As much as I hate tying the investment process to the pace at which the Earth revolves around the sun, this column begins December by revisiting columns written over the past year with some thoughts for the new year.
As regular readers know, I prefer to tackle a few topics in-depth than spread verbiage all over the place. I also have an inclination (which my partners hate) to dwell extensively on a painful micro-examination of things that went wrong. After reviewing what I have written over the past year, it is fair to say we will have some ground to cover.
Amazon: Join the Discussion on
Let's start at the beginning. I'm a value manager in an environment that has not been terribly friendly to the concept of value, which may be a miserable understatement. I don't think I have to go into much detail on just how "narrow" the upswing in the market has been, or how growth has beaten value like a gong. I've survived by running a relatively focused portfolio and our firm only manages $1.2 billion, both of which have provided me with some flexibility. If you run a $20 billion portfolio, it's tough not to be the hero -- or the hostage -- of whatever grand theme is playing on Wall Street. With our size and focus, you can still be mostly in the game if a half-dozen or so of your largest holdings are working. In contrast, a value manager with $20 billion and 212 stocks
the value market and has few places to hide.
Which brings us to today's questions:
Was The Buysider just horribly, horribly early when calling, in
early summer, for the demise of "nonsense Internet investing" -- or just horribly, horribly wrong?
different from nearly all Internet-related stocks; and what exactly is value these days when arguably the most successful "value" manager in recent years,
Bill Miller is touting
I am going to start with the conclusion and work backward, using Amazon as my case study because it is such a wonderful poster child for the fundamentally flawed logic that applies to Internet investing these days. I would prefer not getting 317 emails on Amazon minutiae, although we have spent an awful lot of time reviewing it. Instead, consider the premise that I lay out, and how it applies to
of today's insta-5-baggers. And then
email me, keeping in mind the old saying, "In God we trust ... everyone else better put numbers in their response."
My operating premise: Grossly overpaying for a great futuristic concept with huge uncertainties and limited or no barriers to entry usually results in severe financial pain.
Working backward, Amazon has between 340 million and 390 million shares outstanding, depending on whether you convert the convertibles (we do) and how you treat outstanding stock options (we assume half of them will become real shares). At $84 per share, that values the company at roughly $35 billion. So, what business model over the next 10 years is capable of generating free cash flow and a "terminal value" that adds up to a present value of $35 billion? This is a question you
For the early-year projections, we borrowed a little from the leading Internet gurus:
Morgan Stanley Dean Witter's
Mary Meeker and
Henry Blodget, and then started filling in numbers to get near the current price (since management either has no idea what the numbers will look like -- or they just won't say). As you can see in the attached spreadsheet, what we ended up with was a Melvillian retailing leviathan with sales of more than $100 billion and pretax margins twice that of the world's heretofore most successful retailer,
Click here for spreadsheet: Trying to Justify Amazon's Current Valuation.
Think about this for a second: Amazon
to become the world's most successful retailer
to justify the current price. Just for the record, there are only 13 U.S. exchange-traded companies with present sales of more than $50 billion -- and we've used very new paradigm-like assumptions in terms of scalability. Please Mr. Miller, tell us where we are wrong. (Meanwhile, please continue to buy as much
-- which we are long -- as you can stand.)
On the other end of the spectrum, let's say Amazon just becomes a merely extraordinary company with $40 billion in sales and pretax margins that modestly exceed Wal-Mart's. In other words, a tough, agile competitor that is both online-savvy as well as an adept merchandiser and logistics champ.
If that's the case, the numbers don't work very well, and the current valuation is about 400% too high, as you can see on the attached spreadsheet. Again, Bill, please show me where I'm off here.
Click here for attached spreadsheet: My Estimation of Amazon's Intrinsic Value.
So the problem for me with a lot of Internet-related stocks is that the terminal value required to make the current price work is
enormous as to be silly. It has nothing to do with how much money a company is earning or spending now. Spend all you want, I say. Just create something that has lasting value, which is the whole point behind the discounted cash flow methodology.
After all, I bought cable, cellular, alarm-monitoring and satellite-television stocks in their infancy and during their darkest days -- for one reason: They were spending money up front on infrastructure with business models that had reasonably tethered consumers generating predictable amounts of cash flow.
Which means, yes, I was a moron for not buying AOL, which in retrospect was exactly the same. But having made one mistake, I'm not willing to make another: I just don't see the concept of an Amazon customer, much less the lesser of the B2C customers, having anywhere near the stickiness of an AOL customer. And their declining revenue per customer even in the face of additional product offerings seems to admit to an obvious weakness in their business model.
And exactly what about Amazon is really "new tech"? Isn't it simply an online retailer using technology well, subject to the same seasonable vagaries, inventory and merchandizing challenges as other retailers? Don't most retailers track customers, do direct mail and send targeted credit-card solicitations? Is this not an enormous distance from a proprietary hardware or software company?
But we digress. The point is that value investing is
USX-U.S. Steel Group
every year or sticking only to low P/E or low price-to-book companies. It also does not mean ignoring technology, as
is my second-largest position. There are plenty of opportunities in this screwy market to buy misunderstood, wonderful businesses at exceedingly reasonable prices -- without having to surf the bleeding edge. And it is absolutely commonplace -- and no different than any time in the history of mankind -- that the "market" is grossly overvaluing a lot of high-promise stocks, of which only a precious few will truly flourish.
So yes, "wrong" might be the way to describe The Buysider's call that the overt speculation in many Internet-related stocks was over in late spring. But I'll gratefully take another year of near 20% performance without being forced to drink of the Internet Kool-Aid.
I'll conclude here by replugging
Devil Take the Hindmost
as a book that is a must-read to get some perspective when you are on Peter Island this New Year's celebrating your new eight-figure Internet worth.
Jeffrey Bronchick is chief investment officer at Reed Conner & Birdwell, a Los Angeles-based money management firm with $1.2 billion of assets under management for institutions and taxable individuals. Bronchick also manages the RCB Small Cap Value Fund. At time of publication, RCB was long Albertson's and Comdisco, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Bronchick appreciates your feedback at
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