Chit Chat Stocks - Amazon (AMZN) | Not So Deep Dive

Episode Date: March 15, 2022

Amazon seeks to be Earth's most customer-centric company. It is one of the largest e-commerce and cloud company's in the world. Listen closely as Brad, Brett, and Ryan go through the history, financials, and future prospects of Amazon. Enjoy the show! Our Tuesday Not So Deep Dives are sponsored by Potential Multibaggers. Multis are looking for stocks that have the potential to go up 10x in 10 years. Check-out the service here: https://seekingalpha.com/checkout?service_id=mp_1308 Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Subscribe to 7investing with the code "CCM" and get $10 off: https://7investing.com/subscribe/aff/4/ Interested in more of Brad’s work? Find his Substack: https://stockmarketnerd.substack.com/ Contact us: [e-mail] Timestamps Company Background | (2:48) Industry | (10:30) Management & Ownership | (12:11) Valuation | (16:27) Earnings | (17:31) Balance Sheet | (20:55) Our Analysis | (23:48) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not So Deep Dive episode on Chitchat Money. I'm here with Ryan Henderson as always, and we got Brad Freeman joining the show today every other week as he's

been doing for the past year. So Brad, we're talking Amazon. I can't say on this one, have you heard of it uh but do you follow the stock at all no it's a it's a rainforest and in some no i'm i'm gonna stop making lame jokes now but um i have heard of amazon i i have used amazon before so i guess for any total evidence we'll have some stuff to talk about yeah ryan yeah ryan's in the same boat we're uh yeah everyone knows what amazon is so i don't think we have to explain it too much but ryan's gonna go into the details and probably gonna well i've seen his notes. He's going to hit some of the nitty gritty of what the actual business is because they own quite a few things. But first, let's talk about our sponsor today, and that is

Potential Multibaggers. So Potential Multibaggers is an investing service. And the aim of the service, you've heard us before, is to find stocks that have the chance to go up 10 times over the next 10 years or compound at 26% per year. Now, this means making bets on high growth companies, something like Cloudflare at $39 a share, Upstart at $128 a share. They've been around since 2017. Chris, or his pseudonym from Growth to Value, had been running the service since 2017, and they have a fantastic track record over the long term. They pick high growth stocks, and to hold them for a long period of time, of course, they have to continue performing to hold them. So Chris, the man behind it, he calls this buy and verify. So sometimes a stock will be in

the portfolio and they're not afraid to take it out. It's kind of a rolling thing. They're going to give you continuous updates on these companies. I see updates hit my inbox multiple times per week and maybe even more five times per week during earnings season. There's always updates on there. So if you want a comprehensive service, if you want some help, you know, identifying and doing some analysis on some high growth companies, if you want to become a multi, you can go to seeking alpha look for from growth to value google it or go to at from value on twitter all right ryan let's introduce amazon.com yeah the first line of their 10k says we seek to be the we seek to be earth's most customer-centric company so that's uh i'm not going to go in i i we just simply don't

have enough time for me to go in to everything they do um but i think they've pretty much lived that motto since their inception. I'm going to basically talk about what I think and what a friend of the show that follows Amazon pretty closely thinks the three main drivers of the business are. So that is e-commerce, AWS, and advertising. And so the e-commerce business, you could almost call their legacy business at this point. It accounts for 39% of US e-commerce spend. And if you subscribe to Amazon Prime, and I haven't been a frequent shopper lately, so correct me if I'm wrong, but you get pretty much anything delivered to your door in two days or less. Am I getting that right? Most of it's less than one now. They're trying to do same day.

So it's been two day guaranteed, but well, in the pandemic, it went up a bit, but now they're trying to do one day or less if you're in a major city. Okay. And then people, I think people grasp the e-commerce concept, but AWS or Amazon Web Services is another big driver of their business now. And this is their cloud platform. So I guess for anyone that I'll give sort of the brass tacks on cloud, and I'm not a cloud expert by any means, but companies, organizations, or individuals can store or access their data over the internet instead of on a hard drive. That's basically the concept of cloud computing. This makes data more accessible and it often saves organizations a lot of money. And so it's been a huge driver in terms of profitability for them. It generated

$62 billion in revenue for Amazon last year. And even though it only accounts for 13% of Amazon sales, it accounts for 75% of their operating income. And then the last segment that I'll talk about is their advertising business. So since Amazon accounts for such a big chunk of e-commerce sales in the US. Obviously getting on search rankings is basically really valuable real estate for sellers. And so sellers are willing to pay up for that. I believe that's where the lion's share of their advertising revenue comes from. And it's a quickly growing segment, but there's also other advertising spots that they own. So I think you can advertise on Alexa. I might be wrong on that, but there's like, think of all the real estate they own.

They own, um, fire TV. You can, that's one fire TV is one. That's, that's a big one. Um, I don't know. I'm sure there's plenty. There's a lot of, I mean, the main one is sponsored listings on retail. Yeah. Um, but that's, those are the three main drivers of the business right now.

