10/4/2016

ValueInvestorsClub/AMAZON.COMINC(AMZN)

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AMAZON.COM INC AMZN

August 04, 2016 by mike126
Price:
754.64
Shares Out. (in M):
474
Market Cap (in M): 357,755
Net Debt (in M):
5,959
TEV:
363

2016 2017
EPS
0
0
P/E
0
0
P/FCF
0
0
EBIT
0
0
TEV/EBIT
0
0

Description
IbelievethatthestockofAmazonisoneofthemostattractiverisk/rewardsinthemarkettoday.Overthelong
run,Amazonequityislikelytoa)preservevalue,b)deliveranattractiverelativereturnoverthemarket,andc)
deliverapositiveabsoluterealreturninexcessofinflation.Asaresult,thisisoneofmycoreholdings.

ManyVICreaderswillbefamiliarwiththebusinessgivenitssteadilygrowingmarketcapandmediacoverage,
aswellassomeexcellentpriordiscussiononVIC,particularlythe2011writeupbytrev62.SoIwilljumpright
intothemeatofmythesis,Q&Astyle.

ItfeelsoddtoinvestinAmazonatatimewhenthemarket'sbullishnessandacceptanceofAmazon
hasneverbeenhigher.Whynow?

Iconcurthatthesellsideisgenerallypositive.Thecompanyiscoveredbyover40sellsideanalysts,the
majorityofwhomratethestocka'Buy'.Iamnotawareofanynotable'Sell'recommendationsorsellside
bearsthathavebeenvocalrecently.Havingsaidallthat,Imodestlyproposemyviewthatthebuysideismuch
moresceptical.Severalhighprofileinvestorsareshort(orwererecentlyshort)thestock.Andinmyownlife,I
haveexperiencedmorenegativereactionsfromtherevelationthatIownthestockofAmazonthanpositive
ones,inmyinteractionswithotherinvestors.Soifoneisfocusedpurelyonsentiment,itfeelsthatsentiment
hasfurthertorun.

GivenAmazon'sfailuretoproducemeaningfulnetincome,isthevaluationnotbubbletastic?Whynot
shortAmazoninstead?

Sinceitsfounding,thebusinesshasproducedagrandtotalof$4bcumulativeGAAPnetincome.Yes,this
looksbadonthesurface.Atthisjunctureinourconversation,Icouldfollowtheclassic'IlikeAmazon'lineof
thoughtandextolthevirtueofgrowthandhowthebusinessisaggressivelyreinvestingtomaximiselongrun
freecashflow.Iwillnotdothatjustnow,eventhoughIbuythatargument.Instead,Iwouldliketoproposethe
followingthoughtexperiment.CallitaMungerstyleinversion,ifyouwill.
ImaginethattomorrowyouwokeuptoacrazynewstateoftheworldwhereJeffBezoshasasuddenchange
ofheartanddecidesthatfromnowon,his#1priorityistoachievesalesgrowthbroadlyinlinewithGDPandno
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faster,andthathevaluesneartermGAAPnetprofitsandneartermfreecashflowmuchmorethanhedoes
distantGAAPnetprofitsanddistantfreecashflow.Beforewedothat,herearetheactualLTMJun'16
numbers:

Sales$120.6b
Grossprofit$41.5b(34.4%margin)
EBITDA$10.3b(8.5%margin)
GAAPEBIT$3.9b(3.2%margin)
GAAPnetincome$1.9b(1.6%margin)

SoonceBezoshasthischangeofheart,suspendyourdisbeliefforamomentandsimplyimaginethatBezos
nowdoesthefollowing:

hecutsthemarketingexpensetoabout$2bannualizedfrom$6bannualizedtoday,sotheincrementalPrime
membersandplatformsellersareexpectedtocomeviamainlywordofmouth.TheKindleadvertsthatyou
seeonthemetroortheFireStickadvertsthatyouseealongsideCocaColapromoclipsnexttimeyougoto
themovies?Gone.AlltheoutreachthatAmazonisdoinginIndia,crisscrossingthecountrytosignupnew
vendors?Poof,gone.

hecutscontent(mainlyAmazonVideo)andtechnology(mainlyAWS,possiblyalsosomedroneR&Dandthe
like)spendingfrom$15bannualizedto$8b.NoaggressiveadditionsofAWSavailabilityzones,andnolonger
anambitiontosharplyincreaseAmazon'shoursoforiginalcontenttobetterfeedtheAmazonPrimeflywheelof
customerloyalty.Ofcourse,thisalsomeansacurtailmentofAmazon'sambitiontocompetewithNetflix.

