Is There Method In The Madness Of Jeff Bezos?

Apr 29 2014, 7:15am CDT | by

After many fruitful years, I’ve fallen out of love with Amazon.com and sold my position. Jeff Bezos has built a powerful Internet operation, but I’m convinced he’s borderline psychotic.

I do understand running a public company as if it were private, concentrating on long cycle initiatives that may remain in the investment phase for years. Why report huge profits and pay a high corporate tax rate? Let the government underwrite your startups of new ventures. Right?

Amazon’s coterie of analysts and money managers wisely held this position for years, but it’s begun to wear thin. I applaud Amazon’s Kindle trashing Barnes & Noble's electronic reader. BKS came years late to the game. But, does the smartphone sector need a new player? Amazon ain’t got the wherewithal to trash Samsung and Apple.

I accept we’re at the end of the beginning of the market’s correction of Internet properties and other rangy EBITDA stocks. Unlike 2000, this action is unlikely to precipitate a major market correction or even a mini-recession as did the paid clicks insanity of 1999-2000.

The reason is 85% of the market is fairly priced. Entire sectors like energy, financials and industrials sell at under 15 times earnings. Banks trade near net tangible assets per share while broad based industrials embracing Boeing, United Technologies, Honeywell International and Halliburton sell at the market multiple, approximately 15 times forward 12 months’ earnings power.

Stocks like LinkedIn, Salesforce.com, Twitter and many other cloud computer software houses cannot stand up to traditional security analysis. The tipoff is the tortuous rationalization undertaken by security analysts in their “buy” recommendations.

I’ve written about Salesforce.com’s enormous disparity between GAAP and non-GAAP earnings, that it’s being run for its management and sales employees in terms of stock grants and options. Shareholders get zilch in their earnings column, just outright dilution. Management (and analysts) justify this construct on the basis that this cloud software house has to build out its footprint fast as possible or lose share of market to competition. Tell it to the Marines, guys!

To Amazon’s credit none of this mufti-pufti goes on internally. Share dilution runs little more than 1%, year-over-year. I can live with $453 million a quarter stock based compensation and amortization of intangibles. Relating this amounts to Amazon’s market capitalization of $140 billion. We are talking little more than 1%.

Amazon’s balance sheet remains a powerhouse. There’s $8 billion in cash. Then, cash flow, which includes the float on its receivables, carries all the corporate initiatives into new businesses. Operating cash flow runs at more than a $5 billion annualized clip, with long-term debt around $3 billion.

Operating expenses rise year-over-year in the low twenties, comparable with Amazon’s revenue growth. It was and is forever so. How to value this Schumpeter-like beast who yearns to hose traditional retailers into near bankruptcy?

The analogy with Wal-Mart is wearing thin. Sam Walton eliminated the middleman early on. Jeff Bezos is building out his distribution centers down to 100,000 population centers for overnight delivery. Wal-Mart needs 1.2 million employees worldwide to run its business. Amazon probably can operate with a couple of hundred thousand.

Ergo, within time, assuming Amazon doesn’t give away billed merchandise, operating margins should compare favorably with Wal-Mart’s 5.6%. If you extrapolate Amazon’s revenue growth three years out and use Wal-Mart’s margin you’d have a stock selling no higher than 25 times earnings, an almost acceptable valuation for a feisty topline grower.

Amazon’s initiatives take up several pages in its quarterly report. They cover video transmission games, original television pilot programming as well as major new shopping categories which are understandable. But they are late to the game.

Why not worry that harvesting all these initiatives is indeterminable? I own Comcast. What do I need Amazon for in the home entertainment sector? Sales growth outside the U.S. is beginning to decelerate. Management’s guidance for upcoming quarters is so broad as to be worthless, actually a bad joke on Wall Street. Net sales are expected to grow between 15% and 26% with a possible operating income loss ranging between $55 million and $455 billion. Gimme a break!

Categorically, if Amazon reports just a 15% gain in second quarter revenues and a loss of $455 million, the stock will be selling closer to $200 than $300 this summer. The bulls will give up rationalizing Amazon as a great growthie.

Street rationalizations on Amazon I find downright surrealistic, bordering on wish fulfillment gobbledygook. This is invariably a good leading indicator of brewing trouble for a growth stock. I can understand the use of the price to sales yardstick just so long as there’s a gross profit line that is material. In Amazon’s case this isn’t so. Because Amazon doesn’t break out its cloud infrastructure business where it’s a leading operator there’s no way of putting a number on this business. It still seems to be in the investment phase./>/>

Using a price to gross profits extrapolation on 2015’s numbers gets some analysts to a $500 valuation for Amazon. But, who’s to say the gross profits line is high enough to overcome all Bezos’s initiatives in new businesses, even before ending the build-out in distribution centers? Somebody has to tell me when all this spending peaks. Absent a fix on the size and profitability of Amazon’s web services business it’s impossible to do a sum of the parts evaluation.

Using yardsticks like operating cash flow, free cash flow and return on invested capital are not helpful in resolving Amazon’s heady evaluation. I like the metric that the depreciation account at least covers capital spending, but in an EBITDA construct using my $6.5 billion estimate, Amazon sells at over 20 times, still a troublesome number.

Facebook is cheaper and grows faster. I’d need to see Amazon selling closer to Facebook’s 15 times EBITDA multiple a year out. Then, I’d feel comfortable that I wasn’t overpaying to see the next card face up.

Sosnoff owns personally and / or Atalanta Sosnoff Capital, LLC owns for clients the following investments cited in this commentary: Apple, Boeing, United Technologies, Honeywell International, Halliburton, Comcast and Facebook.

Follow Martin Sosnoff on Facebook. Email: mts@atalantasosnoff.com

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