I, I am certain that they account for the biggest portion of the, uh, the company's overall top line. And then as far as history goes, I think most people have probably heard this story, but Amazon was founded in 1994 by a man named Jeff Bezos. Brett, I heard you're friends with this guy. Yeah, well, you know, we're best buds. We go to the same restaurant. Yeah, we go to the same restaurants in Bellevue. So, you know, what can I say?

Can you tell that story? Yeah. And with this winter, I was at a restaurant in Bellevue, which is where Jeff Bezos lives and we're close to where Amazon's headquarters, close to where we live. And I look over and I thought I recognized him. And most people in the restaurant really didn't because they're not the best in your business community, but I saw him and I was like, that's definitely him. He was with his new girlfriend and then his family. But then when he got up to leave, I went up and shook his hand. and then i said something like i enjoy your shareholder letters and then i just walked away so i didn't give myself like a c i should have said something about like lord of the rings or

something funny but uh i think i i did okay but so i would have been shook his hand while he was leaving were you shaking were you nervous i was i was nervous yeah i'm usually you know one that doesn't get nervous about stuff like that uh but in that case i was since i've read all you know i like his uh he's a role model for the business world yeah um bezos left d.e shaw which was a quantitative investing firm i think that's what they categorize it as it might just be a wall street uh investment they might have different branches but i believe that's what he was doing at de shaw um and he basically wanted to build a business that sold books over the internet and so he went out he moved out to seattle to start the company and i believe part of the

rationale there was there's a lot of tech talent over there um in the business i didn't realize how quickly amazon took off originally it was actually named cadabra um but apparently a lawyer mistook the name for cadaver and so they changed the name quickly to amazon one year after the company was founded it went public so amazon ipo in 1995 and i remember i think it was within like two months of starting the company that they were selling $20,000. They were generating like $20,000 in sales, either monthly or weekly. It really started growing fast. I can't really do justice to the whole story, but there's a lot of books written. One good book is The Everything Store by Brad Stone. I recommend reading that. It's just interesting history to see sort of the

DNA of Amazon and what the culture's like. And you really get an idea of what, even today, what a well-run business it truly is. That's basically it for the history. AWS was started in what, like the late 2000s? I believe 04, 06. Yeah. Something like that. Yeah. But they didn't end up spinning out the financials there until... uh 2015 so they did that in 2015 it wasn't other just like advertising and people thought aws they're like oh it's another others growing quickly and they think it's pretty profitable because like you would think the cloud's profitable or something like that but there's a lot of theories like oh we don't know we don't know but then when they came out and they're like yeah this

business is an amazing you know it's got fantastic margins even though we're growing uh i think the stock went up like 20 after they broke it out so it was like one of those big moments um and wall street history yeah i think i think aws is to the i i actually i don't think i just googled it so i'm cheating aws is 2006 and azure is 2010 and then google cloud is newer obviously but just fyi for our reader or our listeners sake yeah that is sort of a i guess you could call it a first mover advantage there just being early to the space i mean where i don't really know the history of cloud computing whereas were they one of the first were they like a pioneer in the space or were there other they invented it they invented it and they were the first for four years

yeah they invented it and uh well okay they invented like the outsource model like uh like the the model that is followed today i believe they invented that there could be like different like salesforce was founded a little earlier but am i getting brad you might know this a little bit too but we're kind of showing our cards here we don't know cloud computing very well we're hoping actually to get an industry expert on as a deep for a deep dive on aws but really for the show we're just gonna give some brief industry overviews and just say yeah cloud computing big business very profitable um but yeah i'll hit industry and competition uh it's hard to define because they have so many businesses but i'll highlight us e-commerce

international e-commerce player places they're in and then cloud services so the u.s retail market is 5.5 trillion dollars so that's the estimate for 2022 side note the world kind of economy is driven by the american consumer in some regards um it's very like it's very important for amazon's growth even though it's their most mature market um and they're actually expanding a lot to try to get more than just e-commerce now because they own whole foods and they're trying to do a lot with that as well. They're competing for base. I mean, except for maybe some things with like Home Depot or a few other retail outlets like jewelry or something like that. Amazon is really competing for all of that spent. Now in Europe, where they operate in a lot of countries,

the retail market is $3.2 trillion or excuse me, 3.2 trillion euros. India is another company they operate in is that is $1 trillion. India is one of their big markets. And then Europe is their other international ones. And then they're also in Mexico, Japan, and Taiwan, I believe. And then if we want to move out of retail, their cloud market is $300 to $400 billion in spending a year. It depends where you go for your estimates there. And the projections are that that'll grow by about 10% to 15% a year. So large market opportunities. You can see why this is a trillion dollar plus business

and growing really quickly. Brad, do you want to talk management and ownership? So in terms of management and ownership, Andy Jassy did take over the company for Jeff Bezos in 2021. The buyback that they announced this week, the $10 billion buyback, or it won't be this week when our listeners are listening,

but it is for us right now. Loved to see that. Tax efficient shareholder returns are always a wonderful thing, and their balance sheet really puts them in a position to do that, but more on that later. Very smart guy, been with the company for decades, climbing the ladder. He was the first CEO, founding CEO of AWS. He's got a 79% Glassdoor rating with 115,000 reviews, so really large sample size that I think we can take seriously. Brian Olavsky has been Amazon CFO since 2015. Again, he's been with the company for 20 years, climbing the ladder. He was with

