Why Amazon Is Bucking the Trend

36 Comments

Jeff Bezos, when he was peddling the new Kindle on Charlie Rose the other night, kept using the word “seamless.” He wasn’t talking about the device itself, of course, but the experience of the customer that uses it. Whatever you think about the Kindle, Bezos’ choice of that word goes right to the heart of Amazon’s own strategy, and the reason why the company, its operations and its stock have held up so well in the past few months. Everyone knows that Amazon’s (s amzn) e-commerce site succeeded because its interface was intuitive to the point of being completely natural. What isn’t discussed as much is the ethic behind that success: Simplicity is hard. Just as Amazon went to great lengths and expense to make the Kindle experience seamless, it has gone to a considerable amount of trouble to adhere to what is a very simple corporate strategy: Make it easy for the customer, and make it cheap.

What’s hard about that approach is sticking to it over year after year, even when technology is changing quickly and, more importantly, markets are extremely volatile. The success of such an approach could be found in another piece of news out of Amazon this week that didn’t get as much attention as the Kindle but as far as the company’s long-term outlook goes, could prove more important. It’s about to become almost debt-free.

amazon_com_debt_vs_cashBy March 27, Amazon plans to redeem the outstanding principal on its convertible subordinated notes due next year. Amazon offered the notes in 2000, and they accounted for $335 million of the company’s long-term debt at the end of 2008. After the notes are redeemed, Amazon will have only $133 million in long-term debt outstanding. That’s a far cry from the $2.8 billion in debt it held six years earlier.

There are a couple of things to note about this. The first is that, in a market in which companies are in need of new financing and yet unable to find it, Amazon is using cash to escape from debt. Few companies’ operations are that healthy, and the ones that are will likely emerge from the recession much stronger than their peers.

Second, Amazon’s balance sheet has made a dramatic, 180-degree turnaround from the last recession. Remember when there were predictions of Amazon’s demise and rumors of its bankruptcy? As recently as 2005, some were calling for Bezos’ head because his unorthodox approach of favoring revenue growth over profit margin was so unpopular with investors.

Amazon’s hard-line adherence to its basic strategy — keep the prices low, and the experience easy — cost it a lot of debt early on and a lot of short-term profit ever since. But now the company’s debt is being paid off and the cash on hand is growing. And investors patient with Bezos’ approach are left with a stock up 26 percent this year, one of the 10 best performers in the S&P 500.

The recession is far from over, and like all companies, Amazon faces its share of challenges. But there is emerging in the company’s short history an important lesson for tech companies: Find a clear vision and, not matter how fast things change or how impatient others become, stick with it. It’s a very hard road to take. But at least it’s simple.

36 Comments

Fred

No problem, we see Amazon differently, that’s ok, I don’t agree with you, but I do respect your opinion. That’s what makes a market and gives color to life.

Kevin Kelleher

@Fred,

You’re right. That comment was out of line and I wrote it in a moment of anger. I take it back and apologize for it, and if as you say I am wrong about the posts on Yahoo Finance, I apologize for that too.

Kevin

Fred

Sorry for your ignorance, your supposition is wrong and classifying all MBA’s or any group of people in generalities has been the cause of all the discrimination, hate and wars in our history. You are a prime example that humans have not evolved.

Kevin Kelleher

I can’t resist.

First, the “Fred” post on Yahoo Finance is word-for-word identical to your first post as “Fred” here. There’s only one plausible explanation for that.

Second, you may not have noticed that the people who have ruined the financial industry, the economy and so much more are MBAs, but it’s true. So congrats on that.

Okay, no more. I promise.

Fred

You got the wrong person, I don’t post on Yahoo. Occasionally I read messages, but I do not like the manner in which ideas are interchanged there. Don’t insult me and I do not have a yahoo moniker, your way of base. I think tht Amazon accounting is borderline fraud, so what, that’s my opinion as an MBA. It still a free country. I have the qualifications to analyze this company, do you? Just because I do not agree with your analysis here does not mean that I’m being juvenile. Stop chasing ghost and grow up, if you someone doesn’t agree with you is no reason to go on a witch hunt. I reiterate you have the wrong person, sorry to dissapoint you.

Kevin Kelleher

@”Fred”

I went back to the Yahoo Finance thread and noticed that one account “bondman90” was posting under two names, “bill” and “Fred”. Then I noticed that in this thread, “bill” posted at 7:38 last night and “Fred” posted two hours later. Am I right to assume that “Mike” and “david” who posted soon after are also Wasp-y avatars of yours?

