Amazon Revisited

July 16, 2013

Roughly a year ago, we examined whether shares of Amazon could continue to levitate in the face of the company’s minuscule profitability.  See A River of Doubt – June 25, 2012.

Since then, AMZN shares have continued their ascent into the ether, climbing from $220 then to $307.33 as of a few minutes ago – an increase of nearly 40%.

The question is whether this can continue.

By traditional valuation metrics, the contrast between AMZN and another enormous, technologically sophisticated retailer – Walmart – is striking (the table shows, for instance, that AMZN’s price/sales ratio is currently 4.0x that of WMT’s).

Click on the charts to enlarge.

Amazon v Walmart multiples

Amazon v Walmart valuation

Readers could be forgiven for being confused as to which of the two companies was actually making money.

Amazon v Walmart profitability

Since Amazon is barely profitable now (and in fact, the company had negative net earnings for 2012), the bull case is based on the belief that this sad state of affairs won’t continue much longer, for two reasons:  1) retail margins will increase; and 2) the higher margin cloud computing business (Amazon Web Services, or AWS) will drive an ever higher proportion of the company’s revenue stream.

Let’s examine each of these assertions in turn.

What if, for example, Amazon’s margins grew to those of Walmart? (click to enlarge)

Amazon v Walmart spreadsheet

At its current price, AMZN would still be trading at a P/E of roughly 60.

AMZN is facing a number of headwinds, too.

  • Most large states now require the company to collect state sales taxes.
  • Amazon’s efforts to build out physical delivery centers will not provide much of an advantage.  Competitors such as Walmart already have delivery centers – quaint little facilities called “stores.”
  • While Amazon has driven many brick and mortar retailers out of business (the “showrooming” phenomenon), the survivors are responding in creative ways not conducive to increased Amazon profitability.  See The Emporium Strikes Back (Economist July  13, 2013).

So what then for Amazon’s stock price?

WMT trades at a P/E of 15.2.  WMT valuation metrics and some heroic assumptions about  Amazon’s ability to raise its operating margins, translates into a $75 stock, not a $300 one.

Alert readers, however, will ask one final question:  what about the cloud?

Since Amazon does not break out AWS revenues or profitability in its financial statements, this number is really just an analyst’s guess.  At the moment, AWS services appear to constitute about 10% of the company’s revenues, though these are growing rapidly.

Amazon Web Services generated $2.1 billion in revenues in 2012, according to an estimate by Ben Schacter, the Macquarie Capital analyst who is thought to have one of the strongest information pipelines into AWS. Those revenues will grow to $3.8 billion in 2013 and $6.2 billion in 2014, he has said in his reports on Amazon.  See Amazon Cloud Mystery Persists (Information Week).  

The trouble, as the article notes, is that the Cloud is becoming ever more competitive every day, with other large, well-financed competitors like Microsoft jumping into the fray.

We’ll conclude by leaving the reader a table and a chart.  In the table, RAX is Rackspace, a fast-growing pure-play cloud computing enterprise.

Amazon v Walmart Rackspace

Surprisingly,  Rackspace’s PE to Growth ratio is lower than Amazon’s, while its Return on Assets is not much higher than Walmart’s.

In a concluding note, the chart below repeats the point that Amazon has never achieved the operating profitability of Walmart – and most likely never will.

Amazon v Walmart margins

This does not mean that the stock will plunge tomorrow – only that when it does, it will be a long way to the bottom.

Caveat emptor.

Egypt – The Winner’s Poisoned Chalice

July 3, 2013

The recent turmoil in Egypt prompted me to revisit a post I wrote back when the Mubarak regime was beginning to topple in early 2011.  See Musings About Egypt, January 31, 2011.

While the country is large, only a tiny fraction is inhabitable, and this part is  densely packed with unemployed – and in many cases, unemployable, young people.

Fertility rates, though down from their levels of the 1960s, nevertheless remain high – certainly far outpacing the country’s economic growth.

As I commented during the last “regime change,”

Whichever faction emerges as the winner of the current power struggle will have its hands full – with the operative word being “full.”

No one can say who will emerge on top after this latest wave of unrest.  But to whomever you are, I can only say one thing:

Good luck.  You will need it. 