Fisher Scientific before then. And then the new CEO of AWS is Adam Solipsky. And I apologize if I pronounce your name incorrectly. But again, been with the company for 17 years, former president and CEO of Tableau. So I found that interesting. Another Harvard guy, the C-suite is loaded with them. Board is extremely impressive. I mean, it's a trillion dollar plus company. So it's not super shocking that the management team is so sparkling, but it is and really love to see the lengthy tenures and that the trend there just points to strong culture and a strong community that Amazon's built. But in terms of ownership, and this is as of the most recent proxy, which is now a little bit dated, Jeff Bezos owns 15% of the outstanding company. Vanguard owns 6.4%.

BlackRock owns 5.4%. I saw a video on TikTok of somebody ripping into Vanguard and BlackRock saying they own the entire world, but these are shareholders who own Amazon on behalf of, or BlackRock owns them on behalf of shareholders, but I digress. So Jassy's in Wilk's stake. So Jeff Wilkie was seen as Jeff Bezos' right-hand man. He was seen as the next person to kind of take over. They went with Jassy. Wilkie left. I don't know if it was because of that, but it kind of makes sense if it was because of that. He still owns a lot of restricted stock units. He still owns a little bit of a direct common equity stake. Overall, the executive team doesn't really own a lot of shares directly, but there are 14 million total restricted stock keeping units, or stock

units, I'm sorry, outstanding as of the company's most recent 10K for about $28 billion in equity that's going to vest starting in 2023. So there is some compensation coming their way to incentivize the 10 years to keep getting longer and longer. Question, do you guys think Bezos is the, would you put him on the Mount Rushmore of best CEOs of all time? Yeah. Yeah. Would he go number one? No, no, probably not. Well, we'll have to see, like, I think a big question is whether the culture they started can sustain for the

next few decades after that, if that's the case and they're still around, you know, very profitable or something, you know, generating cash, then probably you can put them on there. But as of now, i think the jury's still out you know it's only been 25 years if you're going to be one of the best ever you got to establish a franchise it's going to be around i think for a very long time but you could also say he did it quicker than anyone else well that's true that's true that's that is very true the quick the the quickest uh i think yeah sure well google google actually google is later uh but either way sorry brad do you have anything on that do you have any

Any thoughts? That's, that's such a, I mean, that's a debate. That's not, that's not a topic I can give an objective answer to, but in terms of top CEO ever, he's on the short list for sure. Um, and, and obviously that's recency bias for me being 24 years old and, and growing up, um, watching his fabulous success, uh, not to, not to make Ryan or, or I'm sorry, not to make Brett, yeah, Ryan or Brett, uh, a little bit, uh, steamy through the ears, but I think I'd put Elon Musk up there as well uh yeah i think i would maybe just just because of uh yeah we'll we'll leave it there believe i will i will say i will say brett brett probably has the uh the finger on the pulse here the best since he's really since he's best friends with jeff so well that's right

yeah and i got some more scuttlebutt all right let's uh let's let's hit valuation yeah valuation is pretty well it's hard because of all the cash they are sorry all the capital investments they make, which I'm sure we'll talk about in the second half, but it's pretty easy to value since it's not some money losing company. Market cap, $1.42 trillion. Ticker is AMZN. Enterprise value is $1.37 trillion. And now that's taking market cap, subtracting out the cash, adding back the debt. I'm going to say that every time, but I'll hopefully just do it quick because I know people probably get tired of that. EV to operating income, which is enterprise value divided by operating income is 55. Enterprise value divided by free cash flow is negative. However, it's

because they made this heavy reinvestment period over the last 12 to 18 months because of the pandemic. Before the pandemic, they were very profitable from a cash generation perspective. And I should say share count steadily rising, like Brad was noting, they have about a 3% dilution rate that has been steady over the long term. So not crazy, and maybe that'll balance out now if they do the buybacks, but there is going to be some dilution. All right, Ryan, do you want to hit earnings? Yeah. So they just wrapped up their 2021 fiscal year, literally last night as of this recording, but it'll be, I think, maybe four or five days by the time this is out. So in 2021, Amazon had $471 billion in revenue. That was up 22% versus the year prior. They had 42%

gross margins, which was up slightly from the year before. And then the interesting part, which Brett sort of alluded to, they had $46 billion in operating cashflow, but they spent $60 billion on capital expenditures. So negative free cashflow for the year. And I think maybe it One of his last letters during COVID, he basically said, we're not just letting the company generate cash. We are going to pour money into investing back in the business heavily. And you're starting to see that on the cash flow line. But when that happens, they usually reap quite the reward in three, four or five year periods after the reinvestment. So that's usually a good sign for shareholders. I will say also, big news, they did a 20 for one stock split, which obviously everyone made the joke. So they did a 21, 24, one stock split and they have done stock splits in the past.

