– 23 years later

Article #643 by Edward Rizzo - Published Weekly

Last week marked the 23rd anniversary since the initial listing of Inc on the NASDAQ Stock Exchange in May 1997. The offering in 1997 comprised 3 million shares at a price of USD18 per share valuing the company at USD300 million. After taking into consideration three share splits in the past 23 years, the adjusted closing price of Amazon’s shares on their first day of trading was USD1.96. As such, those who invested USD10,000 on the first day and who maintained their stake since then, would have seen their value grow to USD12 million today since the share price is currently languishing above USD2,400.

Amazon was founded by Jeff Bezos in 1994 in his garage as a simple online bookstore competing with two companies in particular – Borders and Barnes & Noble. The company has expanded significantly in a relatively short period of time from its origins as an online bookstore. Amazon today has close to one million employees, occupies nearly 334 million square feet of real estate, and accounts for nearly half of online retail sales in the US (compared to its next biggest competitor, Walmart, at only 5%). Amazon’s founder and CEO Jeff Bezos is the single largest shareholder owning more than 11% of the company making him the world’s richest person with a net worth of over USD110 billion.

Amazon engages in the retail sale of consumer products and subscriptions divided into three segments: (i) North America, (ii) International, and its cloud computing business (iii) Amazon Web Services (AWS). The first two segments, North America and International, refer to geographical breakdowns of Amazon’s retail business.

While many may only perceive Amazon to be a successful online retail store, one of Amazon’s biggest success stories is the cloud computing business which nowadays generates the bulk of the company’s profits. Amazon Web Services dominates cloud hosting as it captured roughly half of the cloud infrastructure market. Despite the dominant market position in the cloud business, this segment remains among Amazon’s fastest growing business units. AWS provides services to businesses, government agencies and academic institutions to store information and deliver content. Overall, AWS accounts for just over 10% of revenues but around 63% of operating income.

The bursting of the bubble in the year 2000 destroyed many newly set-up Internet companies. Although Amazon survived the tech crash, its share price still lost 90% of its value from the level in December 1999 which was equivalent to 50 times its IPO price only two and a half years before. Despite the huge sell-off in the early 2000’s, an investment in Amazon in December 1999 when the price had peaked at a price of USD85 has still paid off handsomely with a USD10,000 investment at the time being valued at USD283,500 today.

Amazon was still a loss-making company during the bubble and only managed to register a small profit for the first time during the fourth quarter of 2001 on revenues of more than USD1 billion showing the very thin profit margins of the e-commerce business. The loss-making status of the company for many years and the minimal profits margins as from 2001 led many commentators to criticise the company’s business model and predict its demise. However, the business model of Jeff Bezos was largely unconventional at the time with the focus being on building revenues as the CEO believed that in time profits and cash flows would follow suit. The main vision of Bezos was that in order to succeed as an online retailer, Amazon would need to “Get Big Fast”.

In his annual letter to shareholders in 2001, Jeff Bezos stated “when forced to choose between optimising the appearance of our GAAP accounting and maximizing the present value of future cash flows, we’ll take the cash flows”. He further argued that the focus on cash flows is important since the “share of stock is a share of a company’s future cash flows, and, as a result, cash flows more than any other single variable seem to do the best job of explaining a company’s stock price over the long term”.

So how did Amazon really succeed in the crash while others failed?  Apart from ensuring maximum customer loyalty by being a technology company which simplified online transactions for its customers, many commentators believe that the main reason for Amazon managing to ride out the turmoil of the early 2000’s was the USD600 million bond issued just a month before the crash of the stock market. Although Amazon was forced to offer an interest rate of 6.9% for its convertible bond offering, some financial commentators contend that without this fund raise, Amazon could have faced the prospect of insolvency over the next year similar to many other companies.

After the very challenging conditions in the early 2000’s, the company spent most of the following decade consolidating and preparing for its next phase of growth. Revenues grew at nearly 29% per annum between 2000 and 2010 reaching just over USD34.2 billion in 2010. This very strong growth in revenues persisted after 2010 at almost the same rate as the prior decade but on a much larger base indicating the outstanding success of the company.