hebeginstoexploitthecompany'sstrongecommercemarketshareandtheassociatednetworkeffects,and
unilaterallyupsAmazon'stakerateonboth1Pand3Prelationships.Onaverysimplebasis,wecanimagine
thatthecompany'sexAWSgrossmarginincreasesfrom30%todayto34%.Onanannualizedbasis,that'san
extra$5bofincometoAmazon

Nettingallofthisoff,annualizedGAAPnetincomejumpsfrom$2btodaytoa$18bproformafigure,which
roughlymakesthisa20xP/ELTMstock.Ofcourse,futuretransactionandusergrowthwilltailoffsomewhat.
Thisimaginaryvaluationwouldlooklikea'bargain'tomerelativeto,say,HomeDepot(24xP/ELTM)or
Costco(31xP/ELTM).AndevenifBezosdidallthesemoves,canyoureallyimagineAmazongrowingat
merely'withGDP'rates?Ifthishypothetical,alternativeuniverseAmazonwasfreelytradeableinthemarket
tomorrowatthatprice,wouldIpaythatprice?Youbet.It'snot10xtrailingearnings,butstill,Iwouldbebuying
alldaylong.

Theaimofthisexercisethatwejustwalkedthroughtogetherisselfevident:itistohighlightthepowerful
economicsofthebusinessandtoreiteratethatcontrarytowhatyoumayhearfrommostfolks,thevaluationis
notbubbletastic.Atleast,notyet.Atsomepoint,themarketwillswingthependulumtoofarintoridiculously
optimisticterritory,butmyhumbleassertionisthatwearestillratherfarfromthat.

(Consideralsothefactthatsince2000,Amazon'snumberofsharesoutstandingonlygrewby1.8%p.a.,arate
thatrecentlyslowedto1.2%.Amazonoccasionallyrepurchasessomestock,too).

Can'tbusinesseswithmeaningfullogisticsandwarehousingassetscatchuptoorputpressureon
Amazon'sgrowthormarginsintheecommercedivision?Forinstance,whataboutWalMart?
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IfullyexpectplayerssuchasWalMarttoactintheirownlongtermrationalselfinterestandtherefore
aggressivelyinvestintheirecommerceandonlinedeliverycapabilities.IfwetaketheUSforexample,Iexpect
WalMarttobecomeanincreasingcompetitiveforcetoAmazon.IsayWalMartbecauseIperceiveWalMart's
brand,storelocationsandlogisticsnetworkasthemostformidableamongthelargebrick&mortarretail
groups.

Forinstance,researchfromMWPVLpegsAmazon'sUSlogisticsnetworkat180facilitieswithasquare
footageofsomewherebetween71.5and112million.WalMart(includingSam'sClub)has166facilitieswith
124.2millionsquarefeet,inadditionto5,280retailunits(779millionsquarefeet).IfWalMartdecidedthate
commerceisits#1priority,itishardtodenythatithastherealestateandrawlogisticalbasetoseriously
competewithAmazon.ButIdonotperceivethiscomingcompetitivetussleassufficienttoformacompelling
Amazonbearcase.Why?First,lessthan10%ofUSretailsalesareInternetbased(perUSDepartmentof
CommercedataforFY15).IfweassumeforasecondthattheaggregateamountofphysicalstuffthatUS
householdsconsumestaysrelativelyconstant,thenitfeelsthatthereisstillsignificantroomforgrowthinthe
entireecommercemarketsimplyfromsubstitutiontoecommerce.Ifwelookatitanotherway,theshareof
totalpopulationthatshopsonlineintheUSisconsistently510percentagepointsbehindUKanddeveloped
EuropeanmarketssuchasGermanyandSweden.And,thereisnoshortageofstatisticsforindividual
consumerspendingsegmentssuggestinghugeupside,e.g.arecentGoldmannoteestimatedthatonly2%of
consumeressentialsarepurchasedonline.So,ingeneral,Iexpectthatthegrowthofthetotalecommerce
marketwillsomewhatrelievethecompetitivepressuresthatAmazonwillcomeunderasplayerssuchasWal
Martgetuptospeed.