Um, and everyone made the joke that the stock jumped because of it, but I think it also jumped because of earnings. Um, hopefully the earnings were, uh, I don't know if you, you might've misread some earnings were in February or you might have bad earnings last night. No, no, no, no. Earnings were in February. Huh? I must've, I must've, I think you misread it as a March instead of,

February. Cause I believe it would have been like March 9th. Yeah. All right. So then a month ago, I guess. Um, but last night they did announce the stock split and the buyback program. Correct. Correct. Okay. So that was, that was last night. So I got the dates wrong, but the $10 billion buyback on that, there was no ending date on that. So they basically had a $5 billion open buyback program. They just replaced it with a $10 billion program, no ending date on that. So it's kind of open for them to repurchase shares opportunistically. That's pretty much it for the earnings. Those are, I guess, the main takeaways that they are reinvesting heavily. And typically that's a good sign for the times to come.

Yeah. And I would say, do you guys think it should have been another zero on there? Like a hundred billion dollar buyback program, just because if it's going to be indefinite, Like for a company of this size, $10 billion is pretty meaningless. I think they tend to generate great results when they allocate capital to their existing operations. And they have money to obviously buy back shares, but I wouldn't be surprised if they're slow to start choosing to repurchase shares instead of investing back in their own business. yeah that's a good point all right brad any thoughts on that and then move into balance sheet if uh when you're ready yeah i'll just go right into the balance sheet and liquidity so the company has 36 billion in cash and equivalents but it's got another 60 billion in marketable

securities so i'd put um accessible liquid assets right almost at 100 billion dollars uh they but they do have 48 billion in net payables which it uses to finance its marketplace operations and other parts of the business. It's got $32 billion in long-term debt and another $52.6 billion in long-term lease obligations. These are large numbers, but that's what happens when you build out the largest private market set of infrastructure and assets or whatever I'm trying to say and can't get across. In the world, I mean, obviously, long-term lease obligations are going to be a hefty number. But moving on, interest expense was 7.2% of its operating income in 2021. So not super favorable, but could could have just been a timing of payments thing,

because according to their 10k, the weighted average rate for 2022 calendar 2022 is going to be 0.65%, which is extremely favorable. So I would trust Amazon to know what their average cost of capital will be for 2022. And that looks very good. So to probably not many people surprised the balance sheet is yet another strength for the company. Yeah, do we? I mean, do we think they should pull an apple i know it's kind of nitpicky but should they pull an apple and take out 100 billion in debt i feel like like i mean if okay what do they need it for buy back 100 billion in stock that's all apple needs it for and their returns people have been thankful for that i mean there's no like okay there's no way amazon's gonna get in trouble i mean they're

to start generating $50 billion in cash a year soon once this reinvestment period reverts. They did that in 2019 or maybe 2018, I forget the years. The question is why and also just why not? But to me, I think their investment starts at their gross profit line, essentially. You could could almost call it like growth capex, I would say starts there because they do a lot of investing to their income statement. They're generating, what is it? Probably 250, 200 plus billion dollars in gross profit. Is levering up really going to do that much for them? I mean, if you can get some 20, 30 notes at 4% and you can buy back stock at a yield you think will be higher over the next few years i mean it'll juice returns i don't know i think apple strategy is there like i just think

all the big tech companies should be doing this except maybe facebook because they're in a more precarious situation but that's a debate for another day uh let's hit an ad break and we'll talk more about amazon this episode is brought to you by lakinta by windham here you are miles from home and ready to start your vacation good thing you're staying at lakinta by windham they Save free high-speed Wi-Fi to stream all your favorite movies. And in the morning, get fresh waffles with their free Bright Side breakfast. Or squeeze in a workout at their fitness center. Either way, you're ready to conquer the day.

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And now all your computer can play is red color, red color, where are you? All blocked thanks to advanced security included with Cox Panoramic Wi-Fi. Advanced security must be enabled in the Panoramic Wi-Fi app. Restrictions apply. Okay, welcome back. Next up, we have anecdotal evidence. Usually, if it's like a tech business, we don't have any, but this one should be fun. So Brad, what's your anecdote for us today?

Yeah, so I'm a grad student who still lives at home. And I think my mom gets five plus packages from Amazon a day. We just have a steady flow of packages just coming to the door and ringing the doorbell and pissing off my dogs. And like you probably heard in the background earlier in the show, but it's not, I mean, I have no complaints. I'm not going to rave about its fulfillment and marketplace services because it's not noticeably better or different than anything else.

the selection obviously is is quite immense um so thumb firmly sideways on amazon uh versus the competition but it's extremely convenient so i guess thumbs up there yeah i i think everyone probably has some experience shopping wise i'll be honest i haven't bought anything on amazon in a really long time and maybe i'm just not like that much of a shopper to begin with but i just haven't found i don't know the use like the use case for it maybe christmas i'm sure i bought something around christmas time but um on a separate like on a different as far as use cases for other parts of their business i uh i look forward to watching the lord of the ring show but at the same time i kind of question whether some of those expenses are worthwhile and like

What's the ROI on that? Yeah, getting all those lower image rights. Or just even like all their prime video initiatives. I think they've improved on that a bit. I really hope they go more into sports because that's kind of something I feel like they can be good at because they're really good at just efficient stuff where they would just be licensing it.

