I know, I know, I previously announced I was done writing articles, especially about Amazon (NASDAQ:AMZN). And I meant it - I really thought there was no way for me to put pen to paper ever again. But the recent developments at Amazon have been spectacular, and have compelled me to break my vow. Let's take a look at recent events, keeping in mind that the stock is down 20% year-to-date in a market that continues to make all-time highs.
Watch What We Do Next
Recall that in the third quarter conference call (yes, the one where Amazon announced operating losses of half a billion dollars), CFO Tom Szkutak gave us this memorable quote:
"…from a looking forward standpoint we still think that we have a lot of opportunities. That said, we need to be very selective about what opportunities we pursue…"
That was a very responsible statement from Mr. Szkutak. It sounded a note of caution, indicating Amazon realized it must do a better job of evaluating and pursuing targeted opportunities that have a greater chance of success. We like companies that take well thought out risks in hopes of generating massive profits in the future. Let's take a look at what has transpired since:
- October 27 - Amazon buys Rooftop Media, an online comedy service
- October 27 - Amazon launches $39 Fire TV stick (a good idea)
- November 6 - Amazon announces Echo, a personal assistant/speaker that must be plugged into an outlet (a not so good idea in today's mobile world)
- November 11 - Amazon announces 6 new comedy and drama pilots (can't wait for the Emmy nominations)
- November 15 - Tom Szkutak sells his newly vested Amazon shares for $1 million; other Amazon executives also sell (don't be alarmed, this happens every quarter)
- November 20 - Amazon rumored to be starting an online travel service
- November 20 - Amazon signs lease for 470K sq. ft. of NYC real estate across from the Empire State Building (Lord knows what it will be used for, Amazon says it is not for a store)
- November 21 - NY Post reports Amazon will launch an ad supported streaming service (Amazon has not confirmed)
- November 26 - Amazon rumored to be interested in acquiring Indian retailer Jabong
- November 28 - Amazon launches marketplace for service providers (this one makes sense, to install large appliances purchased from Amazon)
- November 28 - Reported that Amazon will open a large London photography studio
- December 4 - Amazon announces Amazon Elements, a products division that launches with Amazon branded diapers and baby wipes
That is one busy month. I leave to your judgment whether this is what being "very selective about opportunities" looks like.
If you want someone to tell it like it is, look no further than Amazon CEO Jeff Bezos. During an interview on December 2 at a Business Insider conference, Jeff Bezos laid it down:
"If your gonna take bold bets, they're going to be experiments, and if they're experiments, you don't know ahead of time whether they're going to work. Experiments are by their very nature prone to failure…A few big successes compensate for dozens and dozens of things that didn't work."
For all the criticisms leveled at Jeff Bezos this year, one thing detractors can't deny is that he has been very forthcoming in his strategy. Amazon doesn't want to be very selective in its bets. It wants to make dozens and dozens of bets, looking for one or two to hit it big. One would think that there is more sophistication to Amazon's approach than going to the roulette table and spreading the chips around on a lot of different numbers. But Bezos is very clear here: these are bets and the vast majority of them will fail.
After placing all these bets, what happens if you don't get one or two big winners?
Time to Raise Some Cash
Amazon bears (myself included) have warned that the company would have to raise additional cash within a year. The evidence was in the rapidly deteriorating balance sheet, deteriorating free cash flow, and the increasing amount of lease commitments the company has made as it continues to expand into areas that have yet to bear fruit (i.e. bets that have yet to pan out). These warnings became reality last week when Amazon announced they were raising $6 billion in new debt, the company's largest debt offering ever, with an average interest rate of 4%. The 4% rate is considerably above market.
Those familiar with my writing know that I do not believe in coincidences when it comes to Amazon announcements. So I was not surprised that Bezos sat down for an interview (with a company he holds an equity stake in) on the same day that Amazon bonds were being sold. The last time we saw Bezos he was on a truck in India talking about how Amazon was going to invest $2 billion in the Indian market. Turns out it was $2 billion dollars he did not yet have (but again, bears previously told you this).
What I am not sure about is if the amount of the bond issuance was in any way influenced by the results of Black Friday and Cyber Monday. Perhaps there is no correlation, but Cyber Monday was December 1st, and the new debt offering was announced on December 2nd. Feel free to draw your own conclusions on what good or poor initial holiday sales may have meant to the amount of cash raised.
Six billion dollars is a lot of money. But just how much depends on how you look at it. It represents a mere 4.1% of Amazon's $145 billion market cap as of this writing. That is not an alarming figure. However:
- It is equal to three times the cumulative profits of Amazon over its entire 20 year history
- It is equal to 86% of Amazon's tangible book value reported at the end of Q3
- It will raise total long term debt to $11 billion
- It will cost $240 million per year in additional interest expense
Of these, the second bullet is what really grabs my attention. Yes, Amazon's tangible book value (when stripping out $3.3 billion in intangible assets such as goodwill) is a mere $7 billion dollars. To this, Amazon is adding $6 billion in new debt. That is a very sizeable increase in leverage, and requires a great deal of faith that the new funds will produce outsized returns. Yet based on the profits returned by Amazon over its entire history, and trailing twelve month losses, there is no evidence that Bezos and his team will produce these results. That is what makes the new leverage Amazon's most brazen bet ever. It is increasing the company's debt to new heights, at above market rates, as the company searches for one or two winning bets to make it all worthwhile.
Any Word From the Analysts?
As of this writing, there have been no changes in Amazon price targets from any of the major analysts. No word from Justin Post at Bank of America, who reaffirmed his buy rating on the stock with a $390 (a $180 billion market cap) price target back on October 10th. No word from Katy Huberty at Morgan Stanley, who initiated coverage on Amazon with a buy and a price target of $420 (a $194 billion market cap). One would think that a large bond offering coming with $240 million in additional interest payments would necessitate a need for analysts to at least revisit their next year EPS numbers, but we haven't seen anything yet.
And yes, I point out Bank of America and Morgan Stanley specifically since they were both major book runners for the new bond offering (Bank of America owns Merrill Lynch). Oh, and Bank of America also granted Amazon a $2 billion line of credit back in September.
Time Will Tell
Over time we will see if Amazon utilizes its new debt to create outsized returns. The bull and bear theses have not changed. Bulls believe that Amazon continues to invest for the future, and once it achieves the future it desires, profits will rain from the sky. Bears believe the company is taking increasingly large bets on low margin initiatives that will result in at best minimal profits or at worst far greater losses.
I'm still in the bear camp.
Disclosure: The author is short AMZN.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.