Post of the Day
July 24, 1998
Subject: Financial Spreadsheet
Puumba is continually asking for a detailed spreadsheet to support AMZN's current/future valuation with no response from TMF's (you gotta admire his persistence). I would also love to see this type of analysis, but probably for a different reason than you - pure entertainment. Let me explain.
I've spent my entire career working with high tech start-ups, some from inception through VC financing and finally an IPO. All of them were required to do some financial forecasting for the next 5 years and rolling budgets for the next 12 months in order to get financing (whether it's public or private financing), and I've helped prepare these financial models in many instances. And although they provide some value in trying to determine a companies overall valuation, they are secondary in the investor's eyes (whether that's a underwriter or a VC) to the "story" and management capabilities.
|"The general rule for these types of companies - develop a long term vision, stay focused but flexible, evaluate your progress against your strategic plan, and manage cash, manage cash, manage cash."|
When a company is in its infancy in a newly developing market space (like Amazon is), the long term forecasts are almost useless. Investors will spend much more time evaluating the companies 5-year strategic plan, and examining their gut feelings as to whether management has the skills to execute. This is the type of discussion that our Foolish leaders partake in, and I for one agree.
What do VC's look for when investing? Here's a very incomplete list, but these are the most important and probably in order:
1. Large potential market 2. Quality of management 3. The vision of management 4. Defensible position/Competition (barriers to entry)
Argue these types of things until your blue in the face, but we're all going to learn together whether Amazon's vision is correct or not. By the way, I enjoy reading posts discussing these types of things vs. valuation or daily stock movements, because for speculative investments, they are truly the things that matter.
I have no clue where to start with developing a meaningful long-term financial model, especially since the assumptions are changing weekly and there is no existing model to use as a guide. Don't you ever wonder why so may of the people who are paid to develop these types of analyses (Wall St. analysts) are developing "new age" valuation methods when looking at companies like Amazon and Yahoo? These are some very smart people (although I doubt that they are smarter than me), and they too are clueless. As a matter of fact, most start-ups aren't even preparing detailed 5-year projects internally because they recognize that there is limited value in their ability to aid in managing the business. The only time they do it is when it is required by investors like VC's or underwriters.
Based on the comments of AMZN's management over the past few months, it seems to me that they have a long term strategic plan that is being evaluated based on a short-term results. Nothing wrong with this approach. The general rule for these types of companies - develop a long term vision, stay focused but flexible, evaluate your progress against your strategic plan, and manage cash, manage cash, manage cash. It's like a giant experiment, with management looking on like a scientist in a lab trying to cure cancer - you know what your overall goal is, but you're not really sure what's going to happen in the short-term in your lab or in the long-term in some other guy's lab. You just stick to your plan, evaluate the effect of your decisions and react accordingly. These guys are pioneers, and as such, recognize that it's hard enough trying to predict what's around the next bend, never mind what's going to happen 5 or 10 years out.
It's very clear to me, and I think bears and bulls alike agree, that AMZN is a speculative investment. There's nothing wrong with this, but investors in speculative companies need to be visionary. A traditional value approach is just not appropriate. I think this is why DG is so frustrated arguing his position (like his post about how AMZN is really a chance for the generally public to get in on a VC opportunity). When people like Rimpinths point to the fact of "sell more, lose more" they are not being visionary. It takes vision to see the potential opportunities (and potential pitfalls) that exist for Amazon. It takes intelligence to argue these visionary points (whether bullish or bearish). But to look at current losses and not see that it is an investment in the future (management's vision) is like sticking your head in the sand (Rimpinths, I'm not attacking you personally, I just remember that you said this because I read all your posts with such interest).
|"...I can develop a reasonable model to fit any valuation you want, but if Amazon continues to execute its business plan, and their vision of the future of e-commerce is correct, the current valuation may look like a bargain."|
Management's strategic plan says that the bottom line is not important now, but sales growth is. Their ultimate goal is not $500 million in annual revuenus (which is what they'll probably exceed this year), but much more. That they are plowing every cent back into the business to build a sales base that will be profitable in the future is exactly management's plan. When will they reach profitability? My guess is that will occur when management determines that additional money spent to grow sales is providing returns lower than if they had not spent it. Why retain earnings when you can use them to grow sales at the rate Amazon is? Question the plan if you like, but do it with a vision of the future, because Amazon is going to be around for at least a few more years. The fact that this quarter's loss was $0.44 or $0.20, as was estimated a few months ago, is irrelevant. Think about that for a while before firing off a reply and you just might grasp the concept.
Remember, these comments are coming from a very conservative CPA whose grounded in financial details (you should see my Quicken accounts - I'm just waiting for an IRS audit so I can be officially tabbed "most detailed recorded keeper in the US). The point is, I can develop a reasonable model to fit any valuation you want, but if Amazon continues to execute its business plan, and their vision of the future of e-commerce is correct, the current valuation may look like a bargain. It's much more beneficial to examine the quality of the business plan, and then using short term results, evaluate management's ability to execute.
This is not more internet hype from a bull (although I am bullish on Amazon). As a matter of fact, I haven't even given an opinion on the current or future valuation. This is just the reality of financial forecasting for high tech start-ups in new industries.
Sharing my real world experiences,
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