They got Thursday Night Football exclusively now. Brad, any thoughts on the sports stuff? Because I really think they should try to get one of the Sunday games because that would lock people in to Amazon Prime in the United States. I took the words out of my mouth. I was just going to say they got the Thursday Night Football deal, which is probably going to force me to download the service. Yeah.

Yeah. Yeah, I felt like initially the whole Prime video thing was just a way for Bezos to get looped into Hollywood. Yeah, that's what they said in the book. That's what the Bradstone book says. I mean, it's worked out pretty good. you know amazon prime i'll have some numbers later of how profitable that is so i i don't think they can complain but yeah who knows buying that uh movie studio too we'll see if that'll be

worth it i don't know what that was like nine billion dollars but back in the retail for anecdotal evidence personally i like it a lot i don't know what really caused me to leave like ryan was saying like shopping i don't really do anything of that there but like i really enjoy subscribing to like staple foods that i get like every month you get five percent off it gets delivered. Sometimes you go overboard and you accidentally get way too much delivered for yourself. But then like staples like paper towels, toilet paper and stuff. I really like to use that instead of going to the store, mainly because with Amazon Prime, it's free shipping. It's usually very cheap and it's just way, way more convenient. But like shopping around for stuff,

it's not the best there. And I think that's the big difference between them and someone like a DTC store. Personally, the only thing I get frustrated with, though, is when they kind of bombard you with whole foods ads in the search results where you can't get like, it's like a whole foods grocery delivery thing. And you get, I get confused and I'm like, all right, I'm going to get this, say this oatmeal or something. And it's like a whole foods direct delivery thing with extra fees. I wish they would separate their grocery from their traditional marketplace. And then I do have some scuttlebutt on the advertising business. So last summer, being that we live in the region where Amazon is headquartered, you kind of, you know,

see a bunch of people that work for Amazon all the time. I was paired up with someone that worked there in the past for golf. And I found out that he was one of the big VPs of advertising. And I asked him about it. And he actually, he said, and this could have been his bias because he was just in the division. He said advertising was a better business than AWS. And I was kind of like, wow. But he, I think he just said that because AWS is capital intensive, so it might not be as profitable. But then he also said that advertising, and this would have been in 2021. So not too long ago he said advertising could double profits over or double revenue overnight if they want to but they just choose not to so you know the people that are bullish on their advertising business

there's your uh there's your anecdotal evidence um all right or ryan you have something no i was gonna say uh that maybe he's just enthusiastic because it's his role but i i i could see that I feel like that for a lot of big tech companies. I was just thinking the other day, I saw an AWS ad on the back of a bus. And I'm like, what a waste of money. And then I'm like, well, maybe they're just choosing to defer profitability or they're kind of masquerading profitability to either avoid regulators or hit like deter competition of some sort it feels like they can grow at will yeah braddy has something remember in the

incredibles movie when dash was kind of like racing on the track meet and mr incredible and the family was like come in second place come in second place because dash was like he had super speed he didn't want anyone to know he had super speed that's kind of how i think of amazon right now. They're kind of just pacing themselves to not invite unwanted attention, but they have superpowers that they can turn on whenever they want to. Yeah. Cause that's what I may have said it wrong, but the guy said that like the, the higher ups were telling them like, okay, no, we want this much in revenue a year. And they, if advertising was on its own, it could have been twice as big just from the demand they were getting, but they didn't, they didn't turn on

to say it yet it's like and i don't want to go too long on this but it's like zuckerberg i think one time had a quote where he he said i want it to be like there's levers i can twist where it's like operating income revenue like profit like all all the line items on the financial statement i can just turn them when i want well apple tim cook said i don't know about that pal yeah he pulled the plug on those levers but let's go growth opportunities brad what do you have Yeah, I just want to say two thumbs up to your future growth opportunity, Ryan. I'm in full support, but I won't spoil it. But the Internet of Things boom, this is more of a profit and margin growth opportunity, but it can really allow them to accumulate a lot more automation within the fulfillment processes. Even like autonomous vehicles could be just a massive cost savings event for them. And human capital, I mean, they're one of the largest employers. Are they the largest employer in the United States private market? two two walmart's one walmart's one i've looked at us walmart's over two million amazon's like

one and a half million okay so just just wild numbers and i think they hired 150 000 workers last holiday season or something ridiculous like that so it's it is a massive cost for them and this would probably be terrible for for the the labor force and and the american economy um or not not maybe not the american economy x amazon but it would be phenomenal for them to to sub out these manual processes with internet of things and automation and artificial intelligence and all these wonderful buzzwords that we like to invest in. Yeah. And remember they pay their workers. Now there's a lot of whatever news stories about, I don't know, treatment at warehouses. I don't know the exact things about that union busting, all that stuff,

