by Dave Kranzler, Investment Research Dynamics:
The mainstream financial media headlines reporting Amazon’s Q2 earnings release were shamelessly pathetic: “Amazon crushes Street forecast,” “Amazon beats again in Q2 thanks to cloud services.” It was beyond nauseating. The entire spectacle reminds me of the tech bubble, when companies like Cisco, Sun Microsystems and Intel would intentionally “guide” Street analysts into publishing a low consensus forecast the CFOs knew could easily be topped with accounting gimmicks.
Bezos applies all the traditional accounting gimmicks plus he’s created his own, specifically with regard to his definition of “free cash flow.”
I don’t want to spend a lot of time on this. I’ve wasted most of my evening untangling AMZN’s numbers as reported in its 8-K filing. Let’s just say that if you dissect AMZN into its “product” and “AWS” components, the results are underwhelming.
Nothwithstanding the fact that AMZN intentionally guides the Street to low-ball estimates ahead of its quarterly earnings report, as you can see from the graphic below, which I created by dissecting and rearranging the sales and operating income numbers from AMZN’s 8-K filed today, AMZN’s growth numbers are underwhelming
The sales growth rates for AMZN’s AWS (cloud computing) revenues and operating income are declining rapidly. AWS is a new business started from scratch a few years ago. Of course it’s going to show a high rate of growth initially. But stock analysts and the mainstream financial media make it sound like AWS is a money tree. Yahoo Finance reports that AWS is “massively profitable” LINK.
Well, look for yourself. The sales growth on a year over year quarterly basis has dropped precipitously from 81.5% in Q2 2015 to 58.2% in the latest quarter. This is a rapid slowdown in growth. The yr/yr quarterly growth rate for AWS operating income, which was $718 million in the latest quarter, has plunged from 407% to 83.6%. “Massively profitable?” You can see that AWS’ operating income actually declined from Q4 2015 to Q1 2016. Declined. Cloud computing services are not seasonal. So that would not explain the drop.
Furthermore, AMZN does not disclose how much of its “technology and content” expenses are attributed to AWS. But its total line-item cost for this in Q2 was $3.8 billion. Yet, AWS’ total revenues for Q2 was $2.9 billion. To be sure, a significant portion of that $3.8 billion in tech costs go with AMZN’s online product sales. But it’s possible that none of the expense is amortized into AWS’ cost of sales. Bezos won’t break that out. He was doing a similar trick with “fulfillment” before the SEC forced AMZN to include fulfillment as a separate line item in the early 2000’s.
Let’s drill down into AWS’s numbers, to the extent that Bezos’ disclosures will allow:
The chart above shows the quarter to quarter growth rates for AWS. Again, recall that cloud computing services are not seasonal. From 2014 to 2015, AWS’ annual growth rate was 70%. But on an LTM basis thru Q2 2016, that growth rate has collapsed to 26%. With operating income the decline is even more dramatic. From 2014 to 2015, operating income grew 182%. But this growth rate on a quarter to quarter basis for Q2 2016 has plunged to 19%.
Bezos is the master of deceptive presentation. But as you can see, rearranging the numbers into a more traditional financial analysis format removes any “sizzle” Bezos imposes on the numbers and reveals that AWS’s growth rate is collapsing.
Circling back to the first chart, you can see that AMZN’s overall profit margin on 90% of its revenues base – its product sales – is more or less 2%. This profit margin is less than half the profit margin of two of AMZN’s primary competitors, Walmart and Target. In general, retailers produce 4-5% operating profit margins. In other words, 90% of AMZN’s revenues significantly underperform that of AMZN’s competitors.
For this investors are paying a 186x trailing p/e for a business with a rapidly declining growth rate and profit margins well below average for retailers.
Finally, the Bezos’ shamelessly promoted Free Cash Flow metric turns out to be borderline fraudulent. In fact, buried deep inside the footnotes to AMZN’s SEC-filed 10-K/Q is a disclosure that states that the “free cash flow” number used in AMZN’s promotional slide is not a GAAP-derived number.
Why? Because Bezos conveniently excludes the cash AMZN’s spends every quarter to pay for property and capital equipment that AMZN finances with capital leases. He also excludes stock-based compensation, which turns out to account for about 50% of AMZN’s salary expense. It’s highly misleading. To give you an example, the very first slide which is shown in AMZN’s quarterly investor presentation is the Bezos-concocted “Free Cash Flow” bar chart shown on a trailing twelve month basis:
This is the very first slide Bezos hits the market with. Talk about shameless promotion, I’ve never seen anything like this in over 30 years of financial market experience. This is more absurd than any type of misleading hype that I saw in the junk bond market. And I thought junk bond presentations stretched the limits of credibility.
But here’s the best part. If you strip out the ongoing cash outflows used for capital equipment and building expenditures by AMZN each quarter for the last four quarters, that “free cash flow” of $7.3 billion LTM shrivels down to $2.5 billion. THEN, if you net out stock-based compensation for the trailing twelve months, which is a GAAP number, that Free Cash Flow metric of Bezos’ disintegrates down to just $85 million.
Pundits will argue that capital lease payments are eventually non-recurring and therefore should not be included in a free cash flow calculation. But that argument is entirely disingenuous and highly flawed because these payments have grown from $1.8 billion in 2013 to $5.4 billion on an LTM basis through Q2 2016. I like to call these, sarcastically, recurring “non-recurring” expenses because it falls into the “non-GAAP” earnings category that every big corporation gets away with presenting now. Bezos clearly stretches this to the limits of the imagination.
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