It looks like a bear trap to me...

Matt Yglesias:

That’s because Amazon, as best I can tell, is a charitable organization being run by elements of the investment community for the benefit of consumers. The shareholders put up the equity, and instead of owning a claim on a steady stream of fat profits, they get a claim on a mighty engine of consumer surplus. Amazon sells things to people at prices that seem impossible because it actually is impossible to make money that way.

This article makes no sense to a finance person... revenue up, sales up, margins thinning, and losing money is a good thing?  That is a company buying market share at the expense of profits which results in a Pyrrhic victory for shareholders.  You won... and lost all your money.

Amazon is such a two headed company - it's got the head of the village idiot and the head of the village genius sitting on the same shoulders...

Here's a useful analysis from Ben Evans:

http://ben-evans.com/benedictevans/2013/1/27/fcf-is-evil

Amazon explicitly states that we should focus on trailing 12m free cash flow, not net income, as the key performance metric. ...

Over the last 3 years, Amazon's revenue is up 130% and its chosen profitability metric is down by two thirds. This is not a coincidence.

Jeff Bezos says that 'your margin is my opportunity': this is what that means."

S-

Scott,

This discussion about Free Cash Flow is fascinating and confusing.. I thought that maybe Amazon had just missed a quarter (they paid big bucks this quarter for their new HQ in Seattle) along with a bunch of other aggressive expenditures on infrastructure.. but Ben Evans' analysis and his graphs are quite persuasive. It seems as if "Sustainable Free Cash Flow" means keep it as low as you can (just like profit margins) and spend/invest money on things you need to grow the business.

Great article from the Atlantic by Derek Thompson, quoting Eugene Wei, sheds some light on this topic: Why Amazon is Special and Apple is not--in 1 Paragraph. 

Why is Wall Street so punishing toward Apple, the most profitable tech company in the world, and so forgiving of Amazon, which can barely turn a profit? This remarkably clear-eyed post by Eugene Wei, "Amazon, Apple, and the beauty of low margins," is the most elegant answer to the question I've read yet. Here is the money paragraph on competitive risk:

An incumbent with high margins, especially in technology, is like a deer that wears a bullseye on its flank. Assuming a company doesn't have a monopoly, its high margin structure screams for a competitor to come in and compete on price, if nothing else, and it also hints at potential complacency. If the company is public, how willing will they be to lower their own margins and take a beating on their public valuation?

And one way for Amazon to keep its profit down is by investing in AWS, a practice that Pete Horne thinks loses them money. He thinks they should get out of the AWS business, since it loses money, and stick to retail, their truly profitable niche.  Bezos’ counter-argument is that in the long run AWS feeds onto the retail business, because they only develop what they need for that business, so it can’t be looked at in isolation.

What the quoted paragraph says is that so much the better if profits on retail made by Amazon are obscured by losses on AWS. Amazon does not need to report profits to attract investor capital, and potential competitors are frightened off by their thin reported profits.

(In fact; does Amazon even need investor capital? How much money from investors does it need? The chief reason for management to act to keep stock price high is either so the company can get new money by selling stock, or if management wants to sell stock it owns. Neither impetus may prevail at Amazon. At this point, almost all the capital needed for expanding their warehouses and inventories can be borrowed at quite modest rates. Maybe the market sees this, and the eventual value of those resources, hence the rise in stock price.)

Tom

Does management have no fiduciary duty to shareholders anymore?  Or is that a quaint old-timey notion fit only for homey little cross-stitched throw pillows nowadays?

S-

I suspect the Amazon answer is yes, it is still the focus. You just need to define the timeframe you’re referencing.  Ours [Amazon's] is a very long time horizon.

Eric

Amazon looks for 5 to 7 year payback on infrastructure investments (fulfillment centers, IT/Cloud/Software) but expects to see BENEFITS to customers perceivable within 12 months.

Patty

What does fiduciary duty to shareholders call for? Long term profits, or highest short term stock price? "Chainsaw Al" did well by shareholders in that last regard, by doing what I have come to call "brand mining"; It may take 35 years to build a brand, like Maytag, say, but it’s value can be “mined” in short order by the likes of “Chainsaw Al”, who bumps up the price of the stock with short term “performance improvement”, then gets out fast.  His cost cutting has its eventual effect on the brand: cutting spending on engineering that keeps the brand competitive, or cheapening a highly regarded reliable brand by cutting manufacturing costs at the expense of product longevity.  By the time the effects on the brand manifest themselves, the brand-miner is gone, along with his bonus and option proceeds. Any shareholder who sells with him profits from this behavior, but not a shareholder who is in for the long haul.  To which shareholder does managements owe its fiduciary duty?

It is also dangerous for management to own options rather than equity for this reason.  An option holder has nothing to lose if the stock goes down, gains only from appreciation of the stock, whereas an equity holder is concerned that the value of the stock be preserved. The tax code now favors options over stock grants; it should be changed, in my opinion, to allow grants of stock to management with no obligation to pay taxes on such stock until it is sold, and the tax obligation on selling should be based on the total value of the stock sold, not its appreciation since the grant. Management will then have  exactly the same interest as shareholders, which now they do not. And the temptation to “time” option grants for low stock prices will be gone. Even Steve Jobs got tripped up by that one.

If “Chainsaw Al” had been granted stock that vested slowly over many years instead of options and big bonuses based on quarterly “performance”, many of the brands he destroyed might still be around, and he might have earned a different nickname.

Tom

Actually under an incorporated entity, management does not have the fiduciary duty to the shareholders.  Management act with the delegated authority of the Directors who are the ones who have the duty.  Management has to be honest, but it does not have to be competent or even correct.

Interesting questions.

Actually, the board is a collection of directors, who elect management. The directors are responsible to the shareholders who elected them, but those majority shareholders themselves hold a fiduciary responsibility to minority shareholders, as does the board - minority shareholders being those who did not vote for the directors constituting the board.  The company cannot run roughshod over the interests of minority shareholders, but that is often what happens. A corporate raider may want short term appreciation of the stock, wins a proxy fight, brings in a Chainsaw Al as CEO, and the brand is soon history, contrary to the interests of minority shareholders (and maybe even contrary to the interests of many who gave their proxy to the raider to make the majority needed to change the board, thinking that management needed shaking up, not realizing what was in store.).

Hence there are many interesting questions around who represents whom, and what responsibilities does that representative have to those who have invested in the company but who voted against the directors running the company. These considerations are always of interest, but especially when a proxy fight occurs because one group of shareholders disagrees with another as to how the company should be run.

All of this has been brought to mind by the fight Patty and I are engaged in to keep St. Andrews Hospital open in Boothbay. Whatever the questions that arise with for-profit corporations, they are amplified when the corporation is a not-for-profit charitable entity with corporate members electing the board instead of shareholders. Who are the corporate members? Who elects them? Who nominates them? Great circularity, with even more opportunity for a board to be captured by management, which it often is in the for-profit world. Most non-profits are run by managements that have captured their boards, and most non-profits are still OK despite this, but every now and then they are not, as in the case of St. Andrews Hospital. And it is amazing how widely misunderstood is the question of who is ultimately in charge. Many on the Boothbay Peninsula are outraged because they thought the hospital, being a non-profit, belonged to those in the area it serves. It doesn’t.  Nor to donors. It “belongs” to the members of the corporation, whoever they are. They elect the board.

Tom