Using multiple aliases and accounts to post messages on Yahoo’s boards is an old trick, and a juvenile one. Just as childish is your logic that someone who disagrees with you a) writes badly, b) is in Amazon’s pocket and c) is guilty of bias bordering on fraud. You say you’ve been an accountant for 30 years – assuming for a moment that’s true, it puts you around 50 or older. That’s a long time to live without learning to act like an adult. Until you can, I have nothing more to say to you or your aliases.

Kevin Kelleher

No, “Fred”, it doesn’t distort the issue, it just doesn’t say it the way you want it to be said. There’s a difference, and your blindness to that undermines your position.

This debate has been going on for years, and there are strong arguments on both sides. As I said, I have gone from leading toward the “Amazon’s model doesn’t work” side to leading toward the “Maybe it works for Amazon, but not for everyone” side. Time will decide which side is right.

I welcome debate here, but it’s always nice to know the identity of the people I’m debating with. Why can’t you extend that courtesy?

Fred

Your article stills distorts the issue because Amazon has chosen to finance with A/P instead of long term debt. Their cash position at 12/31/2008 is about half of accounts payable. Total assets are irrelevant because they include non-cash items as goodwill and deferred assets. Amazon has concentrated on FCF because they need to divert attention that they sell, but net net they have a hard time making a reasonable return on those sales or net income. Funny thing about they way they compute FCF is their own version that is not commonly accepted or used. I have 30 plus years experience in accounting and my opinion is that Amazon is a disaster waiting to happen. Their financial statement cannot be relied to give you a clear picture of the current situation. Were they not one of the early adapters of pro-forma statements ? People are putting too much emphasis on paying down the debt which may have been done for reasons that may portend more difficult times than is believed.

Kevin Kelleher

@R.Kumar: Sometimes things in life happen that mean a delay in responding to reader comments. Mea culpa if I didn’t move fast enough.

Kevin Kelleher

With all due respect, I believe it’s some of these anonymous comments that are distorted in their logic.

I focused on debt because of the news that Amazon is close to paying it off. I compared it with cash to show that Amazon isn’t burning through it to pay off debt, but that it was in fact rising. There are many items on the balance sheet I didn’t mention to keep the post brief. Readers’ eyes glaze over when posts get long and delves into things like accounts payable.

Amazon made a choice years ago to focus on free cash flow even if it meant weaker profit margins and negative working capital. It is a controversial financial approach (if that’s not an oxymoron), and I questioned it at first but I’m starting to think it may be working for the company. I have never bought or shorted shares of Amazon, but it’s clear to me that anyone who doesn’t agree with that strategy has had years to get out. The same people who screamed about Amazon’s crushing debt seven years ago are now screaming about accounts payable and shell games. I imagine they are still short the company, and that they are having a hard time with that in this market where shorting stocks is like shooting fish in a barrel.

As for PE, it’s irrelevant to this story. Amazon is too expensive, in my opinion, and I wouldn’t buy it if I did invest in the stocks I write about (which I don’t), but some commenters have confused an explanation of why Amazon’s stock is doing well this year with a recommendation to buy it. It’s not. Some of the other logic in the above comments is, frankly, comical. Amazon’s suppliers will not pull their supplies because Amazon is one of the very few retailers selling a lot of stuff right now.

One other note. I noticed that some of these comments echo word for word a discussion on Yahoo’s AMZN message board. I’ll only point out that it’s the lowest-rent corner inside Yahoo and possibly the single worst source of stock information on the Web – a haven for bottom-rung hedge fund boys and anonymous people with a loose grip on reality. If someone disagrees with you, they’re idiots. If they offer facts to back up their view, they’re biased. I’m disappointed to see the hysterical tone on on those boards carried over here, where the discussion is more thoughtful.

R.Kumar

Kevin Kelleher, I think you should respond to some of the comments to your upbeat analysis of AMZN’s prospects with either a rebuttal or a mea culpa, otherwise what is the point of having a “reader comment” feature? Right now it seems just a conversation among readers, with the author a mute spectator or totally oblivious to some of the valid skeptisism about your analysis.

david

I don’t agree at all with this article. Amazon is mostly a successfull shell game PR ploy. Their liabilities exceed most of their assets, and their earnings are falling. For a 43 p/e in a depression, with earnings falling year to year, they had better include a new mercedes for every 1000 shares purchased.

Mike

Your analysis is wrong because their accounts payable has gone up substantially and the amount of time they take to pay them has lengthened. In fact Amazon total liabilities have gone up even though they paid their long term debt off. They guided down this quarter as much as 37 percent, a PE of 43, no thanks. Their stock has gone up because of the constant hype and distortion such as this article. They still have negative retained earnings after 12 years, tells you how profitable they have been.

