| Kit Winder | 10 July 2020 |
What could topple the global e-commerce giant?
The gold/oil ratio
Over the past 30 years, the gold/oil ratio has been quite volatile. But it has always been between 10 and 30. This year, it peaked to 90. Even now it's at elevated levels. Does this new level mean we're in a new normal?
| | What could derail the Amazon train?
Yesterday we saw how Amazon's valuation was high but not as far out as many of us (me) thought. Especially given its incredible business performance.
The Economist writes:
Today roughly $11,000-worth of goods change hands on Amazon's e-commerce platform every second. The company delivered 3.5bn packages last year, one for every two human beings on Earth. Amazon Web Services (AWS), its cloud-computing division, enables more than 100m people to make Zoom calls during the day and a similar number to watch Netflix at night. In all, Amazon generated $280bn in revenues last year.
Two hundred and eighty billion dollars... That's more than the GDP of most countries. In fact, it would place it 42nd on the 2019 global GDP list, sandwiched between Chile and Pakistan.
So in some ways, Amazon justifies its enormous valuation.
But I suggested that if investors shifted back to focusing on earnings and valuations, a number of scenarios could see Amazon fall 90% in share price terms.
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For that to happen though, some things need to change.
What could contribute to bringing Amazon back down to earth?
A few things actually, and let's get into them.
The first accusation is that Amazon collects all the data from companies which sell on its platform, and uses it to work out what the consumer wants, and then makes its own copycat "private label" products. It then undercuts the original brand, and overpromotes its own stuff.
Thus, it develops a specific competitive advantage over its manufacturing competitors through semi-illicit means.
It also seems to be difficult to work with as a small supplier – Birkenstock is a famous example of a well-known brand which has pulled its products from the site due to Amazon's failure to police and remove fake copies from its site.
In the book business, Amazon has simultaneously revived and killed it. Obviously, it made all books easily accessible with minimal fuss. But it did it, in essence, by bullying smaller retailers and publishers to give it more and more favourable terms, using its size as leverage.
When publisher Hachette refused to accept Amazon's demands, it was punished. Amazon delayed shipments of Hachette books, and when consumers searched for its titles, they were redirected to similar books from other publishers.
Competition is another concern. I mentioned that Amazon's share of online retail has actually fallen during the pandemic, contrary to common belief.
A key competitor is Shopify, which has come from seemingly nowhere to delivering 6% of US online retail last year, and is linking up with Facebook for its marketplace.
The other aspect of coronavirus is the retailers and manufacturers themselves. The pandemic has forced every company, big or small, to accelerate and improve its e-commerce capabilities, and so Amazon lost out over the past few months as shoppers went direct to the brands.
I, for example, have found Argos to be a great source of cheap standard goods – like a set of picnic chairs for £8 each – when on Amazon they were £40 because of demand pricing.
I also found myself thinking more about supporting local and smaller businesses during the lockdown, because it's not the conglomerates that need us right now. I imagine I'm not the only one.
In fact, I know I'm not the only one, because a bunch of bigwigs in the EU and the US agree with me. Not that I've spoken to any of them personally, but the noises coming from anti-trust legislators suggest that Amazon is reaching the boundaries of its dominance.
The examples of misuse of data for competitive purposes, and leveraging of size against smaller clients will be dangerous threats in the hands of competition regulators.
This is a big factor, and is gaining steam as the EU anti-trust legislation gears up for a fight. The EU announced this month that it is bringing charges against Amazon for abusing its dominance of the sector.
In the US, the fear is that a more left-wing candidate (Elizabeth Warren or Bernie Sanders were the fear a few months back) makes it to the Oval Office and brings their dislike of capitalist giants with them.
But it may not take regulation to split up the e-commerce giant.
There is a concern that all of Amazon's earnings growth is actually just coming from one place – Amazon Web Services (AWS). It's its cloud computing division, and where all the money comes from. And some people think it could splinter off to become its own separate entity.