The full text of the January 31, 2011 post is below: 

In all the coverage of the political situation in Egypt, I haven’t found a single article or report that mentioned the country’s effective size or its incredible population density.

According to the CIA World Factbook, Egypt covers one million square kilometers (387,000 square miles) – an area roughly the size of Texas and New Mexico combined.

However, only a tiny fraction of the country is habitable, and this area, consisting of a narrow strip running along the Nile, is one of the most densely populated regions on earth.

As the above map (courtesy of Google Earth) shows, over 90% of Egypt is desert.  Thus, the population is concentrated in a narrow strip 5-10 miles wide on each side of the Nile, and in the Nile Delta – a combined area totaling roughly 30,000 square miles, or the area of South Carolina or Maine.

Now, fill either of those states with 80 million people, and one approaches a population density of 2,600 inhabitants per square mile – a figure exceeded by only a handful of islands or city-states like Singapore or Hong Kong.

In other terms, the effective population density of Egypt equals that of Bangladesh, which crams what would be half the inhabitants of the US (~150 million) into an area the size of Iowa.

(By way of comparison, the most densely populated US state – New Jersey – and the most densely populated European country – the Netherlands – each have a population density of roughly 1,000 inhabitants per square mile).

In the developing world, high and growing populations are generally correlated with poverty, and this is true of Egypt as well.

Though fertility in Egypt has dropped from 7.2 children per woman in the early 1960s to 3.4 in 1998,  current trends point to a population growing to 100 million in the next fifteen years.

And, as the Rand study points out,

Fertility rates are especially high in the poor rural areas of Upper Egypt, which are least able to support rapid population growth. A third of Egypt’s population and nearly half of the Egyptian poor reside in Upper Egypt.

(Note:  Upper Egypt is the southern part of the country – the upstream portion of the Nile).

Whichever faction emerges as the winner of the current power struggle will have its hands full – with the operative word being “full.”

View from the Front Lines of Health Care

May 17, 2013

I occasionally find myself traveling in remote locations, so I recently took an Emergency Medical Technician course at my local community college in order to gain some semblance of a clue as to how to respond to a medical emergency.

The practical portion of the course called for working a number of shifts in both the back of an ambulance and in the emergency room, and the level of costly self-destruction that I saw was appalling.

Contrary to the denizens of the ER on popular TV shows, none of my patients threatened to infect the hospital staff with some nasty new bug previously unknown to science, and very few had sustained any serious trauma, much less something truly interesting (such as the patient who stumbles into the ER with a hatchet embedded in his skull).

Instead, we regularly confronted the inevitable result of years of self-destructive behavior.

Twice I was called to the home of a 300+ pound behemoth who had fallen off the toilet and couldn’t get up (the spouse called 911).  Neither of these patients consented to be taken to the hospital, so our “treatment” consisted of lifting them up, helping them dress and moving them back to their living room recliners – while maintaining what microscopic shred of dignity was possible in such circumstances.

To no one’s surprise, these patients were diabetic, as were the vast majority of other people who found their way into the ambulance or the ER.

Obesity & Diabetes

Diabetes, however, was rarely the patient’s only problem.  When summoned to a residence, EMS crews always ask what medications the patient is taking, and more often than not, a family member would return with a Walmart bag stuffed with prescription containers.

Try not to think of who is paying for these medications (Hint:  it isn’t the patient).

As others have pointed out, none of this is remotely sustainable.  It is a shame that most of my younger classmates (eager consumers of popular brands of sugar-water) didn’t seem to be paying attention.

The Can Kicks Back (well, maybe not)

January 7, 2013

This morning, an article in my local newspaper mentioned an organization called The Can Kicks Back, which was portrayed as a group of Millennials who have finally woken up to the fact that the crushing burden of the accumulated US debt will fall squarely upon their own shoulders.

At last, some younger people get it, I thought.  But alas, all is not what it seems.  The lead link on the CKB web site describes how the “fiscal cliff deal fails millennials” in a way that reflects almost complete ignorance of basic economic facts.  According to CKB,

Apart from doing little to reduce our long-term deficit and debt, the “deal” fails to adequately address the biggest problem facing young people today: unemployment stemming from an uncertain economy. Under the proposed plan, businesses will continue being too scared of what the future holds to make new hires.