Fred

Distorted analysis, their long term debt has gone done while the accounts payable has skyrocketed. All they have done is transfer the burden of the long term debt to their suppliers and extended their days payable to 62 days. Its a shell game. Current cash position is not sufficient cover the entirety of Accounts Payable, if suppliers all demanded their cash immediately their in trouble. Everyone talks about amazon sales growth, do they include the companies they buy quarterly to boost the sales numbers, generic growth is different. They may sell but can make money, their accounting is smoke and mirrors, in the second quarter they had a sale of a DVD unit as part of operating income, a non-cash sale of 53 million that no one knows how they could come up with such and inflated amount. Third quarter they lowered their tax rate six basis points, fourth quarter their original EPS estimate was lowered from .62 cents to .39 cents and then they bought back 100 million shares to boost EPS. Sales maybe, making money and margins, no. This year they guided down first quarter as much as 37% and everyone thinks is great. For the year estimates, before analyst reduces them is for $1.47 which is less than the 1.49 made in 2008. Zero to negative growth in a depression where margins and revenues will be under pressure and selling at 43 times earnings, right. Amazon is hype and they use their PR department works 24.7 to manage their stock price. They priced to 3 times higher than GOOG, EBAY and AAPL. If you think Amazon is a good investment at this price, I’ve got a bridge to sell you.

blll

Kevin;
In your chart you neglected to include total Liabilities that are up about $2bn in a few years an amount greater than the increase in cash.

Total liabilities-Debt
Years Ended Dec 31,
2008….$5.6bn
2007….5.3
2006… 3.9
2005….3.4
2004….3.5
2003… 3.2
2002… 3.3

NeoTechie

Sticking with a clear vision is difficult in times of turbulence. Amazon has done a great job of sticking to guns to achieve their long-term goals and successes. Less is more. Keep it simple still (KISS) works.

Ranjit Nayak

Earlier this year Amazon announced in that its 2008 fourth-quarter profit rose 9 percent. These are astounding results given the state of the economy, and the daily dose of news signaling bankruptcies by retailers. There are more lessons in this than simplicity and low prices.

Retailers most certainly have to take note and find ways of competing against Amazon. Amazon’s success is largely attributed to its better pricing during the holiday season. Now this capability did not come about overnight or in the last 3 months when the recession was acknowledged. Amazon has been at this for years. They have improved their operational efficiency on pricing by capturing and collecting data on goods and customer preferences. They knowing the customer very well and use dynamic pricing to optimize revenue. They also use a recommendation engine co-relating user behavior to the inventory on hand.

Ranjit

Tim

We always hear that simplicity leads to success, but there is a strong effect in the other direction: success leads to simplicity. If you know that millions of other people are doing something, you give it that extra effort to learn. And everything is simple once you know how to do it. I suspect that most successful products emerge from a convergence of good design, good utility, good timing, good marketing. And, then once everyone has learned to use it, we say “of course, it is so simple to use.”

Carolyn Pritchard

@ Anil-

That typo has been fixed; thanks so much.

best-
Carolyn

courtney benson

Amazon has been in tune with its’ customers needs for a long time -one major exception is Kindle but they are working on that and customer satisfaction will improve overtime. Looks like they will continue to do very well in up or down market.

Screen Sleuth

Amazon is really something…stronger than I thought they’d be. Though I think they’ve mishandled the Kindle 2 so far, they’ll be around for awhile it appears.

PerfectMOney

the recession is a hard road of glory thus its a good test to build “authority of quality when recession over.decreasing prices is good idea.and since amazon is focusing to customer satisfactions I think that will require amazon need more diversification symbiosis relations strengthen.though I wish amazon publisher given more intensive for what marketing effort they do

Woodstock homes

This should be the new business model for US companies. At a time when most high profile companies are drowning in debt, companies like Microsoft, Amazon, and Apple go the different route. I was unaware of Amazon’s debt to cash ratio, but I do find it refreshing in this day and age.

Leon Paternoster

“Everyone knows that Amazon’s e-commerce site succeeded because its interface was intuitive to the point of being completely natural.”

You think so? I use Amazon and don’t mind the service, but I find it pretty clunky and awkward to use. I’m guessing it succeeded for the same reason as eBay: it got in there first and became synonymous with ‘online store’.

Rick

Same deal with Apple, these two companies have tons of cash and are going to make a killing at the expense of their competitors. I bet Microsoft is glad now that they didn’t blow their cash reserves to buy Yahoo, eh?

Anil

“By March 27, Amazon plans to redeem the outstanding principle on its convertible”… Did you mean principal?

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