Over the past few years, AWS has generated roughly 10% of Amazon's annual revenues, but somewhere between 50% and 100% of operating profits, depending on the year.
Crucially, it has covered up a slowdown in the rest of Amazon's business, where growth has slowed.
Between 2016 and 2019, growth in global sales of goods slowed from an annual rate of 27% to 18%.
Even AWS is not accelerating upwards as it used to – its share of cloud computing globally actually fell from 53.7% to 47.8% between 2016 and 2018. There is a concern that AWS is not always positively impacted by being a part of Amazon, and could perform better as its own business. Businesses are worried about data sharing with AWS and helping Amazon to enter and outperform in their space.
So perhaps it will be business logic and not regulation which splits up Amazon first, and it will be interesting to see how much of Amazon's valuation goes with it.
Internationally too, the pricing in of perfection looks flawed. It's burning cash in major markets and not seeing the same incredible performance as in "Western" markets.
It's struggled and pulled out of China after 15 years of trying and at one point claiming a 7% market share. In India, Modi is supporting national champions over foreign firms. Latin America isn't producing the goods either.
And there are two final things, relating to the image of perfection which Amazon has crafted so well for so long.
Firstly, the issue in the US of workers' conditions and rights is becoming harder to ignore, especially during the pandemic where health concerns and workers' rights have become more important than ever.
Vox Magazine describes an "unprecedented series of internal scandals, employee protests, and public petitions that have united some of Amazon's corporate and warehouse employees against their employer for the first time."
As Amazon is the second largest employer in the US, after Walmart, this attracts further interest from politicians and regulators and slightly tarnishes its image in the eyes of shoppers.
Externally, Amazon has responded to this with PR campaigns and even a documentary TV series to premiere on 8 May called Regular Heroes, "highlighting courageous stories from the front-lines of Covid-19".
Internally it has responded by cracking down dissenters, including firing two employees who were outspoken critics of its labour practices.
And momentum is building with these stories about Amazon's worker welfare, so expect it to continue.
The final threat to Amazon's reputation and valuation is its founder itself.
He says, "It's always day one", but we know that can't be true. It has never been true. There are limits to markets it can invade and conquer, and the farther from home the company looks to continue its rabid growth, the harder it will get.
It's also certainly not day one in his marriage, which is over after a secretive affair which shocked everyone at the company, given his intense focus on integrity.
He has also come under fire for things like charitable giving. His wife pledged more of his money the day the divorce settled than he ever had, by taking the "Giving Pledge" – a Bill and Melinda Gates initiative to get the ultra-wealthy to pledge half (in this case $17bn) of their wealth to charity in their will. Jeff Bezos has long resisted calls for him to do the same.
Of course, he has given Western consumers the best retail experience of all time, and himself has given huge amounts of money to charity, but this episode definitely tarnished his reputation.
Looking at Amazon as an investment though, does this really matter? If a lot of this feels a bit like clutching at straws, you may be right.
A divorce, a few firings, and a charitable-giving concern aren't going to topple such an incredible company. But they form part of a building case against Amazon, especially from an investment perspective.
Workers are growing unhappy, the core business isn't performing brilliantly, its best segment might split off voluntarily if regulators don't get there first, political will is turning slowly against it, and I've not even mentioned corporate tax underpayment.
It's struggling in some huge international markets, and competition is rising from e-commerce companies and businesses themselves.
Amazon's valuation is not as extraordinary as a mere glance at the prince-to-earnings ratio suggests, but it is still very high, and we've been here before back in 2001. It can fall a truly mind-boggling amount from these highs, with even just slight hits to its valuation, sales or earnings.
The dominos are lined up, and once momentum turns, expect the themes we've looked at today to gain greater and greater prominence in investors' minds.
And remember, overvaluation doesn't necessarily mean it's going to fall tomorrow. It can always become more overvalued.
But let this serve as a reminder that the higher the pedestal, the further the fall.
The higher the valuation, the lower the expected returns.
Kit Winder
Editor, Southbank Investment Research
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