Amazon Musings

“Will you choose a life of ease, or a life of service and adventure?” - Jeff Bezos

I own Amazon and I own it in size. (10%+)

The classic value investor in me can’t make logical sense of the multiples if you take them at face value. I mean what “value investor,” thinks it’s okay to own a company that is trading for a P/E over 100x? I will not sit here and tell you that I think the stock is cheap. I don’t think I will ever be able to tell you the stock is cheap.

But I didn’t buy it because I thought it was cheap. I bought it because, during the past 12 months, the odds that were offered in the marketplace felt compelling to someone who plans to hold the name for a long time. This position to me is more of “don’t be stupid” rather than “trying to be smart”

The Amazon of 5 years ago bears little resemblance to the one that sits before us today even though the share price has round-tripped. Over the same time period, revenue has doubled from $232B to $513B. Back then AWS did $25B a year in revenue, which is what the segment turns in operating profit today. They had ~650K employees compared to today’s ~1.5M.

I have heard the rule for small businesses that when you double the size of the company you break all the systems and I can’t help but feel this might be a little true here. There are probably some growing pains with all this new overhead.

Do I think they overshot to the upside when they went on a massive hiring spree, building warehouses, and spending over $100B on capex in the past two years? Probably.

I made this with MidJourney

From a strategy standpoint, I think it was the right decision given the environment at the moment.

Looking back, it’s probably accurate to say that COVID pulled the adoption curve of online retail forward by quite a bit and instead of laying off the gas they punched it and decided to go even more on the offense. While others were focusing on survival Amazon was grabbing market share. They saw it as an opportunity to grow and didn’t look back.

Doubling the size of the company in the span of 2 years is going to create a hangover. The returns on spending likely won’t materialize in year 1 or 2, but this is not anything new for a company that has a time span of 7 years on the investments they make.

Getting frustrated with Amazon about making long-term investments is like getting mad at Chik-Fil-A for not serving burgers. They never have and likely never will.

Then I have to ask myself as an owner, what would I have wanted for them to do? Move fast, maybe overshoot and be able to rein it in later down the line, or move too slow and miss the opportunity to really put more distance between them and their competition?

If I am looking at this through a long-term lens, the answer is obvious.

What is this?

Bill Miller likes to do a triangle exercise with his analysts, which I am going to do here.

Here is a company that began with selling books online and now sells over 300M products, has the largest cloud computing business in the world, a delivery network that runs about the size of UPS, and is in the early stages of building an advertising firm that looks like it will break $50B in revenue in the next year or two.

If Amazon were only a retail operation I would have found it less attractive.

Yes, it has a leading market position in online retail and the wind is at its back. The buying habits I have with the company are some strong ties.

Since I have been old enough to buy items on my own, I have had the option to either drive to the store or have it on my doorstep in 2 days. It has always been an easy decision.

On top of the time saving, there is also a subconscious trust I have that I am probably getting the best price on whatever item I am looking at. This invisible nudge guides my buying habits.

I know for a fact I am not alone with these subconscious feelings because there are more than ~145M other prime members in the US.

But at the end of the day, retail is a hard business. The base rates for margins are notoriously low and even though Amazon has little in terms of brick and mortar, there is still massive Capex needed to deliver on their promises.

Instead of “if you build it they will come” it has been “build it to go to them” and so far if measured by growth in revenue, the spending has been worth it.

If one was to put a dollar amount on saving time and money, I bet Amazon saves their loyal customers thousands of dollars a year. With these variables carrying a ton of weight, I don’t see how the retail operation can’t continue to grow for years to come. (They still have less retail revenue than Walmart)

The same can be said for AWS and Third Party Services

At the heart of all business is problem-solving and when you focus on trying to solve the hardest problems for customers you tend to naturally drift into big markets with large opportunities such as retail, IT spending, and handling logistics for SMBs.

As long as they can execute on the core tenants of saving customers’ time and money, all else will fall into place.