but they pay their workers very well, $18 an hour now. And they do the 401k match. That's very healthy. And they also do the career path thing where they pay for people's college. If they want to kind of expand out of the warehouse. So they invest a ton, like Ryan was saying, investing through the income statement in their workforce. And that's one of their basic expenses. Ryan, do you want to hit your future growth opportunity? Yeah. Selling their Rivian steak is my number one. No, that's not really my, I don't know. I don't really have a take on Rivian, but I just, they have a huge like mark to market adjustment on their income statement where they have to value their rivian stake and uh no brett sorry you've

been following say on there they uh they uh they control rivian's destiny basically because they they have all the truck orders from rivian so it's kind of like they can you know what i mean like they have over a hundred thousand truck delivery trucks uh order for rivian i think they're doing a bunch of them in india too so i don't know like it's almost like their long-term partner, if you know what I mean. So it's less risky, I think, for Amazon, where they can kind of decide how profitable and how big Rivian's going to get. Yeah. And I don't think they could even sell their stake if they wanted to. And that would probably just destroy it anyways. But it's hard to think of anything new that Amazon hasn't done. I will pose a question at the end

of my future growth opportunity, but I'm going to go with AWS. This is probably one of the greatest businesses in the world. It grew revenues 40% year over year to this quarter, had 30% operating margins. Like I said, I think it did $60 plus billion in revenue for the year for Amazon. A few sort of highlights from this quarter, some notable customer ads. NASDAQ, the exchange, said it plans to migrate its markets to AWS with the goal of becoming the world's first fully enabled cloud-based exchange. And then Meta, so Facebook, selected AWS as its long-term strategic cloud provider to accelerate AI R&D. I don't know if that's just like a segment that they've dedicated to it, but it's a pretty big vote of confidence, I imagine. And there's so

many businesses run on there. There's plenty of votes of confidence. So I think that's probably going to be no surprise here. One of the biggest drivers of returns over the coming decade. Question, and this is unrelated, but what do you guys think of their cloud gaming uh news i don't know if you saw this but they launched i think it's called luna or something like that right only seen headlines uh braddy have any thoughts on that uh the luna was it called or luna yeah yeah amazon luna you know okay i think i think they would probably they'll probably allude to microsoft microsoft has a big advantage there but who knows um google you know is trying to do it it's early days what do you think just broadly of their gaming investments

strange are do you think it's worthwhile i mean i don't know i think we're both kind of in the i don't know i think bezos always talks about like if i can invest what what's the analogy like i can invest a certain amount of money and have a certain probability of these returns i'll take that bet every single time um this kind of seems to me like one of the bets that may not work out as well for him but he's willing to make those to just to identify the ones that will work which is where aws came from and and where amazon fire came from and yeah twitch is kind of falling off a bit i know it's different than their game i mean they put out a good game i think but it's just not a needle mover for them it's they i mean they

spent like a decade developing games now they're finally starting to become a decent studio but But unless they become the cloud gaming platform, which who knows, they could be, they could be, I think Microsoft will probably win, but who knows if they become the cloud gaming platform, that will be material for them. But just as a studio and with Twitch, which is kind of just plateauing and really getting some big competition from YouTube and Facebook, I don't think it's as material for Amazon. All right. What's your future growth opportunity?

Like you guys said, there's a ton, but I just want to highlight raising the price of Amazon Prime and what that does to this business. So they recently did a $20 price rise for the annual one from $119 to $139. And that will bring in, assuming they have 150 million subs, $3 billion more a year in pure profit. So that gives them wiggle room to say, reinvest into more delivery. It can also just increase their margins. And I really think that they have an easy path to doing this about three to four more times over the next decade, especially because most Amazon Prime accounts are family ones and are really more than one person. Anything else on that, guys, or should we move to highlights and lowlights?

Let's go highlights and lowlights. Brad, what do you have? Yeah, I want to reiterate, I love when teams are in place for decades. I know Bezos stepped on as CEO, but seemingly the entire management team has climbed ladders all the way up through the company to get where they are today. And I really just, I love to see that. Lowlights are very tough. So I'm going to nitpick and come up with some lame lowlights because there are really not other than maybe regulatory stuff, but Google Cloud's finding more market share, Bezos leaving, maybe Amazon, they're allowed public support for cannabis could turn them into a federal government uh, kind of adversary or enemy maybe, but again, I'm, I'm reaching very far to try and come up

with these. And then there's not really a lot of red flags to speak of here. Yeah. I, I had to reach for low lights myself. Um, I guess highlights, it's probably one of the business of the business in the world. And I'm saying moat like M O A T. It just has incredible, incredibly high barriers to entry and thinking about when you look at that CapEx figure and compare it to the second largest e-commerce provider, which is Shopify, it puts in perspective the scale of their business. I also like Jassy so far, and I like the overall culture. Even though it's also overused here, I would say there's tons of optionality, And that's kind of been a big, I guess, thing for them the whole time they've been public is you've been saying, well, they could also do this.

