Wednesday, February 8, 2012

Barron's on Bezos: Time to Rein in Amazon's CEO?

According to Barron's it is.

From this recent Barron's article on Amazon (AMZN):

Amazon has spent like a drunken sailor in the name of innovation, expansion and increased market share.

True believers in the company, at least up to now, have overlooked weaker profit growth as long as the revenue growth continues.

Bezos Gets a "Hall Pass"
"The market has always given Jeff Bezos a hall pass on margin erosion," says Larry Haverty, associate portfolio manager of the closed-end Gabelli Multimedia Trust, which owns a small stake in Amazon. "In this case, it seems that anything that Jeff wants to do, he has a license to do. Will investors ever take the hall pass away?"

Barron's: It's Time to Rein In Bezos

Some fans of the company's stock seem to argue that it is Amazon's superb free cash flow justifies the extreme valuation.

The problem with that is growth in accounts payable makes up a large portion of the company's operating cash flow. It's growth financed (at least in part) by vendors. That may be a good source of "float" (zero-cost financing) and a sound working capital model, but it shouldn't be considered high-quality operating free cash flow. Adjust for the impact of accounts payable growth, subtract CapEx, and it becomes clear that the company's free cash flow has been unimpressive (and I'm being kind here) over the past three years and is certainly not improving.

More from the Barron's article:

"Low Quality" Cash Flow
IN ESSENCE, AMAZON IS THROWING OFF "low-quality" cash flow, which makes it difficult to justify the high price of the shares—even after last week's drop, Haverty argues. 

The article also compares Amazon's extreme price to earnings to Apple's (AAPL) rather modest valuation on that basis.

Apple earned much more money last quarter than Amazon has earned in total over the 17 years that it has been in business. Of course, Amazon didn't become profitable until 2003. So, to be fair, let's not include the early unprofitable years. Instead, let's add Amazon's last nine years* of positive earnings together then compare that total to Apple's most recent quarter. Do that math and it turns out Apple earned in roughly 35 days last quarter what Amazon earned in all of its nine profitable years added together (yeah, that's right).

The article goes on to make the following points:

- Jeff Bezos has always believed in expansion regardless of cost.

- Investors shouldn't expect Bezos to change after 17 years on the job.

I'd add that shares outstanding have grown by well over 20% in the past decade.

It goes without saying that Amazon is a very significant and successful company. The success is born, in part, from shareholders willing to accept modest profits now with an eye toward a promising future.

A long-term view by management is a very good thing. As is a long-term view by investors. Still, investing all comes down to whether the price paid provides an acceptable risk-adjusted return.

Will those who have paid recent prices (and even quite a bit lower) get sufficiently compensated on a long-term risk-adjusted return basis relative to well understood alternatives?

Others may be able to figure that out.

Not I.

Check out the full Barron's article.


No position in AMZN; long position in AAPL

Related posts:
Amazon's Jeff Bezos On Inventing & Disrupting
Amazon Sells Kindle Fire Below Cost
Technology Stocks

* From 2003-2011. Amazon lost money in all previous years so adding in any other year would only make the comparison worse.
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