Weliveinratherunprecedentedtimes.WhereisthelimittoUSshareofretailsalesfromtheInternet?Isit
20%?30%?Itisdifficulttosay.Butitishardtodenythatseculargrowthfromhereispowerful,andthisis
certainlyamarketyouwanttobeinifyoucanbuildscale.Onafundamentallevel,theadvantagesthate
commerceconferstothecustomerarerobust.There'schoiceandeaseofcomparison,butonereallyunder
discussedelementistime.Buyingonlinesavesyoutime.Inaworldofincreasingdistractions(Facebook,
Twitter,Instagram,email,etc)andincreasedsocialcompetition,timeisbecomingmorevaluable.Andthe
squeezedworkingandmiddleclasseswhoincreasinglyhavetosupplementtheirmainjobswithearningsfrom
freelancegigs(fromsellinghomemadegoodsonEtsytoproofingCVsonFiverrandcodingwebsiteson
Odesk,allthewaytoUber)arevaluingtimeevermore.Andforthosefortunateenoughtohavebetterpaying
jobs,atthemarginthedelugeofleisuretimeoptionsattheirdisposal(explosionofcompellingTVand
Netflix/Amazonshowsbeingagoodexample)furtherincreasesaperson'ssubjectiveassessmentoftime's
worth.Allthiswillcontinuetoactinfavourofonlineretail.

Andifwepeeltheoniononelayerfurther,IfinditdifficulttobelievethatplayerssuchasWalMartwillbeable
toquicklyreplicatetheincreasinglycompellingdealthatAmazonoffersUScustomersviaPrime.Notonlydo
yougetfastshipping,butyougetoriginalvideocontent,music,andtheKindlebooklending.Youalsogetvery
goodcustomerservice.SoIexpectthatAmazonwillcontinuetooccupyadecentshareofthemarket.Andall
oftheabovepaintsalsodirectionallyapplytotheothermajormarketswhereAmazonisaforce,suchas
GermanyandtheUK.

AWShasfuelledmuchofthemarket'srecentexcitementoverAmazon.Shouldn'tonebeworried
aboutincreasingcompetitionfromMicrosoft,Google,IBMandothers?WhatisAmazon'smoatin
AWS?

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First,Iwilllayoutsomenumbers.

AWSannualizedsalesrunrate:$11.5b
Microsoftcloudannualizedsalesrunrate:around$10b
Googlecloudannualizedsalesrunrate:around$12b
IBMcloudannualizedsalesrunrate:around$12b
Globalcommercialsoftwarespending(fromGartner):$3,536b,ofwhich$940bisfromITServices(including
cloud)

IconcurthatAWSwillrunintoincreasinglyintensecompetition.Fromasales,technicalandpricing
perspective,thegapbetweenthemainofferingsonthemarketisnotthatbig,inmyunderstanding.ButI
believethatthetotalmarketopportunityistremendous.Forinstance,justthedisasterrecoverysegmentofIT
spendclocksat$90100b,only10%ofwhichiscurrentlyinthecloud.Thegeneralnumberofinhouseand
outsourcedITconsultantsemployedbybigcorporationstendstobeneedlesslyhigh.Onthebackofthis,prior
totheadventofthecloud,countlesstechentrepreneursanddozensoftechcorporationsextractedenormous
economicrentandbuiltvastpersonalfortunes.AWSisnowrapidlybuildingscaleanddisruptingthatmarket,
transferringaportionoftheeconomicrentpreviouslycapturedbytheITvendors&consultantsbacktotheCIO.
Anewplayer(suchasAWS)eventuallyemergingandstartingtodothiswasinevitable.Thattheincumbents
andotherswouldnoticeandgraduallyadaptwasalsoinevitable.

SimilartotheargumentthatIhavemadewithecommerce,IexpectAWStoholdadecentshareofthis
attractiveandgrowingmarket,thoughIdoexpectmargingrowthheretofindaplateausomewhatfasterthanin
ecommerceduetothecloudmarket'sgreatercompetitivedynamism.Inanycase,fromspeakingtostartup
foundersandventurecapitalists,itisclearthatAWSisexecutingtremendouslywellanddoesnothavenotable
gapsorweaknessesversuscompetitorsthattheycannotaddress.ThefactthatAmazonincubatedAWSfrom
scratchwillalsocontinuetohelpitinmovingfastervscompetitorssuchasIBMorOracle,whopsychology
dictatesaremuchmorebeholdentothehumanselfpreservationinstincttoavoiddestroyingtheirlegacy
revenuelinestooquickly.Themoatisnothuge,butinamarketgrowingsoquickly,itisnotathesiskiller.

