Amazon's Story of Cash Value and Naivete
Dana is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Amazon.com (NASDAQ: AMZN) shares took a brief dip, then resumed their upward trajectory, after a quarter that disappointed analysts.
The results had bears scratching their heads.
But looking more deeply into Amazon's situation, it's clear the company has been naive in ways that could impact results in the longer term, and cause the stock to fall hard one day.
The Cash Flow King
The Amazon story is really about cash flow. The company has been steadily increasing the free cash flow it generates, and last year it had $4.18 billion of it.
CEO Jeff Bezos manages the company based on this figure. He husbands cash flow in the Christmas quarter, then spends it. The $4.18 billion figure, which was the net for his full year, was actually the number achieved in the fourth quarter of 2012.
The importance of cash flow is not a secret. It's the headline in each Amazon earnings release.
Thanks to the miracle of cash flow, Bezos doesn't have to take on much debt to fuel the company's rapid growth – which was over 20% from a base of $48 billion in 2012, about $13 billion. Long-term debt at the end of the first quarter was just half the company's cash on hand. Bears will note this was slightly less than the $14 billion sales gain from a year earlier, but the previous year's nearly 40% gain in sales was achieved with just a $10 billion sales gain. That's the law of large numbers – the bigger they get the harder they are to raise.
Other critics call Amazon a black box because it doesn't break out sales figures from physical goods, downloaded products and cloud services. Cloud, for instance, is part of “other” in the figures, which was $892 in the second quarter. It should easily break $4 billion in revenues this year, and since Google is valued at 6 times its sales volume, a value of $24 billion isn't unreasonable.
Take that off the market cap, and you're paying $114 billion right now for an online retailer that should achieve sales of $75 billion this year. That's high, but less unreasonable than it was a year ago, when the ratio was closer to 2:1.
The problems that Amazon experienced in the most recent quarter have a one-word answer: Europe. The company barely broke even in the last quarter in Europe, yet it continued investing that cash flow and running at about break-even. The widely reported loss was $7 million, on revenues of $15.7 billion – basically a rounding error.
Amazon is going to continue to build out a global infrastructure, and global cloud footprint, in order to maintain its high market share in both its key market segments. After hammering the stock in after-hours trading, analysts accepted the explanation and began bidding it back up – most have price targets in the $350/share and up range.
More disquieting was what happened with the federal government, where its $600 million contract to provide a cloud computing platform to the CIA, for analyzing global web caches and phone records for potential threats to national security, is getting immense pushback from loser IBM (NYSE: IBM). The company felt obliged to sue over the CIA's reactions to a negative GAO report on the deal.
The fear is that the contract might become a money-loser due to fights created by other stakeholders in the industry. It's a reasonable fear. IBM is an experienced bureaucratic infighter, Amazon has never played in the political realm, and it's likely that the company under-bid on the CIA deal, when the cost of all this legal and political wrangling is taken into account. If the company is to expand its government footprint, it has to learn to adapt to these kinds of setbacks in its bids, or it will lose money it can't afford to lose due to simple naivete.
See What Halliburton and IBM Do
Companies that do extensive work for the government know the way the business model works. You build all possible contingencies into your bid, and make your price contingent on avoiding implementation problems. Then you escalate costs and take your profit out in the back end.
This is what IBM has long done. IBM's investment metrics are more prosaic than those of Amazon. You look at the price/earnings (P/E) ratio, buying only when it's reasonable, and then take your profits over time. IBM regularly earns margins in the 15-20% range, and while the stock has been waffling a bit this year, it should come close to that mark this year as well.
IBM, now primarily a sales-and-service company with a profitable sideline in mainframe computers that have the rapid throughput applications like transaction processing need, regardless of price, knows this business model, both domestically and internationally. When called to account for things like bribery, it reaches a settlement and moves on. Its success is the result of its ability to monetize the value of acquisitions and keep large customers happy.
It may seem strange to offer Halliburton (NYSE: HAL) as a comparable here, as the company is best known as an oilfield services firm, but like IBM it understands the contracting business, the hidden and long range costs, and it organizes itself accordingly. The company plead guilty to actual criminal charges involving the 2010 Deepwater Horizon spill this week, and the shares then rose in value.
This happened because Halliburton knows its business. Sales growth is nearly Amazon-like, doubling between 2008 and 2012, even after former CEO Dick Cheney left office as Vice President. The company has been steadily increasing its asset base and maintaining its long-term debt level, meaning the debt-to-assets ratio is increasing. Halliburton sells at a P/E of almost 23, about 75% higher than that of IBM, and its operating cash flow figures are close to those of Amazon as well.
About the only advantage IBM has over Halliburton is on yield: dividends yielding nearly 3% against Halliburton's yield of just over 1%.
My Foolish Bottom Line
There are horses-for-courses, and all the stocks mentioned above will have their fans.
Analysts will bet Amazon.Com for price appreciation, IBM for yield, and Halliburton for a nice combination of the two. And they'll be right each and every time.
Amazon's problems in government contracting are troubling, but the good news is that Bezos usually learns his lessons and is likely to bid higher on future contracts, find some people who understand the area, or get out of the business.
The best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.
Dana Blankenhorn owns shares of International Business Machines.. The Motley Fool recommends Amazon.com and Halliburton. The Motley Fool owns shares of Amazon.com and International Business Machines.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!