No, businesses are not “too scared.”  Rather these businesses are confronting the reality that their costs are inexorably going up just as sales are declining – because their customers are too heavily indebted to buy more stuff.

And what is the #1 driver of these cost increases?  Health insurance costs, driven ever higher by the President for whom they voted so enthusiastically - a President who seems convinced him that the best way to encourage companies to hire more employees is to make doing so more expensive and onerous.

The CKB site also links to the National Campus Leadership Council, a group of, supposedly, “100+ student body presidents.”

And what do these students want?  “Bipartisanship and compromise.”

“But to do what?” you ask.

According to the site, they want to avoid drastic spending cuts and tax increases that could “threaten our already fragile economy.”  Oh, by the way, they also want to freeze interest rates and keep Pell grant money flowing.

In other words, these so-called anti-can kickers want:

1.  Someone else (the “rich”) to pay higher taxes; and

2.  No spending cuts that could hit them.

The CKB organizers have identified the problem correctly:

The young people I’ve talked to across the country are afraid about what’s ahead, and I don’t blame them. Until Washington can come up with a real deal to fix the debt, we are left to assume that by the time it’s our turn to be in charge, so much of the money coming in will be going to pay down past spending that we’ll have no way to confront the unknown challenges of the future.

But they fail to grasp that the promises made to every group (including themselves) are false – that none of them will be kept, because the money to pay for them does not exist and cannot be made to exist in any plausible state of the world.

Their demand is for a “real plan to fix the debt” – but one that involves no pain to anyone.  

Young people don’t want to see our parents, grandparents or country hurt, and a real plan to fix the debt should be implemented in a way that will not hurt our fragile recovery or makes cuts that threaten our global competitiveness. But we ask leaders to confront the generational inequity being set up by refusing to deal with the structural drivers of our debt now.

In other words, these students – though they have identified the problem – still believe that it can be solved by Santa Claus riding in on a sleigh towed by unicorns, if only Santa and those bounteous creatures can act in a more “bipartisan” way.

What on Earth Do They Do?

December 10, 2012

Recently, the mainstream media have caught up to the blogosphere and started to take note of the staggering levels of student debt and the limited value that many students have received in return.

But even those who are so jaded by the raw criminality of our financial elites that they consider themselves incapable of further shock have to greet statistics presented by last week’s Economist as a surprise.

In an article highlighting the “declining value for money” that American universities are giving their students, the author quotes a federal study that found that literacy of college educated citizens declined from 1992 to 2003, and that only a quarter of these graduates were deemed capable of “using printed and written information to function in society.”

In large part, this is due to what stands out from another statistic:  one that anyone who graduated from college more than 10 years ago will find hard to believe:

“almost a third of students these days do not take any courses that require more than 40 pages of reading over an entire term.” 

Since most of us had 40 pages of assigned reading every night, this leads to the obvious question of what on earth do these students do?

Not that this detracts from their GPAs. 

The article goes on to mention that “a remarkable 43% of all grades at four year universities are As,” up from 17% in 1960.

This, like so many things in our society, is essentially accounting fraud, as these “straight-A” students will eventually collide with the brick wall of a real world that actually expects them to know something useful before handing out large paychecks.

And the so-called “salary gap” between high school and college graduates is more of a function of the “plummeting value of a [high school] diploma, rather than soaring [college] graduate salaries.”

It is not only under-educated students who will suffer in the end, though.  As with fraudulent subprime mortgages and other forms of toxic derivative waste, the current state of affairs was made possible only with massive federal subsidies – in this case federal student loan guarantees.

For a preview of what lies ahead, 9.1% of borrowers had defaulted on their federal student loans within two years of graduation, and 200 of our colleges and universities have a three year default rate of 30% or more (out of a total of 4140 public and private schools).

What can’t go on forever won’t.  This will get ugly.

Or maybe not.  After all, we’re all winners!