OK,thenwhataboutAmazon'saccounting?Doesn'tAmazon'suseofleasingoverstateitscashflow
generativeness?WhatisthetrueoperatingROCEofAmazon?

ItistruethatAmazonmakesextensiveuseofcapitalleasing,principallyinacquiringpropertyandequipment.
Theruleofthumbisthatforevery$1ofcapexthatAmazonspendsitselfviacash,Amazonalsoexecutes$1of
capexviacapitalleasesthislattercapexdoesnotflowthroughtheCashFlowFromInvestingActivities(CFI)
sectionofthefinancialsinstead,anassetandaliabilityaresimultaneouslycreatedonthebalancesheet.
Amazoniseffectivelyleveringupitsbusinessandacceleratingitsinvestmentprogramme.Whetherornotthis
isagoodideadependsonwhethertheunderlyingoperatingreturnsfromthebusinessexceedtheimpliedcost
offinancing.Foritsordinarylongtermdebt(ofwhichAmazonhasabout$8boutstanding),theweighted
effectiveinterestrateisaround3.4%.Notethatthisisunsecureddebt.Whatistheeffectiveinterestrateon
thecapitalleases?SeeAmazon'scapitalleasecontingencyscheduleasofDec'15,below.
Inlineimage1

GivenAmazon'sFY15interestexpenseof$459manda3.4%effectiverateontheunsecureddebt,Iestimate
thatAmazonspentabout$175moncapitalleaseinterestpaymentsinFY15.GiventhatAmazonstartedJan
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2015with$2,060mofcapitalleaseobligations(inclinterest)forthatyear,repaid$2,462mduringtheyearand
madenewPPEcapitalleaseacquisitionsof$4,717mduringtheyear,theeffectiveinterestrateonthecapital
leaseslikelyrangessomewherebetween2.6%and5.2%(dependingonintrayeartimings),butlikelytowards
thehigherend.Evenifitis5%,thisisnottoobad.IfyoutrustthattheoperatinginvestmentsintocorePPE
suchaswarehousespaceorAWSdatacentreswillcontinuetopanout,Ibelievethisuseofcapitalleasingis
reasonable.Ofcourse,pastexamplessuchasSunEdison(ormaybeevencurrentlydevelopingexamplessuch
asTesla)demonstratethedangerinleveringuptooquicklyandinvestingtooaggressivelyinpursuitoflong
termprojectswithpieintheskylongtermIRRs.InthecaseofAmazon,youaremakingthebetthat
managementwillcontinuetoallocatecapitalinareasonablyrationalmanner.Aquickcheckofthebalance
sheetsuggeststhatthesituationisundercontrol.Below,Ishowtheratiooftotalassetstoequity.

2008:3.1x
2009:2.6x
2010:2.7x
2011:3.3x
2012:4.0x
2013:4.1x
2014:5.1x
2015:4.9x
2016H1:3.9x(goingbackdownagain,whichisawelcomesign)

AndnowontoROCE.Tocalculatea'normalized'ROCE,Ireturntotheexampleofthe"hypothetical,near
termprofitmaximizingBezos"thatwouldinflatetheLTMEBITfrom$4bto$20b.Now,let'salsotreatall
capitalleasecapexascashinsteadthere'sabout$6bofsuchcapitalleasecapexonanannualizedbasis,at
present.Let'ssayBezos'newfoundfrugalitycutsthatdownto$4b.Sothenew,normalized'cashEBIT'would
nowbearound$16b($20blessanother$4bofleasecapex).Nowlet'sfiddlewithcapitalemployed.Asimple
figureforthatisabout$36b(totalassetslesscurrentliabilities).ThatwouldresultinaROCEof44%.Toadda
dollopofconservatism,onecanpenaliseAmazonforitscurrentnegativeNWCof$16bandsetthattozero.
Then,dividing$16bofcashEBITbyaharshermeasureofcapitalemployed($52b),yougetaROCEof30%.
Stillprettygood.Themarketappearstobeabsolutelymissingthis.

Whatelsecouldthemarketbemissing?Andwhatarethebiggestriskshere?

