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  • Brett Schafer

Not So Deep Dive: Amazon Stock

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Show Notes

(Ryan) What they do: The first line of their 10-K says “We seek to be Earth’s most customer-centric company.” And pretty much everyone knows Amazon, but if not, I’m not going to be able to explain everything they do because they have their hands in pretty much every single industry at this point. You name it, I’m sure they have some venture in it.

So I’m going to try to focus on what I think the 3 main drivers of the business are. E-commerce, AWS, and Advertising. And I stole those 3 from a good friend of the show, because I enjoy following his coverage on them.

Their E-commerce business you could almost call their legacy business at this point. It accounts for 39% of US e-commerce spend. And if you subscribe to Amazon Prime you get pretty much anything delivered to your door in 2 days or less.

AWS is another big driver of their business now and this is their cloud platform. Companies, organizations, or individuals can store or access their data over the internet instead of on a hard drive. This makes data more accessible and often saves organizations tons in expenses. And it generated $62B in revenue for Amazon last year. It’s only 13% of Amazon’s overall sales but it’s 75% of their operating income.

Lastly their advertising business. Since Amazon accounts for such a giant chunk of e-commerce spend in the US, their platform is obviously a great spot for retailers to be. And if you can pay to promote your product to the first page, it’s going to get you in front of plenty of customers. That makes up the lion’s share of their advertising, but there are other ad inventory that Amazon owns as well.

(Ryan) History: No doubt, this is a story that many people have heard before, but Amazon was founded in 1994 by Jeff Bezos (Brett’s friend). Jeff left DE Shaw – a quantitative investing firm – because he wanted to build a business that sold books over the internet. He moved to Seattle to start the company and also because there was a lot of tech talent out there and the business quickly took off. Originally named Cadabra, but they changed it after a lawyer mistook the name for cadaver. 1 year after the company was founded, Amazon IPO’d (that’s a hot start).

Over time they added new products and became what is now known as the everything store. I’m not going to be able to do all the history justice here, so I recommend reading The Everything Store by Brad Stone for all the details.

(Brett) Industry/Landscape/Competition:

  • Very difficult to define, since they do so much, so I’ll highlight U.S. commerce and cloud services

  • U.S. retail market is $5.5 trillion in 2022 (the world is driven by the American consumer). Amazon is really competing for all of this now.

  • Europe retail market is $3.25 trillion Euros

  • India retail market is just under $1 trillion

  • Cloud market is around $300 billion - $400 billion in spending a year growing 10% - 15% a year

(Brad) Management and Ownership:

  • Andy Jassy is the president and CEO of Amazon – shout-out to him for that share buyback. We love tax efficient shareholder returns

  • Took over for Bezos in 2021

  • Was the CEO of AWS for 24 years before then. Solid resume.

  • Harvard for undergrad and grad school. It’s casual.

  • 79% glassdoor rating but 115,000 reviews so I actually find this to be more realistically bullish than some of the 98% scores we see with 10 reviews.

  • Jeff Wilke had been the right hand man and CEO of Amazon’s Worldwide Consumer since 2016. Oversay retail, prime, marketplace and whole foods. Left last year.

  • David Clark replaced him (was with Amazon since 1999)

  • Brian Olsavsky has been Amazon’s CFO since 2015 and with the company climbing the ladder from VP of Finance since 2002

  • he was a VP of finance at Fisher Scientific for 7 years before then

  • New CEO of AWS is Adam Selipsky – been with them since 2005

  • Former president and cEO of Tableau

  • Principal at Mercer before then

  • Harvard guy

  • Board members include Starbucks COO, the former CEO of Pepsi and more bellwethers, unsurprisingly.

As of the most recent Proxy:

  • Bezos owns 15%

  • Vanguard owns 6.4%

  • BlackRock owns 5.4%

  • Jassy’s and Wilke’s direct stakes are tiny but he has some handsome RSU incentives packages for more shares if he performs which will begin to vest next year. Similar deal with Olsasky. This is how it pays employees to align long temr interests

  • Looks like execs have around 152,000 shares in RSUs that haven’t vested for about $250 million.

  • It has 14 million total RSUs outstanding as of the company’s recent 10K for about $28 billion in equity or 3% of the company’s equity.

(Brett) Valuation:

  • Market cap of $1.42 trillion, ticker AMZN

  • EV of $1.37 trillion by my count

  • EV/OI of 55

  • EV/FCF is negative (makes it difficult to put a multiple with the reinvestment they just made)

  • Share count steadily rising

(Ryan) Earnings: Just wrapped up 2021 FY last night as of this recording

  • In 2021, Amazon had $471B in revenue, up 22% YoY

  • 42% gross margins, up from 40% last year

  • Had $46B in OCF, but spent $60B in capital expenditures, so negative FCF for the year

  • But we’ve seen what happens when Amazon starts investing big and they seem to be doing that again.

