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Amazon Is No Wal-Mart...Yet

This article is more than 10 years old.

CEO Jeff Bezos

Amazon is a case of mysterious and magical realism.  I find myself inside a coterie of near certifiable money managers and analysts who believe Amazon is a “creative destruction” operator, hell bent on transforming retailing and book publishing, and likely to emerge as the Wal-Mart of the Internet.

The Amazon story is about scale and momentum in general merchandise sales, here and abroad.  I don’t care how many Kindles they deliver or their burgeoning downloads in books, music, video games and streaming of films.  All this activity is designed to suck you into buying TV sets, washing machines, even disposable diapers and bottled water by the case.

Among big capitalization properties, Amazon is the most overpriced growth stock extant, but I’m still trying to learn to love it.  The concept is simplistic.  In an economic setting where major corporations on average can’t grow revenues more than 3 percent, Amazon compounds revenues 25 to 30 percent.

The dream is sooner or later (probably later) Amazon’s currently nonexistent profits approach Wal-Mart’s 6% operating profit margin.  The Amazon dream is taller than Harvey’s six-foot-three-inch white rabbit, but still invisible to everyone but Harvey.  It’s not impossible that Jeff Bezos is as crazy as Harvey.

But, Harvey was a charming nut job.  Bezos is at the least unfriendly.  Harvey socialized with the psychiatric staff hell bent on incarcerating him.  Bezos lusts to dismember Wal-Mart, mortally wound Best Buy’s big boxes and Barnes and Noble’s expansively homey establishments.  Best Buy shareholders should hedge themselves by going long an equal amount of Amazon, maybe even a 2-to-1 ratio.  Book publishers already have the shakes.  Twenty of Kindle’s 100 best selling titles originated from Kindle’s direct publishing authors with selling prices around three bucks a copy.

Earnings have nothing to do with the trajectory of Amazon.  Nobody, including Bezos, can project with any accuracy Amazon’s numbers.  Bezos may wake up one morning and decide he needs to be in the smart phone business.  Chalk up another billion to fund this venture.

For the June quarter, year over year, sales rose a snappy 29 percent, 32 percent before foreign exchange adjustment.  Amazon will end this year with a $60 billion revenue base, possibly levitating at a 25 percent rate.  By 2014’s end we’re looking at close to a $100 billion revenue base.  Serious money.

While all this goes on, management plays its cards close to the vest when communicating with Wall Street’s analysts who abhor any information vacuum.  There’s no guidance on gross margins, operating income and the ramping of infrastructure both in the U.S. and abroad.  This past quarter, on foreign revenues of $5.5 billion, operating income was next to nothing.  At home, $7.3 billion in revenues produced $344 million in operating income, a big increase over year ago results and fairly comparable with Wal-Mart’s 6 percent operating metric.

The multi-pronged assault on bricks and mortar retailing is relentless.  Streaming content for Amazon covers books, films, television broadcasting, games and music - worldwide.  This sector probably operates no better than break-even, an initiative aimed at consumers to log onto Amazon for all their everyday consumption as well as hard goods and apparel.

Content is a $4 billion business growing at 15 percent.  Microsoft just invested $600 million for a piece of Barnes and Noble’s E-book business, hungry for content on its MSN network.

Amazon also offers third party retailers customer order fulfillment.  This is a recurring revenue stream that should be highly profitable going forward.  Management won’t discuss the magnitude of this business as yet.

I use Wal-Mart as a template for what Amazon could look like several years out.  Wal-Mart’s revenue base quarterly runs comfortably over $100 billion, growing at an 8 percent annualized clip.  Comparable store sales growth ranges between 1 and 3 percent, depending on the state of the worldwide economic setting.

This big box giant employs over 2 million “associates”, a sobriquet Sam Walton dreamed up as an ego enhancer for his minimally paid employees.  Wal-Mart carries over 10,000 retail outlets, worldwide.  I buy my kosher franks at Mr. Sam’s, but go to Costco for 312 hearing aid batteries.

