How Amazon Trained Its Investors to Behave
In March 2000, Barron's reported that 51 Internet companies were burning cash so fast that they'd be broke by the end of the end of the year. The article (it's behind a seemingly unbreachable paywall) has acquired the reputation of having marked the end of the dot-com boom. The Nasdaq composite index peaked on March 10 at 5132, and by the end of the month was in a full-on collapse (as I write this, it's only at 3155, despite years of gains).
The Burn Rate 51 was made up mostly of now-forgotten companies like drkoop.com and CDNow. But it also included a certain Internet bookseller from Seattle. The Barron's article mentioned that a 690 million euro convertible bond sale in February had bought Amazon some more time (the list was based on 1999 year-end data) — but that the company would still run out of cash in 21 months.
In fact, Amazon was only operating at such a high burn rate because it could. Once investors stopped giving it free money, the company quickly cut back on its investments and its losses. By the fourth quarter of 2001 — that is, within about 21 months — it was turning a profit.
That opportunistic approach to financial markets has defined Amazon since it went public in 1997. And while it has certainly burned many buyers of Amazon shares through the years — Amazon's stock price took a decade to get back to its 1999
2009 peak — the long-run returns have been spectacular. In Morten T. Hansen, Herminia Ibarra, and Urs Peyer latest ranking of long-run CEO performance in HBR, Amazon's Jeff Bezos now ranks No. 2, behind the late Steve Jobs, with an industry-adjusted shareholder return of 12,266% during his tenure.
So when Amazon reports below-consensus earnings, as it did Tuesday, and the share price jumps, as it did after-hours Tuesday and again Wednesday morning, the reaction isn't quite the puzzle it seems. Slate's Matthew Yglesias cracked that "Amazon, as best I can tell, is a charitable organization being run by elements of the investment community for the benefit of consumers." But what's really going on is that Jeff Bezos has trained elements of the investment community to expect that low profits (or big losses) now represent investments that will eventually pay off, not signs of trouble.
How has Bezos done this? Well, he's a hedge fund veteran who has always taken a skeptical view of Wall Street, treating it more as a loopy rich uncle than the efficient information processor of standard finance theory. When Uncle Wall Street (also known as Mr. Market) is in a generous mood, Bezos is always ready to take advantage by putting investment ahead of profitability. But he's also always been ready to shift gears when the mood turns stingy.
And so Amazon thrived in the crazy late 1990s, when Henry Blodget made his name as an analyst by making outrageous guesses about how high Amazon's stock price would go and seeing them come true long before he expected. It also thrived right through the gloomy early 2000s, when bond analyst Ravi Suria made his name picking apart Amazon's balance sheet and worrying that the company wasn't generating enough cash to make its bond payments (along with the 690 million euro issue in 2000, the company had sold $1.25 billion in bonds the year before). Suria was wrong about that. In fact, Amazon retired the last of the $1.25 billion bond issue just before the debt-market meltdown of autumn 2008. Nice timing, huh?
Of course, none of this would have worked if Bezos hadn't been making the right strategic bets, running the company spectacularly well, and catching the occasional lucky break. There are lots of corporate executives who think they know better than Wall Street. Most turn out not to.
But when you combine Amazon's success with its resolute unwillingness to take financial markets too seriously, the result is an amazing thing to see. Clayton Christensen has long complained that standard financial metrics can be enemies of innovation and growth. As he and two co-authors wrote in 2008:
The emphasis on earnings per share as the primary driver of share price and hence of shareholder value creation, to the exclusion of almost everything else, diverts resources away from investments whose payoff lies beyond the immediate horizon.
With Amazon, though, nobody emphasizes EPS. Or, when they emphasize earnings, it's in the opposite direction from what Christensen's worried about. A few months ago, I heard analyst Mark Mahaney, now of RBC Capital markets, argue (at about minute 26 on the video) that Amazon's razor-thin profit margins were a source of competitive advantage:
You really develop very sustainable moats around a business when you run it at low margins. Very few companies want to come into Amazon's core businesses and try to compete with them at 1% margins or 2% margins.
This sounds eerily similar to what Yglesias was saying, half-jokingly, on Tuesday:
Competition is always scary, but competition against a juggernaut that seems to have permission from its shareholders to not turn any profits is really frightening.
Amazon has this permission because it has trained its shareholders to believe that everything will work out in the end. As a result, it has a shareholder base that's geared for the long-run. The biggest holder, by far, is Bezos himself. After that the No. 1 institutional holder, by a good margin, is Capital Group, the giant Los Angeles mutual fund complex with a reputation for having long investment horizons. I've been looking through transcripts of the company's past couple years of quarterly earnings conference calls with analysts (thanks, Seeking Alpha), and have learned that Bezos never participates (most CEOs do) while CFO Tom Szkutak always concludes his remarks with the sentence, "We believe putting customers first is the only reliable way to create lasting value for shareholders." Nobody complains.
Being long-term oriented isn't necessarily the same as being right. Amazon could make the wrong bets. Bezos could get more interested in space travel than selling massive quantities of stuff at just above cost. But Bezos seems to get this. From an interview with Fortune's Adam Lashinsky last year:
"We believe in the long term, but the long term also has to come," says Bezos, explaining that periodically Amazon wants to "check in" with its ability to make money.
Just "check in," mind you. Wouldn't want to get hung up on flawed financial metrics when there's a world to conquer. Which Bezos can get away with — now that he has housebroken the investment community. The key to success in dog training, I'm learning (we just got a puppy), is to appeal to instinct and memory. Reasoning with the animal, or getting mad at it, doesn't get you anywhere. Neither does mockery, whatever Will Ferrell says. Bezos did lose his cool a bit over Suria's claims back in 2000 ("hogwash," he kept calling them). But in general he has exuded the steady authority of a good dog trainer. Hey, Wall Street! Roll over!