Doonesbury 2012 04 13

Tax Rate Nonsense and Congressional Corruption

December 4, 2012

With all the hyperbolic argument over tax rates, it is surprising that few mainstream commentators have addressed a simple, fundamental fact:  in terms of the overall economy, the top marginal rates are irrelevant.  (Top rates do matter to honest individuals, but not in the big picture). 

As the following chart demonstrates, federal tax receipts have consistently hovered between 16 and 20 percent of US GDP since the Second World War, even though top marginal rates during this period ranged from 28 to 92%.

Federal Tax Receipts as % of GDP

Analyzed by income strata, effective taxes paid have not varied a great deal since 1980, either, even though top marginal rates that year were 70%.

Taxes Paid

The reason is straightforward:  except in a few limited cases, taxpayers do not pay high marginal rates, despite whatever the headline number of the day happens to be. 

Instead, taxpayers with income subject to confiscatory taxes are driven to bribe contribute to Congress to enact tax shelters to bring their actual rates down to a manageable level.

Rather than raise additional federal revenues, high tax rates instead foster a culture of corruption and dishonesty, rewarding clever lawyers and accountants, while serving as parasitic drag on the productive economy. 

Moreover, many of the tax shelters of the 1970s drove mal-investment in otherwise economically unjustifiable strip centers and apartment complexes.  In the words of a New York accountant:

Many wealthy Democrats in NYC [in the 1970s] avoided higher tax rates with plenty of tax shelters, mostly in real estate and energy. I worked on a tax return for a family member of one of the biggest family Wall Street brokerage firms. He had close to 100 tax shelters plus very high dividends.

Readers who lived in Dallas or Houston in the late 1980s can surely recall the aftermath of this misguided state of affairs:  apartments that went from yuppie party-villages to Section 8 almost overnight, once the 1986 tax reform stripped away these complexes tax advantages and the oil bust removed even the pretense of actual economic demand for the space.

Unfortunately, the same people who thrived on the corruption and mal-investment of the 1970s are eager to repeat the same error – this time in the guise of “saving housing.”

For instance, the accountant quoted above blames the elimination of passive activity losses for the Savings & Loan debacle and even the 1987 stock market crash.

Yes, the 1986 tax reform may have hastened the demise of the S&Ls, but that is akin to saying that a strong gust of wind blew down a house whose frame had already been almost entirely consumed by termites.

High marginal tax rates punish the honest and productive, and reward a parasitical class of political fixers, but do little to raise federal revenues in any meaningful way. 

How to Repair Institutional Credibility (or Maybe Not)

December 3, 2012

Over two years ago, we directed readers to polls that demonstrated marked declines in credibility for almost all of our country’s major institutions.  See “Public Perceptions” (August 3, 2010), as well as the following charts.

Gallup Ethics CongressGallup Ethics

This decline has not gone un-noticed by others, either.

Consider the following missive inviting alumni of the consulting firm McKinsey to register for a webinar on the subject. 

On December 11, Managing Director Dominic Barton and Richard Edelman, CEO of Edelman Worldwide, will present an exclusive session on the future of capitalism and public trust in institutions. They will review how public trust – in most institutions – has neared all-time lows, and discuss areas leaders should focus on to rebuild trust in their organizations.

Alert readers will undoubtedly connect the dots – the McKinsey offering this webinar is the same firm whose managing director from 1994-2003, Rajat Gupta, was recently convicted of insider trading in the Rajaratnam/Galleon case and sentenced to two years in prison. 

Business Week reports that true to form for this sort of thing,

Gupta has been removed from the prominent corporate and philanthropic boards on which he once served and is shunned by business leaders who were once his friends.

But this is less due to Gupta’s actual conduct than the fact that it exposes the extent of the rot, hypocrisy and self-dealing that permeate our so-called political and financial elites.

Readers with longer memories will recall McKinsey’s prominent role in the Enron affair, led by another McKinsey director, Jeff Skilling, who now also resides in a taxpayer-provided facility (and, whose name, like Gupta’s has been struck from the firm’s alumni directory).

We may, over time, be able to rebuild public trust in our country.  But the first step will be to recognize that the same people and organizations who got us into this mess are not going to be the ones who get us out.

