Wednesday, November 2, 2016 0 comments

Quick Thoughts on Amazon

I haven't been following the markets, nor investing for about 3 or 4 years, and it is interesting to see how things have changed. Not sure if any long-time readers are still around but some may remember that my favourite company (from a business perspective) was Amazon (AMZN). It was always seemingly too expensive so I never invested in it but if the valuation was lower--say during a stock market crash--I would have no problem investing a large sum for a long time (big risk with Amazon is management risk--loss of Jeff Bezos would be a big negative). Amazon changes more than most other companies of its size so there has been quite a few changes over the last 5 years or so.

First, the Kindle (or tablet in general) does not appear as lucrative or revolutionary as many investors, including me, imagined. I always thought Kindle had too much hype but I thought tablets as a category finally reached the stage where they could be used as a reading device. Obviously this didn't happen; some hardcore fans still use Kindle for books, but a lot of people, including me, don't use it as our primary reading device. Competitors like the iPad have also done poorly and personally speaking, I feel it is too limiting and lacking innovative features. For instance, it's hard to type up a blog post on the iPad, and don't even think about trying to download/edit photos (beyond something very basic) from a camera or something.

AWS (Amazon Web Services) has grown much larger within a few years. Cloud computing and web services seemed uncertain a few years ago but has now gained wide acceptance. Amazon is clearly a leader and will remain one of the top companies in this space for decades. Their lead is fairly large and, in addition, network effects and economies of scale keep strengthening Amazon's moat every single day). Having said that, it's not clear how good the web services/cloud services economics are. I think the market is attaching too high a multiple on anything cloud-related. Good example is how the market has bid up Microsoft (MSFT) largely on its perception that Microsoft is, all of a sudden, a cloud and web services company and profits are going to be great. The big question is whether the industry will generate commodity-like returns or something much better. SAAS (software as a service) might be able to generate high returns but not so sure about IAAS (infrastructure as a service) and PAAS (platform as a service). Overall, AWS is going to be a big competitive advantage for Amazon but not sure how much it will contribute to profit in the long run.

Another big development is Amazon's push into logistics. Amazon became a fairly sizeable cargo airplane operator recently, after leasing 40 airplanes. This is in the very early stages but if Amazon could make this a success, it will radically transform the company and significantly reduce shipping costs and, perhaps more importantly for the future, shipping time. Quicker shipping time would be a big service differentiator.

Finally, I notice that Amazon sort of has some Costco-like characteristics: the Amazon Prime membership. A few years ago Amazon Prime was mostly a shipping thing. If you wanted faster shipping and/or cheaper shipping (if you ordered a lot of items), it was something to consider. Quite a number of people who signed up for Amazon Prime cancelled it after a while. Over the last few years, Amazon has bundled certain additional features/services, such as free online movies/television shows. This has resulted in many customers signing up and remaining recurring customers. It's almost like an optional membership now. The interesting thing is that the financial characteristics resemble Costco in a minor way now. Costco competed with discount retailers like Walmart but its membership fees generated guaranteed revenue every month. Based on some estimates, Amazon has about 54 million Amazon Prime customers. At around $100 per year ($99 but let's just round it up for simplicity sake), that means Amazon is earning around $5.4 billion per year just on Amazon Prime memberships. That has to cover shipping and other services that are bundled, but it means customers are likely to be sticky. Similar to Costco members, Amazon Prime customers are likely to consider Amazon as their primary shopping destination and spend more at Amazon.

Overall, the company looks overvalued just like when I last looked at it briefly. But it has executed well and its moat is significantly larger. I also like how the company, through luck or foresight, has diversified into adjacent businesses.

(On an unrelated note, one other subtle change over the last few years I notice... that impacts small investors is how trading commissions have gone down significantly in Canada (USA was always cheaper and hasn't dropped as much). It used to cost around C$25 to place a trade--less if you traded a lot or had some premium account--but now it is around $10. If you portfolio is small, this is a big change for things like risk arbitrage. Before a "round-trip" buy/sell would be around $50 so if you invested, say, $5000, that's like 1% cost. Now it is less than half that so risk arbitrage positions with small spreads can actually be considered.)

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