Thursday, January 22, 2015

We Give Amazon Two Thumbs Up

As we always wanted to say in our days on the police beat: Get me rewrite!

Just when Amazon (AMZN) was being written off, it is writing itself a new script, announcing a plan to enter feature film production with streaming to customers available soon after theatrical release. We think it's a big deal, big enough to start coverage of the on-line retailing-entertainment behemoth with a buy recommendation.

Amazon Original Movies creative development will be led by independent film maker Ted Hope, who co-founded and ran the production company Good Machine. Production will begin this year and titles will be released to Amazon's Prime Video customers 30-60 days after theatrical release. A press release can be found here.

The movie-making business can be feast or famine, but we think Amazon has proven it can create popular and critically praised content by virtue of its recent Golden Globe award for the comedy-drama TV series Transparent. Its likely focus on "indy" films should keep costs in check.

It's impossible to predict the financial outcome of Amazon's foray into movie making, but a few examples can lend some perspective. The general rule of thumb is that a movie needs a box office take of double the cost of production and marketing to start making money. "Boyhood," the Oscar-nominated coming-of-age film directed by Richard Linklater cost about $2.4 million or more to make (about $200,000 a year over 13 years, according to Linklater) and has grossed $28.9 million worldwide, according to At the other end of the budget spectrum, Sony's Amazing Spider-Man 2 cost $255 million to produce and $190 million to market and grossed about $708 million worldwide, "just enough worldwide to save the current regime at Sony," according to Deadline.

Of course it's anyone's guess what the percentage of hits, break-evens and flops will be, but creating content as well as just purveying it has certainly served Amazon (and Netflix and cable channels) well on the small screen.

Meanwhile, valuing Amazon shares is difficult if not impossible given startling revenue growth and equally startling lack of profitability. We'll take a stab at it anyway. Since we can't use price-to-earnings multiples, price-to-cash flow multiples could help, but they are by any perspective way rich. In the 12 months ending Sept. 30, Amazon reported $1.077 billion in free cash flow compared with the $388 million in the 12 months ended Sept. 30, 2013. At yesterday's closing price, the company traded at a whopping 124 times trailing 12 months' free cash flow. But the case can be made that Amazon is reasonably priced and even cheap at a price-to-sales ratio of 1.56. In the last 52 weeks, Amazon shares have traded between $408 and $284. Its current price is just $5 above that low.

A pithy rundown of the Amazon cash machine and investors' disenchantment with the model can be found here at the Harvard Business Review. In sum, Amazon's cash conversion cycle, that is, the difference between when it gets paid and when it pays suppliers and retail partners, though still wide, has nevertheless been shrinking.

We'll spare you the tables and charts; you can find them in a million places if pictures speak to you more than they do to us. The chief investor concern, in our view, is stalling growth. In the latest reported quarter, revenue increased 20% year-over-year, compared with 24% growth in the 2013 period. For the nine months reported so far, revenue has grown 22% compared with 23% in 2013. The fourth quarter will be reported Jan. 29. According to Yahoo, analysts are expecting $29.73 billion vs. $25.59 billion last year, a 16% year-over-year growth rate.

Another headwind is the tax inquiry by the European Union into Amazon's Luxembourg unit that could result in steep penalties. The unit had a net turnover of about one-fifth of Amazon's worldwide sales, according to Reuters.

The shares have skidded in the past 52 weeks, down 27.6%. Through the first 20 days of 2015 they have shed 6.7%. Our assumption is that once the movie production and streaming business delivers a hit and recharges growth, investors will reward the company with a more "Amazonian" stock price. Hurray for Hollywood.


No comments:

Post a Comment