Amazon Prime, a membership programme which provides free shipping of various items, access to unlimited streaming of movies and TV (in competition with Netflix), and other services was launched in February 2005. Subscriptions to Amazon Prime, which costs USD119 annually in the US, surged to over 150 million as at the end of 2019.

After struggling for years in the intensely competitive grocery delivery business, Amazon conducted its largest acquisition in 2017 when it paid USD13.7 billion for Whole Foods – the organic food retailer with 471 stores across the US market.

Amazon is one of the relatively few companies that is actually benefiting from the COVID-19 pandemic which contributed to record demand for its two largest businesses, e-commerce and cloud computing. The entire world is getting more used to online shopping and remote work, accelerating the development of these important industries. In fact, in recent weeks, Amazon hired 100,000 additional workers and announced that it will be employing an additional 75,000 workers in order to cope with the rising demand for its e-commerce business.

Amazon first hit a USD1 trillion market value in September 2018 before easing lower and regaining this coveted milestone again in July 2019 and also in January 2020. However, as a result of the outbreak of COVID-19 leading to the fastest bear market in history, the share price dropped sharply to a 52-week low of USD1,626 on 16 March. Since then however, the share price rallied strongly and climbed by 52% hitting a fresh all-time high of USD2,475 on 30 April in anticipation of the publication of the first quarter financial statements which were due for publication after the close of trading that day.

The company reported a 26% increase in Q1 revenue to USD75.5 billion as it experienced ‘holiday-season order volumes’ in what is typically the slowest quarter of their financial year. Although revenues exceeded expectations, the company’s operating expenses jumped to USD71.5 billion resulting in a 9.8% decline in operating income to USD4 billion. During the first quarter of 2020, revenue from AWS climbed by 32% to USD10.2 billion despite increasing competition from Microsoft’s Azure platform, Alphabet's Google Cloud and IBM. The AWS business segment reported operating income of USD3.08 billion during the first quarter of the year, accounting for the bulk of Amazon’s profits.

Amazon expects revenue in the range of USD75 billion to USD81 billion during the current quarter to 30 June, which would represent another growth in excess of 20% from the same period last year. However, it expects operating income to range between a loss of USD1.5 billion and a profit of USD1.5 billion compared with an operating profit of USD3.1 billion in the second quarter of 2019. Amazon’s chief executive Jeff Bezos stated that “under normal circumstances, in this coming Q2, we’d expect to make some USD4 billion or more in operating profit”. Instead, the CEO committed to spending the next quarter's operating profits of roughly USD4 billion on COVID-related expenses comprising extended bonus pay for Amazon's workers, more cleaning supplies and personal protection equipment, and an investment in producing COVID-19 testing capabilities in-house.

For a company with sales of USD280 billion in 2019, Amazon makes surprisingly little profit since the bulk of sales come from the retail business, which generates a very modest profit margin. However, the company’s CEO has never been focused on profitability but on revenue growth, cash generation and investment opportunities.

Analysts are clearly anticipating that the convenience of online shopping and cloud computing will outlast lockdowns once the pandemic subsides and lead to higher revenue and profitability in the long term. In fact, despite the recent rally in the share price, just two analysts have a "hold" rating on Amazon and no analyst has a “sell” recommendation from among the 51 analysts who follow Amazon, according to Refinitiv. The average 12-month target price is USD2,670 and one analyst in particular described the leading online retail and cloud computing giant as the ultimate 'stay-at-home stock'.

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This article was produced by Edward Rizzo, Director at Rizzo Farrugia, which is a company licensed to undertake investment services in Malta by the MFSA under the Investment Services Act, Cap. 370 of the Laws of Malta and a member of the Malta Stock Exchange. The company’s registered address is at Airways House, Fourth Floor, High Street, Sliema SLM 1551, Malta.