They could also do this. And so far they have. Low light, the only one I could really think of that the one that's actually potentially deterring me from investing is just the size of the company. And I know people talk law of large numbers all the time, and it never seems to come to fruition. every big tech earnings report uh i i there has to be i don't know they have to be close to e-commerce saturation at some point like they can't just keep i don't know like how big can their e-commerce business get maybe it's much bigger than current if e-commerce continues growing in x in excess of gdp i think paypal is that you're expecting like 10 e-commerce growth

this year. So they don't really need to take a lot of market share to still grow and access of GDP. But I know that's not the expectation for Amazon shareholders. They want a lot more growth than that, but just thought I'd throw that out there. Yeah. I think that that's kind of where I fall as well. 10% growth in retail seems very reasonable to me, but yeah, the historical growth rates have been more than 20% plus for retail. Anything else, Ryan? Should I move to mine? No, you're good. okay yeah same same with you ryan i think they have tremendous competitive advantages i think we're all aware of those and it's kind of weird that both aws and retail have the scale

advantage um and the switching costs and all that type of stuff they're very similar even though they're completely different business you have a logistics mode and then the cloud tailwind so cloud i mean the cloud tailwind is is is uh it's amazing like it seems like it's a guarantee it's going to grow at 15% a year for this next decade. And then I do like their culture of focusing on long-term cash flows. They're not an earnings per share company, which is great. They're focusing on cash generation, which I like as a shareholder. Lowlights though, I have a few that you guys didn't have. Well, I guess you guys had the stuff about worrying about the bloat from being just a large and disjointed business. I worry about the true profitability of retail. Now, could that be

saved by advertising, sure. But man, they have a lot of expenses right now. There's a tougher competitive environment in international markets, especially in India, where they're investing a ton of money. I think that's just going to be really difficult over there. And it's not growing as quickly and as I think as a lot of people expected. And then lastly, Alexa and some of the other bets, I think are quite dumb. But a lot of people have said that about Amazon's projects over the years. So, you know, if it has a 10% chance of working out like Brad was saying, then maybe it's fine. But they are spending, I think I saw a Bloomberg report that they're spending $4 billion a

year on the Alexa division. And that's just, that could be $4 billion in profits. And is it going to have a good return on invested capital? Gosh, I really doubt it. All right, let's move into bull case. Brad, what's your bull case for Amazon? well alexa actually just integrated with with teledoc health uh which is a position of mine so that would be there no i'm just kidding uh you guys covered the quantitative bull case i'm seeing

pretty well so i won't repeat that just really plainly and simply the bull cases that amazon continues to perform exactly as admirably as it's performed over the last um several decades uh proof of concept is as concrete and clear as day as it gets um and and the bull cases that that continues on well after Jeff Bezos retires, which he just did. Yeah. I think more of the same basically as the bull case. I put some numbers on it just to kind of boil it down. I think if they reach a billion dollars in revenue, which is a little more than a double from here. Trillion, trillion, T, T. Sorry. Yeah. A trillion. It would be, yeah, it's a trillion. And they can get to a normalized free cash flow margin of about 15%, which I don't think is too unrealistic.

They'll be doing $150 billion in free cash flow at 20 times that, their annual free cash flow. That's a $3 trillion market cap. I think that's, unless the stock has moved today, I think that's a double from here. And all those numbers seem realistic within the next five to seven years. I don't think that much. If nothing changes, if they just keep doing what they're doing, this will probably be a fine investment. Yeah, I agree. I worry about a lot of large numbers for retail a bit because it's going to, you know, they got to execute now and kind of in-person stuff and stuff like that.

But I think with cloud, there's no real concerns with that. I have the same thing kind of as Ryan. And if anyone's like, whoa, 15% free cashflow margins, that sounds absurd. They got close to 10% free cashflow margins in 2019. And now AWS and advertising are making up a bigger percentage of revenue. I think 15% free cashflow margin is fairly doable. If you think, okay, I'll put on a different number here too. If you think they can get to 10% free cashflow margins, we're basically sitting at an EB, which is enterprise value to free cashflow, which is enterprise value divided by free cashflow of 29 right now. So basically I'm just taking their current last 12 months revenue numbers and

slapping on a 10% free cashflow margin, and then using that compared to their enterprise value. And then if you believe they can get to a 15% free cashflow margin, like Ryan was saying, the EV to free cashflow ratio is below 20, which feels very, very cheap. In either of those scenarios where you have a 10% or 15% free cashflow margin, I think you do great. I mean, you're really just kind of banking on revenue growth over the next whatever years. And I think it'd be 10% plus, it's going to be a good investment. All right. Bear case, Brad. I know it's very hard for everyone here because everyone in the world is so bullish on Amazon, but what do you think the bear case is? Sure. So in the past, I've invested in direct

to consumer brands. I'm thinking Canada Goose, which I no longer own, but they and several other brands with any kind of brand equity have been shifting aggressively to direct to consumer businesses just because of the vast gross profit margin boost it gives to their businesses, their operations. So I've read about vendors like Allbirds and Nike pulling their gear off of Amazon just because of counterfeits and copycats that were to be candid, pissing them off. Um, and, and if that continues, if these, if these large brands continue to embrace this direct to consumer transformation, um, then that, that could be problematic for what is the largest segment of its, of its business, at least by revenue, not by operating income.