They also announced a 20 for 1 stock split and a $10B buyback program that does not have a fixed end date

(Brad) Balance sheet and liquidity:

  • $36.2 billion in cash and equivalents

  • Another $60 billion in marketable securities

  • $48 billion in net payables it uses to finance its operations

  • $31.8 billion in LTV and $52.6 billion in long term lease obligations

  • Interest expense was 7.2% of its operating income in 2021 – so not really that favorable but could just be a payment timing thing as its weighted average rate is listed at 0.65% for 2022.

Anecdotal Evidence:

  • (Ryan) I honestly haven’t bought anything on Amazon in a while. I am looking forward to this lord of the rings show though.

  • (Brett) I don’t know what would cause me to leave the retail ecosystem. I personally get frustrated when they put in the Whole Foods only stuff in my search results. I wish they would separate grocery delivery from traditional marketplace. Also got some scuttlebutt on the advertising business.

  • (Brad) We use Amazon all the time. No complaints. Not noticeably better than shopping elsewhere.

Future growth opportunities:

  • (Ryan) Selling their Rivian stake. Hard to think of anything new that they haven’t already tried, so I’m gonna go with the easiest one AWS. This might be the greatest business in the world. It grew its revenue by 40% YoY this quarter, had 30% operating margins. And had a few notable customer adds this quarter. Nasdaq said it plans to “migrate its markets to AWS with the goal of becoming the world's first fully enabled, cloud-based exchange.” And Meta, “selected AWS as its long-term strategic cloud provider to accelerate artificial intelligence research and development.”

  • (Brett) There are a ton, but I have raising the price of Amazon Prime. The recent $20 price rise will bring in $3 billion more a year in pure profit (assuming 150 million subs). I also think they have an easy path to doing this 3 - 4 more times over the next decade.

  • (Brad) Please sell Rivian. But also the IoT boom could allow them to automate a lot more of their fulfillment processes (thinking about all of these commercials). Human capital is a massive cost for them so being able to automate would be terrible for the American workforce but good for Amazon’s profit growth.

Highlights and lowlights:

  • (Ryan) Highlights: Incredible moat (spending so much on capex). I like Jassy and just the overall culture. And even though it’s overused, there’s tons of optionality here. Lowlights: Honestly, the size of the business is the only thing I can really think of. I think its e-commerce business has gotta be close to saturation at least in the US.

  • (Brett) Highlights: Tremendous competitive advantages, logistics moat + cloud tailwinds, culture of focusing on long-term cash flows. Lowlights: I worry about the bloat from just being a large and disjointed business, worries about true profitability of retail, tougher competitive environment in international markets. Alexa and some of the crazy spending on other bets.

  • (Brad) The team has been largely in place for decades and was able to execute a business plan that became wildly unfavorable at numerous points in its maturity. Lowlight is tough. Maybe Google Cloud is finding more market share lately? Maybe Bezos leaving? Maybe Amazon’s loud public support for cannabis makes them an enemy of the Federal Government? I am reaching.

Bull Case:

  • (Ryan) Top line reaches $1B (double from here) and they can get to normalized FCF margins of 15%. 20x FCF there you’ve got basically a double from here. My question though: Does the law of large numbers come into play here?

  • (Brett) If you believe free cash flow margins can reach 10% (they got close in 2019) once things normalize, we’re sitting at an EV/FCF of 29 right now. If you believe FCF margins can hit 15% (not unrealistic) we are at an EV/FCF below 20. In either of those scenarios forward returns will be great if revenue grows at 10%+ and they implement smart capital allocation (i.e. buybacks)

  • (Brad) To put it plainly, the bull case is that Amazon continues to perform as admirably as it has since the turn of the century. Proof of concept is concretely built here.

Bear Case:

  • (Ryan) I think the law of large numbers is the only bear case here. E-commerce has hit its peak, AWS growth slows quicker than expected, and the other bets in the business don’t bear fruit. Also they do spend a lot on some dumb shit.

  • (Brett) Margins never materialize given the heavy costs going on right now, and other retailers/businesses like Shopify are able to slowly pick away at the retail advantage given how massive/messy they’ve become. Hard to say what could kill AWS.

  • (Brad) Ancillary projects distract them from their dominant market share in the marketplace and that begins to erode as more competition rapidly comes online. Vendors like Allbirds and Nike continue leveraging their own brand equity to pull products from Amazon to juice margins via DTC channels.

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Disclosure: The author and podcast guests are not your financial advisors. Ryan Henderson and Brett Schafer are general partners and portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this show.

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