Managing to Cash at Amazon

Kevin Meyer at Evolving Excellence has a skeptical post about Amazon’s Long Public Haul. He has some compliments for Jeff Bezos’s leadership and Amazon’s culture, but also takes some shots that are unjustified and need correction:

When they began in the mid-90’s they were the poster child for the internet… a radical, game-changing concept that leveraged a new technology. They were also the poster child in that they were extremely unprofitable, but claimed that the fundamental financial rules that govern all enterprises… ie bottom line cash flow… could somehow be warped. In mid-’97 they did an IPO to raise cash… and give effective control to the shareholders. Going public seems contrary to the current trend of going private, but they needed cash to fund the obscene losses they were generating. [ellipses in original]

Actually, Amazon is one of our most vociferously cash-focused public companies, and has been since its IPO. From Jeff Bezos’s letter to shareholders in 1997 (the year Amazon went public):

When forced to choose between optimizing the appearance of our GAAP accounting and maximizing the present value of future cash flows, we’ll take the cash flows. … We will work hard to spend wisely and maintain our lean culture. We understand the importance of continually reinforcing a cost-conscious culture, particularly in a business incurring net losses.

In 2001, Jeff Bezos’s letter to shareholders noted lean manufacturing touchstones such as increased inventory turns and “relentless focus on the customer.” The letter read in part:

In every annual letter (including this one), we attach a copy of our original 1997 letter to shareholders to help investors decide if is the right kind of investment for them, and to help us determine if we have remained true to our original goals and values. I think we have.

In that 1997 letter, we wrote, “When forced to choose between optimizing the appearance of our GAAP accounting and maximizing the present value of future cash flows, we’ll take the cash flows.”

Why focus on cash flows? Because a share of stock is a share of a company’s future cash flows, and, as a result, cash flows more than any other single variable seem to do the best job of explaining a company’s stock price over the long term.

If you could know for certain just two things–a company’s future cash flows and its future number of shares outstanding – you would have an excellent idea of the fair value of a share of that company’s stock today.

From Amazon’s 2005 annual report (this language first appeared in 2003):

Our financial focus is on long-term, sustainable growth in free cash flow. Free cash flow is driven primarily by increasing operating income and efficiently managing working capital and capital expenditures. Increases in operating income result from increases in sales through our websites and a focus on keeping our operating costs low, offset by investments we make in longer-term strategic initiatives including hiring additional software engineers and computer scientists. (p. 25)

In fact, beginning in 2003, Amazon began publishing its statement of cash flows ahead of the income statement and balance sheet in its annual reports.

The following table compares Amazon’s reported net income (as reported) and free cash flow (defined as cash flow from operations less capital expenditures, including capitalized software). Amazon’s focus on cash flow over GAAP earnings is clear. Note that Amazon generated positive free cash flow in 1998 and had positive cash from operations in 1997 and 1998, so it’s not the case that “they needed cash to fund the obscene losses they were generating.”

Cash Flow
2005 $359 $529
2004 588 477
2003 35 347
2002 (150) 135
2001 (567) (170)
2000 (1411) (265)
1999 (720) (378)
1998 (124) 3
1997 (31) (7)

(Source: 2005, 2002, and 1999 annual reports, as reported. Dollars in millions.)


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