Why the Fiscal Cliff Debate is Irrelevant

November 30, 2012

As our Congresscritters and the White House continue to squabble over the upcoming “fiscal cliff” (and in the process whipsawing the stock markets with each new pronouncement that a deal is on off back on), investors should be aware of the big picture – that neither scenario (deal or no deal) will address the fundamental issue of unsustainable federal deficits. 

Two charts put this in perspective.  The first, an excerpt of a larger chart in USA Today, shows that even if all of the fiscal cliff’s tax increases and budget cuts go into effect, the deficit will only decline from $1.1 trillion to $641 billion (-42%).

USA Today Fiscal Cliff

To put this $641 billion figure in perspective, compare it to all federal budget deficits since 1972 (source:  Congressional Budget Office).

Fiscal Cliff

Even if we plunge over the cliff’s edge, the federal deficit will still be higher than it has been for any year before 2009.   And this is a baseline.  Any “deal” will result in fewer spending cuts, and thus higher deficits.

If deficits truly don’t matter (as we learned from Dick Cheney), then all is well.   But if not, the outcome of the debate will be simply a choice between “horrid” and “atrocious.”

CEO Psychopaths

October 23, 2012

Even a cursory reading of the business press reveals a plethora of stories about CEOs or private equity moguls walking away with hundreds of millions while the companies under their charge lay off workers and/or file for bankruptcy.

Just last week, Vikram Pandit was forced out, er, resigned, from his post as CEO of Citigroup.  having been paid over $260 million during his tenure while presiding over a 90% drop in the company’s stock price.

And this morning, Bloomberg reports that the private equity moguls behind the largest LBO in history have paid themselves $528.3 million in fees as the company teeters on the verge of bankruptcy – a bankruptcy that will be the direct result of the enormous debts that KKR and TPG piled onto the company in the first place.

The greed, and in many cases outright fraud, has become so brazen that one has to wonder:  are these people psychopaths?

And the answer, according to Scientific American, is that, in fact, they are. 

In an October 2012 article entitled, “The Wisdom of Psychopaths,” the author finds that psychopathic serial killers and business/political leaders share many of the same traits, namely:

a grandiose sense of self-worth, persuasiveness, superficial charm, ruthlessness, lack of remorse and the manipulation of others … [and that] such a profile allows those who present with these traits to do what they like when they like, completely unfazed by the social, moral or legal consequences of their actions.

In the words of Jon Moulton, one of London’s most successful venture capitalists, determination, curiosity and insensitivity were the three most valuable character traits that vaulted him to the top. 

The first two are taught in business school.  But the third?

As Moulton explains, the great thing about insensitivity is that “it lets you sleep when others can’t.” 

The professionals who used to at least try to put a check on this sort of thing are no longer in positions of influence (see “The Rot Runs Deep:  The Capture of the Professional Class“).

We’re doomed.

They Walk Among Us … and Vote

September 7, 2012

Separating well-meaning but uninquisitive donors from their money is a scam as old as charity itself. 

Over a century ago, Mark Twain’s Huckleberry Finn scoundrels, the Duke and the Dolphin, bilked gullible church-goers with their tales of Indian Ocean pirates and their intentions to convert these malefactors to the Way of truth and righteousness.

But today, social media has greatly expanded the fraudster’s bag of tricks.  The name of the game is to create “buzz,” so that the charity can become the cool new cause. 

As to what the cause is, or – more importantly – what the charity raising the money will actually do in furtherance of that cause – these are just bothersome details. 

As the latest Bloomberg Business Week explains:

Millennials donate money differently, explains Richard Honack, a nonprofit marketing expert and a professor at Northwestern University’s Kellogg School of Management. “Baby boomers and most Gen Xers give to what they know: their churches, universities, maybe a cancer society. But [for] younger people, a buzz cause will come on, like the Haiti earthquake or Invisible Children, and they’ll donate money without even thinking about where it’s going. They just assume they’re doing something good.”

We already know that hundreds of thousands of young people are taking on enormous, non-dischargeable debts to acquire college degrees that are, for all real-world purposes, useless.  But it still comes as a surprise to learn that so many are failing to learn even the most basic critical thinking skills – namely, to ask at least a few rudimentary questions before handing over your money.


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