A wonderful business throws up great opportunities one after another. This seems to be the case here.

The retail business has well over $200B in sales, 3rd party services is over $100B, AWS is within spitting distance, and Ads that have the opportunity to touch that level, one could make an argument that the offsprings of Amazon will collectively surpass the “parent” that raised them.

When the checker flag drops of Amazon, which I don’t expect to be for decades from now, I wouldn’t be surprised to see the name with the main retail engine running with the usual margins of a good retailer in the mid-single digits. But the offspring, like cloud computing, 3rd party services, and advertising could have operating margins in the high teens to low 20s.

Retail has been the trojan horse while the services hid inside waiting to take over the city.

Some Downsides

Let’s address the elephant in the room first, the market cap of the company currently sits at ~$1.5T. If we assume a terminal value of 15x FCF then we need $100B in FCF to justify today’s price.

The closest they have come was in 2020 FCF totaled ~$30B. Then the massive investment went into Capex and we have been in the red for the past two years. But we know Amazon makes long bets and looks to reinvest into their business as much as they can. There are plenty of companies who showed negative FCF as they chased scale, Walmart and Home Depot being a few that come right to mind.

The best way I know how to track this progress is through Operating Cash Flow which on a TTM basis sits around $60B. With this reality, there is still plenty of expectations in todays price.

I am not jumping to conclusions yet but these massive investments( Capex, employees, and SBC) over the past 3 years need to put the OCF in the ballpark of $145-165B in the next 5-7 years to justify the expectations baked into today’s price.

They built a huge lever of operating leverage and we need to see them pull it.

So far, management has earned my trust with their reinvestment activities and I continue to believe they will do right by shareholders. It’s in their culture.

“We believe that a fundamental measure of our success will be the shareholder value we create over the long term. This value will be a direct result of our ability to extend and solidify our current market leadership position. The stronger our market leadership, the more powerful our economic model. Market leadership can translate directly to higher revenue, higher profitability, greater capital velocity, and correspondingly stronger returns on invested capital” - Jeff Bezos, 1997 Letter to Shareholders

Another large downside that I think about was sparked by Antonio Linares, who writes Investment Ideas, a wonderful publication if I do say so. His article on Amazon was fantastic.

In this article, Antonio writes about the demise of General Electric and how the thing that made GE great turned out to be the Achilles heel in the end.

Jack Welch, CEO at the time, was known to beat earning expectations like clockwork and this carried the stock price from $3.39 in 1990 to a peak of $250 in October of 2000.

This focus on financial performance was a huge driver for GE shareholders but also the reason behind its demise as segment heads began to commit fraudulent acts to show better financial performance so they could get promoted from within the company. Once everyone cared more about climbing the corporate ladder than actually creating value, the whole thing fell apart.

I worry about the same fate for Amazon, except instead of being the “quarterly” beat company they are the “innovator” and will be unable to fold the cards when it’s smart and the rationale is because we “make bets”.

The evidence so far to support this claim has been small. I won’t say the operation is running lean but with the recent moves from Andy Jassy, cutting the headcount, and keeping a keen eye on venture spend, I don’t see this growing into a huge problem anytime soon. It is something to keep in mind.

All in All

At the end of the day, my investment in the name rests on the track record of the company being able to:

1) Offer each customer an asymmetric value proposition

2) Reinvest their own cash flow into their operation at high rates of return

3) Spawn higher margin businesses from the launching pad of their retail operation

When it comes to my own expectations for the company, coming out of this massive Capex cycle I expect these investments to begin to bare fruit and for OCF to surpass $100B by the end of 2026. This would mean a growth rate of ~17.9% a year, I think it’s doable.

I will be keeping a keen eye on SBC and the increase in share outstanding as time goes on. They have been able to keep dilution down and I think this trend will continue, however, dilution is the silent killer among tech names like this.

To me, the best days are still ahead. There are lots of runways and plenty of capital to deploy.

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