IbelievethatonethingthatthemarketisnottoofocusedonisthepotentialforAmazontograduallytopupthe
platformwithimprovingcapabilities.Forinstance,ineducation,Amazonhasalongrunopportunitytoeataway
atthemarketcapsofincumbentssuchasHoughtonMifflin,WileyandPearson(combinedmarketcapof$15b).
Themarketisalsonotpayingattentiontothefactthatinvideo,Amazon'scontentisrapidlyimprovinginscope
andquality.JeffBezospersonallyattendedtherecentGoldenGlobes(whereMozartInTheJungle,an
Amazonshow,tookkeyaccolades),andAmazonisaggressivelygrowingcontentspendthisisabsolutelya
significantfocusofthecompanygoingforward.IhavecomeacrossanecdotesofpeoplecancellingtheirNetflix
subscriptionsbutkeepingtheirAmazonPrimeones,andunlessyouviewHouseofCardsorMarvelsuperhero
showsasabsolutemusthavekindofcontentinyourhouse,Icanunderstandwhyyouwoulddothis.The
relativeallinvaluepropositionofAmazonPrimeisbecomingsimplytoocompelling($10.99permonthor$99
peryearvs$9.99permonthforNetflix).SeveralintangiblefactorsarehelpingpeopleskewtowardsAmazon
PrimevsNetflix,andIhaveyettoseethesellside(orthebuyside)focusonthem:1)Amazon'sintegrationof
IMDBhaslongtermpotentialtodeliverastrongrecommendationengineandisalreadyyieldingsomeresults
viatheXRayfunctionalitythattellsyouwhichactorsorsongsareinascene,andalsofeedsyougoofs2)
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Amazonhasanofflineviewingfunctionality,andNetflixdoesnot3)Netflixcontentqualitylatelyappearsto
havetakenahit(seeAdamSandlerandsimilarcontent)4)Amazonfundamentallybenefitsfromitsabilityto
upsellsubscriberscontenttorentorbuy.Ifyouareinthemoodtoconsumecontent,youaremuchmorelikely
toultimatelyfindsomethingtoyourlikingwhenyoulogontoAmazonVideovsNetflix(onceyoucount
Amazon'sRentOrBuysection,whichisprominentlyhighlightedintheinterface,butnottoointrusively).

Becauseofallthesefactors,IbelievethatAmazonishavinganimpactonNetflixchurnfiguresandfuture
growth(thoughthisisdifficulttoproveaswewillnothaveacounterfactual).Ihaveapositivelongrun
fundamentalviewonOTTvideoingeneral(formanyofthesamereasonsthatothers,notablyWinBrun,raisein
therecentNFLXdiscussionsonVIC),andIexpectAmazontoplayasignificant,almostcentralroleinthe
developmentofthatsectorandareaofconsumerhabitastimeprogresses.

Andinthemidstofallthat,Amazonalsocontinuestositonacertifiablegoldmineofauniqueassetthanksto
itshugedatabankofconsumerdata(names,addresses,carddetails,widerangingconsumptionpreferences)
thatcanbeutilizedtoupsellandrapidlyrolloutentirelynewcategoriesofgoods/services.Ifthoseproducts
haveaphysicalaspecttothem,themarketismissingthefactthatAmazon'sbroadlogisticalcapabilitieshere
haveadecentchancetograduallyapproachthoseofmuchlarger,moreestablishedlogisticsplayers.Inthe
nextfewyears,Amazonwillhaveanoperationalfleetofcloseto50jumbojetsmovingcargoUPShasaround
250,meaningthatAmazoncouldsoonapproach20%ofUPS'saircraftcapacity.Thiswasalmost
unimaginabletothemarketjustafewyearsago.ThemoreAmazon'slogisticalmoatgrows(combinedwiththe
ecommercenetworkeffect),thestrongertherationaleforthebusinesstocommandanincreasinglylower
earningsyield.

Withregardstokeyrisks,Icannoteacouple:

Poorcapitalallocation.Managementmaydecidetowastecapitalonoverpriced,illconceivedacquisitions
thinkSoftbankbuying80%ofSprintafewyearsback.Thiscanalsotaketheformofoverlyaggressive,overly
hastyexpansionmovesonprojectswithnegativeorlowultimateIRRthinkUber'seffortsinChina.

