I don’t post on specific stocks very often but today I offer a guest post from Leah Grace Capitan who blogs on technology, retailing and fashion at Quiddity. Leah’s piece on Amazon’s acquisition of Twitch is thoughtful and provocative on this beloved stock selling at a 3-digit P/E ratio and at 15x book value when ROE is barely positive.
Amazon has been unprofitable for years. In a 1997 interview with Inc., Jeff Bezos said:
“We’re going to be unprofitable for a long time. And that’s our strategy.”
Image from International Business Times
Bezo’s long-term view does not equal profits
Kudos on Bezos for such a long term view: always make customers happy, earn their trust, get their business, and offer them even more business beyond what you were originally offering. Investors are more than happy to buy Amazon stock at P/E multiples of hundred times earnings, betting that Amazon’s constant reinvestment and foregoing of profits will allow the company to capture the biggest slice of the retail pie, with e-commerce only set to increase over the years. In 2013, US retail sales reached $4.5 Trillion with e-commerce accounting for 8% of that number. In 2nd quarter of 2014, e-commerce sales accounted for 6.4% of total retail sales.
This strategy comes with a huge price of multi-million dollar acquisitions and infrastructure investments to constantly be ahead of logistics technologies. In the spirit of building new business lines to always keep customers within the Amazon umbrella, the company entered hardware with the Kindle readers and most recently the Kindle Fire Phone, offering these devices at cost and making money with e-book purchases.
Is Amazon Prime past its prime?
As a fervent Amazon Prime member, I can attest to being a very satisfied customer and perfectly willing to pay the recent Prime price hike. Two-day shipping that spans beyond Amazon.com (Prime shipping includes Shopbop.com), excellent customer service, easy payments (Amazon payments can also be used at Diapers.com) and for a long time, tax free purchases. Being a Prime member also meant that I get free access to a selection of Prime videos and e-books.
I have certainly been a great believer in Amazon’s long-term and dominant strategy but I have been having doubts lately. The shopping differentiations that I mentioned as a customer are being whittled down by increased competition from other retailers, new services (eg. Shoprunner which offers 2-day shipping in partnership with hundreds of online stores ) and a lobby to abolish the Internet sales tax loophole. Since May 2014, Amazon started charging sales tax in Florida for example.
To add to all these, Amazon seems to be on a roll of fighting with its suppliers – its fight against book publisher Hachette has yet to be resolved, canceling pre-orders of books from Hachette. Already, the company is in the middle of a dispute with another supplier, Disney; again restricting DVD pre-orders from the supplier.
Amazon’s investments in hardware and digital media content add more costs
Beyond these examples focused on Amazon’s e-commerce portal, I question Amazon’s investments in hardware and content offerings. I am not a believer of the Kindle Fire Phone. It is a cool gadget, yes, but imagine the resources that Bezos spent on developing a device that many consider to be a flop – resources that he could have used elsewhere.
Then, there’s Amazon original programming. The company’s last quarter report ending June 30, 2014 showed worldwide revenues of $19.34B. To get this seemingly impressive revenue, Amazon had to spend $19.3B (Cost of sales at $13.4B and SG&A expenses at $5.93B). The quarterly report was vague on how much the company spent on original programming but they do attribute theincreased cost of sales to digital media content.* And the company is far from finished.
This week on August 25, 2014, Amazon bought game-streaming site Twitch after Google/YouTube failed to close the deal. At $970M in cash, the acquisition must surely be hurting Amazon’s cash flow. At least with Twitch, users are the ones who upload the content and with 45 million viewers watching 13B minutes of gaming a month, Amazon reaches a broad, new audience to peddle gaming hardware and software.
Is Amazon losing its focus?
Despite the massive size of Google, its acquisitions and its projects have almost always been aligned with its business model: ads. Build Gmail, Chrome and Maps, offer it for free, serve ads, accumulate data to make those ads even more relevant. Build a driverless car so people can spend more time online; expose them to ads. Buy a satellite company for an even better Maps experience and improve Internet access. Some moves are longer term view than others but they somehow still make sense.
Amazon is blurring the lines between its core business model and new business lines that bolster the core. Amazon means (or maybe meant) e-commerce. The argument with its hardware investments is that they enable customers to shop at Amazon. A new business line such as Amazon Web Services makes sense because Amazon has gotten so good at managing its infrastructure, they might as well offer the service to other companies as well.