Approximately 20 percent of Wal-Mart’s revenues are consumed by operating expenses.  Here-in lurks the Amazon dream, taller than Harvey’s white rabbit and just as invisible in terms of bottom line results to all of us excepting Jeff Bezos.  Amazon employs some 70,000 spear carriers to Wal-Mart’s 2 million, a pleasing ratio considering Amazon’s revenues by yearend 2014 approach a $100 billion run rate.

Wal-Mart’s capitalization is 3.4 billion shares vs. 468 million for Amazon.  Market value for Amazon approximates $100 billion vs. $255 billion for Wal-Mart, so the market expects Amazon to keep growing at a 25 percent clip.  Wal-Mart chugs along at maybe 8 percent per annum.  According to Harvey’s buddy, Jeff, “Amazon Prime is now the best bargain in the history of shopping, capable of delivering 9 million items with free 2-day delivery.”

Let’s dream a little.  On a $100 billion revenue base, conceptually, Amazon could show $5 billion in operating earnings.  I noticed in Amazon’s June quarter’s report that their lead sentence talks about operating cash flow, not operating earnings - for obvious reasons.  Operating cash flow was $3.2 billion, but operating income totted up to just $107 million and earnings per share a coppery cent.

Analysts’ ciphering puts these numbers higher but nothing to write home about.  The typical Wall Street music sheet looks for $4.50 a share next year.  If there’s multiple compression in the e-commerce sector, Amazon is vulnerable selling at more than twice the sector’s EBITDA multiple of 11 times and over 50 times next year’s estimated earnings of $4.50.

Amazon does hold the wherewithal to soldier on.  Capital spending at a $2 billion clip is covered by their depreciation account, a non-cash charge.  There’s several billion in cash on the balance sheet for new initiatives and EBITDA should run at a $5 billion rate next year.

After stepping back from all this ciphering, I noted stock based compensation approaching $1 billion.  A fair question is does Amazon run the company for employees or shareholders?  So far, employees are winning.  Amazon is returning nothing to shareholders, merely wiping out options grants annually with sizable share buybacks.

Consider Google, where you get a 20 percent topline grower selling at 14 times earnings.  After digesting all the implications of Amazon’s second quarter, I went out and added to my Google holdings.

For contrast, I looked at General Motors, selling around 6 times earnings and under 3 times enterprise value, now a tightly run ship commanded by Dan Akerson.  For me, the pivotal GM variable is market share.  Consumer Reports highest ratings are crowded with Japanese models, and there’s no sign of change.  The problem with GM is Toyota and Honda.  GM fights to keep its U.S. market share at 18 percent.  Nobody cares that they have $33 billion in liquid assets doing nothing.

If Amazon is not Jeff Bezos’s white rabbit, he’s got to deliver $5 billion in operating income 3 years out.  Using a 25 percent tax rate, this translates to $3.75 billion in earnings.  I assume a share base of 500 million so we’re talking about $7.50 a share.  On these numbers Amazon would sell at over 25 times earnings.

Face the facts.  Amazon remains an enticing luxury in an unforgiving market that doesn’t tolerate luxuries forever.  But, a few years ago Amazon sold at $44 and GM needed a U.S. Treasury bailout.  I thought Amazon was as pricey then as now.

Someday, I’ll get it right, but I’m not dumping my GM to buy more Amazon.

 

Martin T. Sosnoff is chairman and founder of Atalanta Sosnoff Capital, LLC, an investment management company with $6 billion in assets under management. Sosnoff has published two books about his experiences on Wall Street, Humble on Wall Street and Silent Investor, Silent Loser.  He was a columnist for many years at Forbes Magazine and for three years at The New York Post.  Sosnoff owns personally and / or Atalanta Sosnoff Capital owns for clients the following investments cited in this commentary: Amazon, Wal-Mart, Microsoft, Google and General Motors.

 

Martin Sosnoff : mts@atalantasosnoff.com