Toomuchsuccessforitsowngood.AmazonhasbeendescribedbyStanDruckenmilleras'aserial
monopolist'.HardtodisagreewithwhereMrDruckenmillerwasgoingwiththatlineofthought.ThoughI
recognizethatitwasacompliment,Ialsoseeariskthere.Overall,businessesthataretoosuccessfulfortheir
owngoodendupgettingtaxed,finedorregulatedUStechcorporations'repeatedtravailswiththeEU
CompetitionCommissionareanexample.Thosekindsofruninsareprobablyjustamatteroftime.

Macro.Anymacroshockthathasanegativeimpactonhouseholds'disposableincomeorconsumer
confidencewillconstrainAmazon'stoplinegrowth,slowtherampofoperatingleverage,andalsoimpactthe
overallmarketmultiple.Butthereisalsotheflipside:ifgovernmentseverendupinstitutingadirectversionof
helicoptermoney(wherebymoneyismagicallydroppedintopeople'sbankaccountsinanefforttospur
inflation),Amazonwouldbeaprimebeneficiary.

Keymanrisk.IhaveafriendwhohadaleveragedlongcalloptionpositioninApplejustpriortoadramatic
turninSteveJobs'healthsituation,soIcansaywithconfidencethatthisisnotarisktobeunderestimated.An
expectednegativeeventimpactingJeffBezos'focusonthebusinessorlongterminvolvementwiththe
companywouldmeaningfullyimpactAmazon'sintrinsicvalue.

Marketpatience.EverycoupleofquartersAmazonsurprisesthemarkettotheupside,mainlyviaafaster
thanexpectedoperatingleverageramp.AndthenjustafewmonthslaterAmazonputsadowneronthe
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analystsagain,bydoublingcapexhereandthere(e.g.HBOcontentspendinthepastortheplanneddoubling
ofcontentspendinthenearfuture),givingwideguidancerangesorplainnotansweringtheanalystsquestions.
Thestockislikelytocontinuetojumparoundthatisjusthowthisstocktrades,eventhoughthatisnothowthe
intrinsicvalueisprogressing.Thoseperiodsofcontainedvolatilityarelikelyopportunitiestoaddtotheposition
(shouldcapitalbecomeavailablefromelsewhere).

Conclusion

Amazonisanabsolutegemofabusinessthatcontinuestobeundervaluedbythemarket.Reversiontothe
meanworksmostofthetime,butIbelievethatthisisnotoneofthosetimes.Thequalityofthebusiness
resultsinithavingthebestattributesofabondlikedownside(lowriskduetoamassivemoat)withsignificant
upsideforallthereasonsdescribedabove.Initscurrentconfiguration,IbelieveAmazon'sFY21revenuescan
cross$320b,withaGAAPoperatingmargininexcessof8%.Thatwouldresultin$26bofEBITand$20bof
netincome.Inmyview,thegrowthprofileofthebusinesscombinedwiththemarket'seventualrealizationof
Amazon'spotentialtogeneratemeaningfullyhigherneartermcashflowsifit'sstewardsdecidedtodosowill
likelyresultinAmazonmaintaininganopticallyexpensivemultiple,and35xP/Ein2021isprobable,resultingin
90%upside.

Notes/links:
1.ThereisaninterestingpaperpreparedbyJoshTarasoffandJohnMcCormackonAmazon'soperatingreturns,available
onlinehere.ItisbehindapasswordwallbutIwasabletoaccessitfromalibrary.Themethodologypursuedbytheauthorsofthat
paperissomewhatdifferenttowhatIpresenthereinassessingtheprofitabilityandROCEofthebusiness,butthedirectional
conclusionsaresimilar.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst
Successive quarters of continued evidence that management is taking steps to maximize long-run absolute
free cash ow, with no unreasonable acquisitions or uses of liquidity, and no overly aggressive capital
expansion plans. Continued improvements in operating margin, with operating leverage effects continuing to
come to the fore (although not in a straight line). Market realization of some of thespecics of the story as
outlined in this memo.

