Yesterday I spent an hour speaking with Russ Grandinetti, Amazon's treasurer. Russ seemed straightforward, confident, and eager to answer questions to every extent that he could. These are qualities that I've found when speaking to anyone at Amazon's offices, and this is one reason that I continue to believe in the company's long-term potential to become more valuable than what it is today. Amazon has smart people.
I asked Mr. Grandinetti why he believes the public has so much passion about the company. He replied that Amazon is a company with which most of these vocal people have direct contact. Most people who have a passion towards Amazon (pro or con) have been customers and have had contact with the company's services, and those experiences have, in whatever way, changed their shopping behavior. When a business changes how you behave, you remember it, and this can make you feel "closer" to the issues at hand. Secondly, Amazon is not your typical retailer operating in a typical fashion, and this naturally causes debate.
For one, Amazon is investing in external businesses in a way that few retailers ever do (HomeGrocer, Drugstore.com, etc.). Second (and this is my own interpretation and not said by Russ), the company is growing up publicly, but the public critics are not letting it grow up gradually (meaning realistically). For instance, Amazon has spent more than $300 million on capital expenditures for assets that it hasn't utilized fully yet, and yet the company's numbers are typically analyzed at "face value" anyway. This perspective skews the operating numbers considerably towards the negative. Critics say, "Look how much Amazon has needed to spend already! And for what!?"
Proponents of Amazon can respond with this: In the long-term, Mr. Grandinetti states that Amazon believes that it can generate the same amount of sales dollars as a traditional retailer (at approximately similar margin levels) while working with only one-fourth to one-fifth the investment in fixed assets, and only one-fourth to one-fifth the working capital of traditional retailers. To do so, Amazon needs time to grow a sales base that more fully utilizes its current investment in assets.
As sales grow on a fixed asset base, returns on invested capital will jump, especially because new capital investments will, overall, continue to slow. In 1999, Amazon spent $320 million on capital expenditures. This year, the number should drop to between $200 million and $250 million. Overall, the number should continue to slide from there.
What About the Cash Balance?
The big issues discussed recently involve cash (will Amazon run out!?) and profitability. One major fault of the recent analysis that cited Amazon's cash running dry by early 2001 is that it relied on numbers from the first quarter of 2000. The first quarter is seasonally the weakest quarter in regards to cash flow at Amazon and for most retailers.
In January, Amazon paid the bill for many of the sales that it already booked in December, making its cash flow much more negative than it will be in subsequent quarters. The company's cash outflow in the first quarter was just over $300 million, but a whole $200 million of that went to "Accounts Payable" to pay for inventory shipped during the holiday. The negative analysis from last week assumed that these metrics wouldn't markedly improve from this level and thus cash would run dry in one year.
In actuality, operating cash flow should improve in every quarter of this year. Meanwhile, operating expenses should shrink until they are in the single digits (as a percentage of sales) in the fourth quarter. (Of course, the fourth quarter sees the largest jump in revenue, making this performance easier.) Operating expenses were negative 26% of sales in the first quarter of 1999, and they should be negative single digits in the last quarter of 2000. Even accounting for seasonality, this shows how Amazon is beginning to leverage its sunk costs.
Given that the next three quarters combined will be operating cash flow positive (obviously the fourth quarter is what makes this possible), Amazon (which had over $1 billion in cash and equivalents at the end of the last quarter) should end 2000 with at least $700 million in cash (according to Amazon in our interview). That's far from being broke! (Far enough that it deserved bold font.) From there, other than during first quarters (perhaps), Amazon's cash balance could (and should) steadily improve from operations alone.
Finally, due to cash generated by operations starting by the end of this year, it is likely that Amazon will never need to seek outside financing again. That is, unless it wants to. (Management won't comment, per the policy all companies have.) Meanwhile, the first bond payment doesn't come due until 2008. (As a sidenote, Russ Grandinetti stated that at least Amazon's books, video, and DVD divisions will be profitable this year. So, how does Amazon measure for profitability? I posted an answer.)
Today's comments, which I mean to be clarifying comments, don't mean that Amazon is in the clear. Many risks remain, of course, including the more than $2 billion in debt. At best, this debt stands to dilute current shareholder value. At worst, the debt represents an enormous cash outlay that Amazon will struggle to make. Other risks obviously exist. However, the swelling notion that Amazon is a company on its last legs is extremely misinformed. To the contrary, Amazon is very likely past its shakiest period regarding operating performance, and is now ready to grow some legs.
Former Fool writer Randy Befumo wrote three excellent articles on Amazon. If you're interested in the company and the recent events surrounding it (and its potential future), don't miss these: Part 1, Part 2, Part 3.
Fool "howardroark" wrote about Amazon's cash conversion cycle on the Amazon board: first post, second post.
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