at $13bn, ($685ml x 20 = $13.7bn?) when it all vanished in the following quarter?
Two methods of computing Amazon's FCF for 2007
1) Cash Flow From Operations...........$... bn.
Less Capital Expenditure..............
Free Cash Flow.....................
2) Net Income...................
Plus Depreciation.............
Less Capital Expenditures.............
Free Cash Flow..................... ml
But as I reread this, I think your concern is that while an increase in A/P is in fact cash flow coming in the door, it is not FREE.
I think I see your point better. The intuition for increases in A/R and Inventory as uses of cash make sense (the owner does not have access to that cash because you have to invest in inventory and extend credit), but the intuition might be less clear with increases in A/P as a source of FREE, extractable cash to the owner.
More on that in a second, but first the topic of timing. I don't think you can just isolate on Q1 '08 as a reversal of Q4, because it cherry picks the only quarter that WC results in an outflow of cash. From a valuation perspective, I do think you need to look at it over time (i.e., it will be a big source of cash in Q2, Q3, and Q4 and negative again in Q1 '09, and for the next 4 quarters, still a big source of cash). As long as the firm continues to grow (and consensus seems to be that AMZN has a lot of runway for growth), this reduction in A/P is offset even more by increases in A/P from new business. So the "float" continually grows itself. When does it stop? When AMZN's business stops growing.
Another way to help the intuition on this: it seems like a negative CCC is akin to every day going and taking out a line of credit. But you keep paying it off all the time by taking out ever bigger lines of credit. From time to time, you can't get the bigger line, so you have to dip into your own pocketbook, but the long-run pattern is that you pay off older credit lines with newer, bigger credit lines. So on a NET basis (until growth stops), more money is coming in than going out. The excess is extractable - free, real, greenback, take-your-wife-on-a-se... cash.
I am not going to get into your point by point on how much AMZN is worth, because as I am now saying for the third time, it is just not my cup of tea and you're cherry-picking Q1 data. I'm talking about the process.
Very well put. You explain it a lot better than I. KingCPA is just repeating what he wrote in his earlier post on the exact same subject. I tried my best to explain why his ideas are wrong, but got nowhere. You can read the thread here.
seekingalpha.com/artic...
- the 'free float' advantage should be awarded a money market interest rate and valued as a separate financial asset.
- it should not be included as a cash flow from operations.
the problem with shorting AMZN is when does the market recognize this phenomenon is bogus? probably when the growth slows and the working capital advantage ceases. when does that happen? no one knows, not goldman, not bill not even AMZN itself...
You are correct that I was overly aggressive in writing "Cash is cash is cash" – I was trying to get across that cash flow is a lot closer to economic reality than GAAP, and that one cannot fault cash flow for not being the same as GAAP profits (they are inherently two different things). Cash flow figures can indeed be manipulated, but I still maintain that this is more difficult than manipulating GAAP earnings.
I agree that the benefit of negative CCC will only happen as long as they have revenue growth. But one does not need the negative days to EXPAND in order to generate FCF from WC as long as the business is growing. It appears your argument mirrors Mulford’s (I own a copy of this book) on page 137 regarding HD. Incremental improvements from the current level probably should not be counted on without strong justification. But I would also point you to page 250, where he goes through the different layers of CFFO adjustments for WC. Most of the arguments presented in the original post and responses seemed to designate AMZN’s WC changes as “layer 1,” or CFFO that warrants reversal since it is clearly non-recurring. I tend to think that given AMZN’s long history of negative CCC, it is not clear that such an adjustment is required, and if it is, it may be more appropriately classified as layer 2 or 3, which require greater care and judgment in their application.
I agree that it can be dangerous to extrapolate this out too far, but is that any more true for WC changes than revenue, COGS, or any other financial metric? There seems to be an almost visceral reaction to negative CCC such that people think it is unsustainable, and that the natural state of the world should be for it to be positive. I just don’t think the case for that point of view has been made.
Additionally, if we were to take the alternative route, how would one go about valuing the float as a financial asset?
The tricky part really is evaluating the supplier/customer relationship and who has what bargaining position over time. A possible reason why Dell's WC has reversed trend in the last 3 years might be due to their faltering market position and lack of 'power' over suppliers. If AMZN's market position becomes challenged as digital distribution of books gains populairty (and whatever else they sell -- maybe Newegg.com, Walgreens or other industry vertical players materially challenge them online), then perhaps their capacity to charge their suppliers the cost of financing their inventory expansion will ebb. Time will tell.
In terms of approaching it from a valuation standpoint, I think I would try to think about it the way a credit analyst might look at the company. I would treat the WC advantage as a source of financing or cost of debt (your obligations to your suppliers as creditors of your business). Let's say my suppliers/creditors are giving me truly 'free financing' and while my competitors get 3%/45 day terms, I am getting 3%/90 days payment terms due to my industry position advantage (also note: I don't cover retail and haven't the foggiest what actual #s should be, tho most retailers seem to operate on lines of credit/payment terms). I would probably set the cash conversion cycle to zero days, eliminating any swings in WC and the inherent negative cash conversion cycle advantage. Then I would take whatever the average net balance is over 1 year (Accounts Payable Less Accounts Receivables) and multiple it at some rate of return -- money market or what have you. At some point, if this is a credit risk the business will wind down and you will have to pay out monies owed to your suppliers. Then all you have achieved over time is the 'free float' and use of capital provided to you by the suppliers. It's what ADP does with the wages they hold on behalf of employers before their corresponding employees cash their pay checks.... they carry the cash and manage float at money market rates.
Perhaps the more intelligent way is to say, this is a going concern... it will not be wound down, so forget this credit risk perspective. But what I really have here is extremely cheap financing from my suppliers to expand my business. I have a line of credit that is cheap. Again bring the cash conversion days to 0, and attempt to eliminate the WC cash flow benefits from your FCF evaluation. But then drop your cost of capital in a DCF, by add the average Net Working Capital advantage to the remaining balance of debt in the cost of debt calc (at a rate that will obviously be very favorable). I can't remember if AMZN still has converts or what their cost of debt is excluding the WC advantage, but whatever it is... the cheap inventory financing will certainly lower the cost of debt and the total cost of capital, which then boosts the underlying equity value.
Upon further reflection, I think William Kensington's approach is too much of an accountant and not enough reflection upon the economic valued benefit that AMZN is carrying in this negative working capital scenario. It needs to be valued in some way. But I do think Bill Miller and the bulls tend to over extrapolate it though... the WC advantage isn't 'structural free and clear cash flow' in the sense that AMZN sold a book for $1.00 that cost them $0.90, plain and simple. It's borrowing ahead of time and paying back later, which gets magnified as the business ramps and then trails off as it slows or they lose their market position (as seen in their seasonality).
best regards,
-pro
Out of curiousity, I downloaded from bloomberg the cash conversion cycles for all the S&P 500 companies. Of the 500, only 69% had data (not sure why so many were missing, but whatever). Of the companies with data, 13% had negative CCC. While a distinct minority, that's still 1/8 of the investment universe (assuming it's representative) for which, at a minimum, there seems to be a lack of clarity on the best way to treat this wrinkle.
At any rate, good luck with your fund.