Recently, Jim Cramer widely promoted on his show, “Mad Money,” the notion coined by John Malone that Amazon is the “Death Star” of retail. I’m sure his remark sent shivers down the spines of many a brick n’ mortar retailer and their investors. Don’t get me wrong, I think Amazon is an interesting company that has and continues to do some great stuff, but I just don’t buy into what I feel are hyperbolic statements frequently issued by market pundits that continue to pump the Amazon hype engine at the expense of other enterprises out there doing some great innovative things.
Rather than take Cramer’s (or Malone’s) word for it, and given the slew of strong results from the likes of Walmart, The Home Depot and many others, I decided to examine the scale of the threat that Amazon poses to the galaxy of “traditional” retailers. In keeping with Malone’s metaphor, let’s call this band of retailers that are supposedly threatened by the Amazon “Death Star” the “Rebel Alliance.”
I took the top 20 global retailers listed in the National Retail Federation’s “2017 Global 250 Chart” study conducted by Deloitte to see how the “Death Star” measured up to the Retail Rebel Alliance. Consider that my evaluation includes just the top 20 global retailers (Top 20). The retail galaxy is much bigger than the 1.88 trillion USD in revenue represented by the Top 20, which I used to benchmark the Imperial threat. The analysis is also based on 2015 numbers provided in the NRF study. Yes, Amazon’s revenue has inorganically (no pun intended) increased 15 to 16 billion USD with the recent acquisition of Whole Foods, but you will see that that acquisition barely impacts the bigger picture.
I find it difficult to understand how Amazon’s $79 billion in retail revenue versus the $1.87 trillion of the top 20 retailers would prompt anyone to consider Amazon remotely a “Death Star”-level threat. Are the Wall Street gurus getting market capitalization confused with revenue? Amazon is ranked the 10th largest retailer by revenue in the 2017 NRF study and has only a minor fraction of the retail market; less than 4% of the revenue of the top 20 retailers. Even if Amazon continues to grow at the historic 20% CAGR, Amazon itself will not make a dent in the overall retail market as the revenue growth of the Rebel Alliance based on a 6.3% CAGR dwarfs Amazon’s revenue growth in absolute terms.
In short, there will be plenty of retail market for other players online, brick and mortar, and otherwise, who are increasingly innovating and delivering excellent customer experiences. The question is, can Amazon continue to sustain its pace of 20% annual growth in its retail business? Probably not. All growth curves eventually hit an inflection point and begin to taper off, as we have seen with the retail darlings of yesteryear like Walmart and the Home Depot. Do I dear say, Sear Roebuck? Sorry, no such thing as magic or infinite scalability and growth.
The retail universe is vast and has an exciting future of innovation and reinvention in front of it. Eventually Wall Street will realize that eCommerce is just a channel, not a planet-destroying business model.
Let me know what you think and May The Force Be With You!
Free Cash Flow: Does Amazon’s Story Measure Up?
Monday, November 27, 2017
It’s been a week since I published the first section of this article. Since then, I have had a number of interesting debates on the future of Amazon and its current valuation. Not to pick on Amazon, we debated the market valuation of several of Amazon’s high-flying peers, widely known as FAANG companies – Facebook, Amazon, Apple, Netflix and Google (Alphabet). Some of these debates inevitably veer into the age old topic of free cash flow as a proxy for profit. P/E is dead, right? Personally, I have heard that before. It’s not a new notion. It was after all, coined as a widely-popular justification/argument for the astronomical, and often irrational, valuations of DotCom start ups almost 20 years ago.
