Looking for the next Amazon in the technology industry
Of the newer batch of technology companies, Facebook, as a very profitable enterprise, is a rare exception. Other big names like Netflix, Tesla, and the still private Uber are burning through billions of dollars each year as they try to scale. The promise is that they each will one day look like Amazon when they scale, dominating markets — but with the financial security of massive levels of cash flow to reinvest in still enviable growth markets.
Nevertheless if we go back to 2001 and the Internet bust, things did not look so good for Amazon. There was even talk of Amazon’s going bankrupt. I think what happened to Amazon leading up to the bust and afterwards is instructive when thinking about the new crop of technology darlings.
Let’s start with a price chart from the internet boom and bust. What you see is a double top in 1999 above $100 a share before Amazon lost over 95% of its value and fell to a low of almost $5.50.
Source: Yahoo Finance
With Amazon trading above $1350 a share, you are up 13x in the 19-odd years from the peak during the Internet Bubble and almost 250x from the lows in 2001. That is a very enviable recovery. So clearly, becoming the next Amazon would be a very good thing.
Now, if we go back to the Internet bust, Amazon was a loss-making company that was trying to grow as fast as it could into as many online retail spaces as it could, while burning through a huge amount of cash to fuel that growth. When the Internet boom collapsed, the company was left exposed because it not only had a large cash burn rate, it also had started to take on debt to fuel growth.
The denouement came in February 2001 with a negative research note from Lehman Brothers’ Ravi Suria. The Lehman convertible bond analyst covered Amazon because the Internet company had issued convertible debt at the top of the market, since the debentures offered bond investors an attractive upside due to a likely conversion into equity as stock prices rose. That held down the funding costs for Amazon. The company issued 10-year paper at 4.75% in January 1999 and then still more debt in February 2000 at 6.75%. Both issues were junk-rated.
But when the Internet Bubble popped and share prices began to plummet, Amazon’s negative cash flow became a problem. Instead of focusing on the possibility that the convertible bonds could be profitably converted into common stock if the shares rose 36% above the February 2000 share price, analysts were focused on the cash burn rate at Amazon. In the summer of 2000, Ravi Suria’s analyst report detailing an allegedly worsening credit position at Amazon caused a one-day loss of 20% for shares.
By February 2001, Suria was writing about Amazon’s facing a “creditor squeeze” in the second half of the year. And he told investors to “avoid” Amazon’s convertible bonds because the company’s liquidity was “tenuous.” Of course, Suria was right from an investing standpoint. As TheStreet.com wrote around that time, “No Wall Street analyst saved professional investors more money in 2000 than Ravi Suria”. Amazon shares lost 90% of their value between when Suria first raised his concerns in the summer of 2000 and the summer of 2001. Moreover, Suria was correctly making the same calls about a bunch of debt-laden telecom issuers who were also cash-flow negative.
I mention this not just because Amazon is the company others want to emulate, but also because the same sort of dynamic is now taking place with today’s new crop of technology darlings. For example, with Tesla, just as Tesla was issuing a convertible debt offering last summer, a Harvard Business Review article was exclaiming that “traditional business metrics are outdated” and shouldn’t limit our thinking about Tesla. That’s convenient for Tesla CEO Elon Musk because he was able to get a Single-B rated bond issue away for a low 4 7/8% yield as a result.
Right now, we’re in the extreme growth phase of the technology cycle. For example, just this week Netflix announced that, during the last quarter of 2017, it added more than 8.3 million new members. That’s 2 million more than the company had expected. And shares soared on the news. But this growth comes at a cost. The $100-billion market capitalization is underpinned by investments so large that Netflix expects negative cash flow in 2018 of $3 to $4 billion.
What happens when the music stops? In Amazon’s case, the company was forced to temporarily downshift its growth model and reduce investment in order to demonstrate it could turn off the spigots at the drop of a hat. By January of 2002, Amazon was posting a net profit of $5 million for the quarter — and using standard GAAP accounting. That compared to a net loss of $545 million in the same period a year earlier. Revenue was still up 15% too. By the summer of 2003, Warren Buffett’s Berkshire Hathaway had bought $98.3 million of Amazon’s junk bonds, as the insurance giant increased its portfolio of junk bonds sixfold in 2002.
But that’s Amazon. Not every company is the next Amazon. A lot of the telecom companies that Suria panned in his research notes went bust. And even Amazon faced a trial by fire and fears of a liquidity squeeze. Right now, investors are focused on growth as they search for the ‘next Amazon’. But we are in the midst of late-cycle and synchronized global growth. On the back side of this period, there is a global growth slowdown. And that’s when these companies’ business models will really be tested.