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Messages
Subject USPS parcel injection... delivery cost will go up a lot
Entry
08/04/2016 08:30 AM
Member lordbeaverbrook
My issue with Amazon is that they are very reliant on USPS parcel injection. USPS rates for these services are incredibly
low due to cross subsidization of "competitive products" by the "monopoly products" division. FDX and UPS won't even
stop the truck for the amounts that the USPS is charging for parcel injection. The parcel division represents about 25% of
overall USPS revenue and is only allocated about 5.5% of institutional costs (which are about half of overall USPS costs).
They are probably breaking all sorts of anti-trust laws (yes, the "competitive" business of USPS is not immune from antitrust laws). I think parcel injection rates will go up substantially (indeed the new postal bill will require the PRC to look at
allocation methodologies between the two divisions); thus, I would expect Amazon's delivery costs to go up substantially
(especially if they decide to do more in-house deliveries).
Subject also agree
Entry
08/04/2016 08:47 PM
Member socratesplus
i appreciate your thought experiment, but it raises the question whether a shareholder can trust management to reinvest
capital into the business rather than return it to shareholders. with almost every rm i would say give me the money. with
amzn, i say reinvest. while i dont want to be pedantic, i think anyone who doesnt have at least some exposure to the two
best rms in existence (using any metric you care to choose), googl and amzn, needs to think about it a bit more.
Subject Re: also agree
Entry
08/04/2016 10:49 PM
Member gocanucks97
OK please don't take this the wrong way, but I nd the level of condence amusing. 1) Yeah amzn will have tons of room to
invest capital at decent (not super) returns, but at current price you are paying a pretty big premium for that previledge. 2)
what exactly differentiates your bull thesis? Longer tail of growth? Higher margin? Higher multiple on 2020 normalized
EPs? Who out there still questions the fact amzn will dominate two huge markets?
Maybe it's just me, but I nd it funny that the write-up and replies seemingly try to pitch it as a contrarian idea. Who cares
about sentiment in 2014? Even us cheap mortals in VIC are marveling/drooling at the company. I will go out a limb and say
this is the most loved company in history of investing. Even apple in its heydays or the tech darlings in 1999 had plenty of
skeptics.
To be fair, I enjoyed the original write-up. But the piling on and the universal love on Twitter ville really rubs me the wrong
way, like this one,

AsIsaidduringmykeynote@SohnConf,$AMZNisthemostdurablebusinessintheworld.$3T
herewecome...ps,you'rewelcome.
Subject Re: Re: also agree
Entry
08/05/2016 08:37 AM
Member nondescripthandle

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AMZN is a big long for me, but it is very much a consensus long. I can't say I'm happy with the valuation, but in this market,
these kinds of growth names are quite expensive and there is plenty to hedge with. I've been seeing a lot of fellow bulls go
thorugh extreme mental contortionsto try to justify AMZN's valuation, an activity that seem to get more egregious with
each passing year, and we see some of that demonstrated in this write up:
"Bezosbegins to exploit the company's strong e-commerce market share and the associated network effects, and unilaterally ups
Amazon's take rate on both 1P and 3P relationships. On a very simple basis, we can imagine that the company's ex-AWS gross
margin increases from 30% today to 34%. On an annualized basis, that's an extra $5b of income to AmazonNetting all of this off,
annualized GAAP net income jumps from $2b today to a $18b pro-forma gure, which roughly makes this a 20x P/E LTM stock. "
So in two simple sentences the author manages to increase the protability of the company by 8 fold. Such analysis is reminicent of
the tech bubble, and when we see value investors broadly capitulate and buy into these lines of thought, perhaps it speaks to the
stage of the market cycle that we're in.

Subject Value?
Entry
08/05/2016 11:19 AM
Member zzz007
Bezos is a smart dude, a whole lot smarter than me. That said, I don't think there are any number of semantic contortions
somebody could go through to convince me that this is a "value" investment by any reasonable denition. History is littered
with the carcasses of investors who have bought into names on the basis of "earnings potential" as opposed to real
earnings.
I think there are plenty of people who will make money on this one. I'm not sure, however, that there are many true value
investors in that group. When people start talking about using "creative" valuation approaches, as a value investor I get
nervous.
Subject Re: Re: Re: USPS parcel injection... delivery cost will go up a lot
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08/06/2016 08:35 PM
Member lordbeaverbrook
Nails,
This is the best report I have seen on the issue of USPS cross-subsidization of the the competitive business:
http://www.sonecon.com/docs/studies/Study_of_USPS_Subsidies_for_Its_Competitive_Operations-Robert_ShapiroSonecon-October_21_2015.pdf
Subject Re: Re: Re: Re: USPS parcel injection... delivery cost will go up a lot
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08/06/2016 08:51 PM
Member lordbeaverbrook
Nails -Amazon's response to the cross-subsidization issue...