But, uh, yeah, I, I think that's, that's the bear case and it's not all that it's quite realistic, honest, it's already happening. Um, I just, I just don't think it'll matter for Amazon over the longterm that they've just got so much momentum, but something to keep an eye on for sure. Yeah. I hadn't really thought about that one, but that probably is, I guess, the biggest threat to their e-commerce business. But I would have said that two years ago and it hasn't seemed to affect them. I honestly can't think of a very realistic bear case where like, what's going to stop AWS? What's going to stop like is e-commerce going to decline it doesn't feel very that doesn't feel very

realistic um maybe they just spend too much like and yes even i don't know yeah maybe the return on their current like their other bets actually bogs down cash flow enough that this is a sub market performer yeah i mean that's one for me as well i think margins could be a concern say the labor stuff um which again like from investment perspective we're just looking at labor like objectively if that hurts them a ton if say supply chain costs really hurt them because i mean they've had to do some tough stuff with that materials costs are huge for them that could really hurt margins and that sustains itself over the next decade their margins could be hit and then combine that with people partnering with Shopify and then the Shopify clones out there, if they can slowly

pick away at the retail advantage, which I kind of doubt they can do because of the logistic stuff is just so insurmountable, there's a chance that e-commerce, the e-commerce and retail businesses are tough. But again, with AWS, I think this kind of shows that we don't know enough about the cloud business, but it's really hard to see a bear case for AWS. And I think we're all in the same boat there. But let's move into the final thoughts, more or less interested. Brad, you own some big tech, but I believe you do not own Amazon. So what are your final thoughts after looking at them? No, I own Facebook. I can't believe I'm saying it, but it's just not within my kind of niche of investing. I mean, I do own Facebook, but I also see that as still a kind of

It's weird to think about it at whatever it is, $600 billion or something, but as a younger growth stock and a more speculative company than Amazon, which is kind of where I skew, I can't say less interested because it's just such an incredible company. So I'm going to say more interested, but I'm probably never going to own it just because of how massive it is already. Yeah, I don't know. Like if, if I didn't care about investing, I would probably just buy some and close my eyes for the next decade. But the only thing really determined me is that like owning it just doesn't seem that fun. It like, it wouldn't take, it just like, yeah, making money will probably be fun, but it's

not like, I kind of like the part of investing where like I found something unique and was able to do it. like a little bit i know there's no points for originality but i kind of like being invested in companies where not everyone's invested no yeah i'm in the same boat it's just i mean look we're it's it's not even for uh it's for enjoyment i mean i'm more interested this is i think everyone follows all the big tech companies at least glances at their earnings reports especially because they can affect so much the other markets but i mean if i would say older investing wasn't a something i wanted to do with my life as kind of the industry i was in it was just something i

was saving for retirement i mean i don't think i can go wrong with owning microsoft google and amazon and going to sleep i mean those platforms they said dominance brad you have something to add here yeah and i agree i almost think at that point just buy qqq and make it even like make it even more boring and drama-less for yourself. So yeah, but which is kind of, I think why the three of us are saying less interested because we see it as somewhat similar to index fund investing, which is funny because it's one company, but it's just such a massively important company that that's, I mean, it's, it's sort of true. Yeah. It kind of goes in the same boat as me with Microsoft, Google, and Amazon. Those are the big tech companies I'm very interested in just because

I think they have really long-term with, by saying the cliche, durable competitive advantages. And And yeah, if Amazon got cheap enough, maybe it'd get very interesting, but I'll let the returns go to someone else and I'll play with the stuff with market caps below a hundred billion dollars, maybe to our detriment. But that's just going to, that's just how it's going to be. All right. Stock for next week. Ryan, do you have one?

I know we were kind of, you know, this is a hectic week for us. Did you have a choice? If not, I got something in my mind, but if I have one. Two, I have two and I want to let you guys kind of vote. so one would be guidewire software which is like a it's business to business software for the insurance industry so property and casualty insurance um it's kind of like a pretty sticky software business from what i understand and they're making a shift to cloud um or celsius holdings the energy drinks uh kind of been looking into them a little bit as well

which one Celsius yeah let's do Celsius more more fun for the podcast all right Celsius hold incidents yeah b2b insurance software providers just doesn't sound quite quite as fun yeah like it could be a great investment I mean that sounds like you know something boring that's going to grow forever but not about energy yeah energy drinks will definitely be more more fun all right that's going to do it for this episode thank you all for listening remember we are not financial advisors. And then we say on the show is not formal advice or recommendation. However, Ryan and I are general partners at Arch Capital. Arch Capital clients may hold securities discussed in this podcast. Give us a review on Spotify or Apple Podcasts. We're going for a hundred on Spotify.

Very, very close. Takes you about five seconds to do it on our homepage. So make sure you do that. And then we'll stop hammering it home at the end of each episode. Thank you all for listening. We'll see you next time. do you wish you could just hit skip on the worst parts of your life you know the same way you can skip an ad i get it i'm siaya and i live in ice cove i've made some questionable decisions that didn't end up the way i planned and today i'm still figuring it out somehow things usually get worse before they get better. Apparently that's how I roll. So bundle up and come along for the bumpy ride. Stream a new episode of North of North Tuesdays on CBC Gem.