Supposedly with the Twitch acquisition, Amazon can take a cut from video game revenues, serve ads, and help Amazon with digital content. But that’s precisely it. I struggle to understand Amazon’s drive for content, rather than remaining as a platform for content. The only thing I can think of is this: offer content to attract customers to Amazon Instant Video and thus pay $100 for Amazon Prime. For a cost that is estimated to reach a billion this year, that’s a very expensive customer acquisition strategy. After all, Amazon already executed a major coup with its multi-year agreement with HBO – the first time HBO content is streamed legally. This alone can already steal customers from Netflix or Hulu and attract a slew of new Amazon Primers. So what gives?
Apple, Google, Facebook and Amazon each want to be THE platform for our lives
The interactions we have with companies like Apple, Google and Facebook are almost constant and continuous. If you have an iPhone/iPad/iWhatever, Apple will work hard to keep you within its walled gardens – iTunes, iCloud, iMessage, etc. Google might be more “open,” but being that it canscan your email and access your web searches, they don’t need to work hard to keep you in. Facebook is the go-to for interacting with friends or almost-friends online for an average of 40 minutes a day, according to Facebook.
But unless you have a problem, shopping is not something you do every minute of everyday. If being THE platform is Amazon’s play then it needs to catch up. The company needs to find a place to engage customers constantly and they may have found it in video content. Nielsenreported in June 2014 that video on demand (VOD) users watch 20% more live TV than non-VOD users; Americans already watch over 5 hours of traditional television per day. Meanwhile, gamers spend an average of 22 hours a week playing video games. These are big chunks out of customers’ lives and Amazon is willing to pay to be a part of that. The question is: how long before investors start balking and lose faith in Bezos’ long-term view?
*This was originally inspired by a blog post here.
I am truly fascinated by GOOG and AMZN, two really fabulous companies that are constantly so meaningfully impacting our lives. A substantial part of the productivity gains of the past 2 decades originate from these two companies.
Dealing with their market valuations is not simple but here’s a quick comparison of both companies since 2005 with the help of CPMS/Morningstar charts:
SALES PER SHARE: Since 2004, AMZN: +10.4x; GOOG: +18.6x. Since 2012: AMZN: +27.4%; GOOG: +42%.
EARNINGS PER SHARE: Since 2004, AMZN: –56%; GOOG: +22.4x. Since 2012: AMZN: -28%; GOOG: +19%.
CASHFLOW PER SHARE: Since 2004, AMZN: +11.4x; GOOG: +15.5x. Since 2012: AMZN: +77%; GOOG: +27%.
P/E RATIOS: AMZN: 100x+; GOOG: 29x.
P/CF RATIOS: AMZN: 34x; GOOG: 20x.
P/S RATIOS: AMZN: 2.1x; GOOG: 6.2x. Interesting to see that AMZN’s P/S ratio has been fairly stable since 2010, ranging between 1.7x and 2.6x and is currently right in the middle. GOOG’s P/S ranged between 4.8x and 7.0x and has been trending up since 2012.
NET PROFIT MARGINS: Price to Sales ratios are meaningless if not accompanied by an analysis of profit margins. AMZN: 2.0% earnings margin, pretty flat since 2012; GOOG: 21%, down from 32% in 2011. Have they finally stabilized? (The dot on the chart is the consensus forecast). Now you know why GOOG’s P/S ratio is not out of line compared with AMZN’s. Each dollar of GOOG’s revenue is clearly worth a lot more than AMZN’s.
CASHFLOW MARGINS: Also significant when interpreting Price to Sales: AMZN: 6%, up from 4% in 2013 but down from 7% in 2010; GOOG: 31%, stable since 2013 at the low end of their 7-year range. Each dollar od revenues generates $0.31 of cash flow at GOOG, $0.06 at AMZN.
If I had to pick one, I’d go GOOG. In retailing, the tough part is not to produce sales, it’s to be consistently profitable. AMZN’s ROE has stabilized near zero. Will Bezos be able to transform its cash flow into earnings without raising prices? But also importantly, will GOOG be able to arrest the decline in its ROE. Fifteen percent ROE is good, but certainly not great for a growth company selling at 4x Book.
That said, do you prefer AMZN’s stock at 15x Book?
Full disclosure: Leah is our daughter-in-law. Apart from being a smart and skilful blogger, she is an astute fashion analyst and an accomplished and tech-savvy shopper. Her blog is well worth following.