http://www.prc.gov/docs/94/94997/16-02-12%20AFSI%20reply%20comments.pdf
Subject Re: Re: Re: Re: Re: USPS parcel injection... delivery cost will go up a lot
Entry
08/07/2016 07:43 PM
Member socratesplus

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lord

great additions, thanks.

the whole issue of whether and to what degree govt regulation results in cartelization (ie, only the big boys can comply with
all of those regs, which sties innovation and small rm success) has been something i have followed as a legal/civic
matter for quite some time. it is, shall we say, ironic for amzn to say "The defects of fully allocated price oors include their
tendency to operate as cartelizing devices, suppressing competition and creating havens of inefciency." where the
proponent of this statement is one of the largest rms in the world...time well past for USPS to look at its rates to
determine if upstarts like amzn are being adversely impacted. while i am not an expert on the statutes and regs relating to
USPS, it seems amzn's argument is that new legislation or at least a sea change in regulatory practice would be required in
order for your risk argument to materialize. maybe amzn is overstating the legal case.
Subject Re: Re: Re: Re: Re: Re: USPS parcel injection... delivery cost will go up a lot
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08/07/2016 10:00 PM
Member lordbeaverbrook
thanks for the comments socratesplus. the cost (mis-)allocation is so blatantly obvious that i think that this will eventually
be rectied. UPS sued the German post ofce for the same issue (using monopoly business to cross-subsidize
competitive business) and won the case (it was about 15 years ago). I don't think the USPS situation will lead to litigation
(although UPS has recently hired the leading anti-trust litigation law rm) but probably through legislation and pressure on
PRC. The "general subsidies" (as opposed to the cross-subsidies) is an even bigger issue ($18B per year or so according to
one report) and I am not condent that those issues will be solved anytime soon.
amzn is lobbying against USPS e-packets... and I don't blame them. these are cartel-like arrangements which lead to
shipments from China to NYC to be cheaper than shipping a similar package from San Franciso to NYC. ironic that amzn is
lobbying against USPS subsidized shipments via e-packets but has no problem getting subsidized prices for USPS parcel
injection (especilly for the special amzn-only sunday deliveries).

Subject Re: Re: Re: Re: Re: Re: Re: Re: USPS parcel injection... delivery cost will go up a lot
Entry
08/08/2016 11:27 AM
Member lordbeaverbrook
hi mip14,
yes, good point. while i think there is very little chance drone delivery ever takes off in a major way (air transport is always
more expensive than ground transport, and point-to-point courier-like service is more expensive than driving a truck into a
neigboorhood and making multiple drop-offs), i think autonomous vehicles (with robots making the delivery for the last few
feet) are a very likely outcome. but, i'm not even sure how much cheaper autonomous vehicles will be versus the current
parcel injection set-up. if the usps is already droping off a letter (monolopy mail business)at 42 Elm Street, the package
(from competitive business) is basically riding in the truck for free for the last mile delivery.... and the USPS prices
accordingly. again, ups and fdx won't even stop the truck for some of these lightweight packages so they ofoad these
packages to the local post ofce for last mile delivery (via surepost and smartpost).
Subject Re: Re: Re: Re: Re: Re: Re: Re: USPS parcel injection... delivery cost will go up a lot
Entry
08/09/2016 10:22 AM
Member lordbeaverbrook
mip14 -usps reported their quarterly earnings today. parcel services had quarterly volume of 583 million packages (up 23% y/y)
and revenue of $1.151 billion. That works out to revenue per box of only $1.97... i doubt even autonomous vehicles/robots
could have costs lower than what the usps charges for parcel services!

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Subject Re: Re: Re: Re: Re: Re: Re: Re: Re: Re: USPS parcel injection... delivery cost will go up a lot
Entry
08/09/2016 01:57 PM
Member lordbeaverbrook
air travel is always more expensive than ground transportation due to the laws of physics (energy consumed). no, i don't
think we will have a lot of direct shipments by drone to a house then the drone returns to the distrubition center. it is much
more efcient to drive a (automonous) truck into a neigboorhood and then have the packages moved a few feet from truck
to doorstep (by robot).
Subject Re: Re: Re: Re: Re: Re: Re: Re: Re: Re: Re: USPS parcel injection... delivery cost will go up a lot
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08/09/2016 02:48 PM
Member zzz007
Does anybody know why Bezos has a droopy eye?

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