Thursday, January 28, 2010

AMZN's Rose Colored Glasses

Do you remember those guys in high school who could get away with anything because they were popular? I do. And I'm not bitter about it. Really! I'M NOT.

Well, Amazon.com (AMZN) is so popular that they can get away with anything... and they know it.

How else can you explain the most recent quarterly earnings report?

Here are the first couple of lines in the release:

Operating cash flow was $3.29 billion in 2009, compared with $1.70 billion in 2008. Free cash flow increased 114% to $2.92 billion in 2009, compared with $1.36 billion in 2008.

Common shares outstanding plus shares underlying stock-based awards outstanding totaled 461 million on December 31, 2009, compared with 446 million a year ago.

With a $55 billion market value (round numbers please), Amazon is trading at a very reasonable 19 times free cash flow. Given their torrid growth, this is downright cheap. Heck, I've been wrong about Amazon! They aren't overvalued. My bad.

But wait just a minute. 2009 reported earnings are $902 million. For a backward-looking price-to-earnings multiple of 61.

Major differences between cash flow and reported earnings is a huge red flag... or it used to be. Do we have a difference set of rules for Amazon?

Net income is up 39.8 percent year-over-year, but operating cash flow is up 94 percent? And free cash flow is up 114%? With each successive number, the burden of proof gets higher. Is that red flag going up yet?

What accounts for the differences? Huge increases in current liabilities that may (or may not) be temporary. Accounts payable increased $1.8 billion alone. String out one big supplier to the tune of $1.8 billion and (whammo) you triple your "free" cash flow... until the bill comes due.

Profit and free cash flow should be pretty close at Amazon, especially since depreciation and capex match up pretty closely. In fact, they are almost identical.
2009 Depreciation of fixed assets, including internal-use software and website development, and other amortization = $378 million

2009 Purchases of fixed assets, including internal-use software and website development = $373 million
This $5 million difference isn't material.

At the very least, the deviation in net profit and free cash flow are cause for further investigation. Is anyone doing it?

Given Amazon's growth, one should expect free cash flow to trail profits because of rising receivables and inventories. In fact, they did rise and have been for several years. Increases in inventories and accounts receivable used $531 million and $481 million respectively in 2009, a $1 billion hit to reported free cash flow. This makes the huge reported gain in free cash flow year-over-year all the more suspect.

Why is Amazon touting these (misleading-at-best) numbers in LINE 1 of the release? Because they assume nobody is going to dig deeper and be skeptical.

Did anyone even read the report? (Be among the few, the proud... here's the link.)

No, people saw that headline about revenue growth (SALES UP 42%) and fell in love all over again. Oh, and don't forget the buyback.

CNBC is gushing over the buyback! $2 billion.

But what about the increase in shares outstanding mentioned above? Year-over-year shares outstanding are up 16 million shares, probably due to employee stock options.

The current market value of those dilutive shares? $2 billion.

You can't make this stuff up.

So did Amazon shareholders get the benefit of any of the $900 million in profits last year? It's a philosophical question. Rhetorical really.

I say "no". Yes, the stock is up. Everyone loves Amazon. But I thought these kinds of earnings releases died with the Internet Bubble. Apparently not.

For those of you who are long Amazon, keep those rose-colored glasses on. You'll need 'em if you read the earnings release.

Disclosure: No position.

4 comments:

  1. At least I remember there was an article questioning Amazon's accounts payable on marketwatch after Q3 earnings. If you can squeeze suppliers permanently, then that will be OK. So we have to wait and see. But it's really not good to repurchase shares at such a high price, actually decreasing shareholder value. Do you agree?

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  2. I'm not very familiar with Amazon practices; but don't they have to differ the Kindle revenues and costs?
    Wouldn't they have an artificially low revenue but cash going in anyway and the liabilities being the deferred revenue/
    Just a theory.....

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  3. The increase in payables and other current liabilities is NOT a result of permanently squeezing suppliers. But I agree it is a good thing if a company CAN do that.

    I agree with you that repurchasing Amazon shares at this level (for whatever reason) is not good for shareholders. But the options already destroyed the wealth. The repurchase would just make that destruction worse (and more explicit).

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  4. Companies do capitalize costs and defer revenues. Don't think that is the case with Kindle and in any case, it does not affect the situation I am addressing in the article. But I appreciate the constructive feedback very much.

    I should learn not to write about this company. You should see the "hate" mail.

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