Admittedly, I put this cursory analysis together for the sake of healthy debate and,…. well, fun. I’m sure a more in-depth analysis will bring forth even more interesting insight into the prevailing arguments for FAANG market valuations. I also centered this analysis around Amazon, which is currently trading at more than 10 times the P/E of many of the FAANG companies. I also compared the trailing 12-month free cash flow per share of some of Amazon’s retail peers (Walmart, Best Buy), IT sourcing peers (IBM and Microsoft) as well as Fedex, an arguable leader in logistics and supply chain. The thinking in including Fedex is that from a cost structure perspective Amazon is increasingly adopting the characteristics of a logistics and delivery business model rather than a pure play online retailer like Alibaba or eBay. In my opinion, the assumption that Amazon’s business model has the scalability and elasticity of a “Digital First” business is a flawed one. Getting a bit of brick n’ mortar reality is helpful in viewing an increasingly brick n’ mortar company, Amazon.
Here is what I found presented in the diagram below….
No doubt, Amazon comparatively has very solid cash flow per share at $14.81 per share beating out Facebook’s $5.34 per share and Apple’s $9.54 per share showing over the last 12 months. Google simply blew the other FAANG companies out of the water with $33.11 trailing 12-month free cash flow per share, yet it is trading at 37.71 times earnings as of November 24th, 2017 versus Amazon’s 301.63 times earning valuation. If we were to take Netflix as a proxy for Amazon’s streaming and media business, at a negative $4.65 per share one might feel the urge to retest one’s assumptions regarding the profit potential and economic scalability of digital media streaming business models. If you are curious, Netflix is currently priced at 195.55 times earnings as of last Friday.
The big surprise for me was IBM’s showing with at $11.71 FCF per share, especially given that Wall Street and investors have slammed IBM for declining revenue over the last few years. It’s good to see one of the old guard make a strong showing.
In short, from a FCF/share perspective I don’t see what what market sees in Amazon. I suppose I could just go with the flow, but when you dissect the arguments and the points of view floating out there, they don’t hold as much water as you would think. This is especially true given that many “traditional” retailers seem to be making a turn in the U.S., and global competitors such as Alibaba are hitting grand slams of their own while delivering significant profit to investors. Hopefully this light and fun analysis will be helpful to some folks, and bring the “digital” discourse a bit closer to the ground and out of the stratosphere of hype.
I’m looking forward to your thoughts!
Free Cash Flow: The Hope for Profit
Thursday, December 7, 2017
A week and a half has passed and a lot has happened. We had Black Friday. We had Cyber Monday. With a slew of positive results from a wide range of retailers such as Nordstroms, J.C. Pennys, and many other surprise performers, Jim Kramer has had to walk back his claim that retail is dead in the age of Amazon. Again, I have nothing against Amazon. Great company that delivers experiences that its customers seems to love. I have clarified myself ad nauseum in prior posts. It just peeves me when guys like Jim put gasoline on the fire of “digital” hype. Here are the final thoughts that I have put together on the “Amazon Death Star” topic.
Last week, we talked about how free cash flow has been widely cited as the justification for Amazon’s sky-high valuation. For start ups, that’s fine if you are not delivering profits. But it is even better if you are delivering profits and returns for your investors, not just appreciation. Reward for risk, right? Well, let’s face it, Amazon is no longer a start up. Yes, Amazon is reinvesting back into its business but where are the returns after 23 years? Let’s see how Amazon’s recent operating margins stack up with other FAANG companies and some relevant peers? Here you go.
I’ll let you judge for yourself. I’ll just note that Facebook and Microsoft (Amazon’s cloud arch-nemesis) are putting up some big operating margin numbers while trading at a fraction of Amazon’s market multiple. Again, IBM surprises. Not only are they generating some nice cash flow, they seem to be able to get some nice returns that they are passing on to shareholders, while trading at only 12.85 times earnings as of the 7th of December, 2017. I’m just saying. The numbers are the numbers.
Well, that is the last of my thoughts on this topic. Short and sweet. I just hope that I have injected a bit of sensibility into the wildly hyped retail discussion. I firmly believe that hyperbolic statements such as those consistently made by market pundits like Jim Kramer should be challenged. Certainly they should not be taken at face value. You can disagree with me, that’s fine. Many of you will, but please test your rationale. Calling a company the “Death Star” of the industry without perspective and rationale does none of us any good, and waters down our discourse on the value of innovation and operational excellence.