Jeff Bezos and the Power of the Amazon Model

Here’s an interview with Warren Buffett – published February 27, 2017 on CNBC – where Buffett talks to Becky Quick about retail, Jeff Bezos, and the power of Amazon’s business model.

Becky Quick: A major investor I spoke with recently asked me this question, I’m not sure if it was supposed to be on the record or not, so I won’t use the name. But this investor said that here she had heard you recently making some comments about Amazon where you where very complimentary of Amazon, it’s founder Jeff Bezos, said he’s probably the best manager you’ve ever seen.

Warren Buffett: I think maybe he is, yeah. You know, I’ve said that. I mean, it’s remarkable I mean, here a guy, you know, gets in a car with his wife to travel. Leaves you on and starts travel across thinks “How am I going to take over the world?” Maybe I’ll sell books online. He is one terrific business person.

Becky Quick: That investor then asked me “Why don’t you own shares of Amazon?”

Warren Buffett: Well, that’s a good question, but I don’t have a good answer. Obviously I should have bough it a long ago, because I admired him long ago. But I didn’t understand the power of the model as I went along, and the price always seemed to more than reflect the power of the model at that time. So it’s one I missed big time.

Becky Quick: Is it to late? Or you just don’t know?

Warren Buffett: I just don’t know, yeah. Retailing is tough for me to figure out. I mean, if you go back to when I was a kid, in every town the guy that owned the big department store was king. I mean, whether it was Marshall Field, you know, or Dayton, or Hudson in Detroit, or Fredrick & Nelson in Seattle. You name it. J. L. Brandeis in Omaha. The department store was king. And people said “What can happen to them?” You know, it’s down there with the street car lines crossed, and the women took the street car to shop there and they could see five hundred spools of thread, and five hundred wedding dresses. And they couldn’t see anything like that. It offered this incredible array of goods. And somebody came along with a shopping center. And instead of making it vertical with all this display by one person, they spread it out one by many. And now comes the Internet. And that’s it, all of it, variety of things that you can get to very easily. People love variety, they love low prices and all bunch of things. So it just keeps evolving and the great department stores, many of them have disappeared and the rest are under pressure.

Source: CNBC’s Warren Buffett Watch

There’s an article published by Morningstar today that discusses Amazon’s $13.7 billion acquisition of Whole Foods. According to Morningstar, Amazon gets a wide economic moat rating. The article brings up and discusses some of the different parts making up Amazon’s wide moat, that is, its sustainable competitive advantages. To read the article, click here.

What’s This Business Worth?

What exactly goes through your mind when you’re actually making an investment? Warren Buffett got this question during an interview and talked for a moment about a few of the things that come to his own mind when he’s trying to evaluate a certain business and it’s future economic potential.

“Well, if I drive by a McDonald’s stand or a Kentucky Fried Chicken stand I will automatically think to myself “What is this business worth?” You know, how many customers can walk in the door? What kind of gross margins can they have? How many people do they need? How likely is it that another chicken stand opens across the street? I mean, all of those things. And that’s true of the chicken stand and it’s true of Google or you name the business. I mean, it’s all about evaluating the economic potential, the economic future of a given business. And most of them you don’t know the answer on. But every now and then you run into one where you know the answer. But that’s all business is. It’s what Aesop said a long time ago: “A bird in the hand is worth two in the bush.” You know, that was said in 600 BC and that’s now what’s called discounted cash flow and all that sort of thing. But he saw that and figured it out, you know, twenty-six hundred years ago. And all I’m trying to figure out is if I could take that dollar in my hand: When do I get the two dollars out of the bush? How sure am I of getting it out of the bush? Is there some other bush where I can get three dollars out of it instead? I mean, it’s very basic stuff. And a lot of times you look at it and you say “I don’t know how many birds there will be in the bush.” So you go in to the next one until you find the answer.”

(Source: 56:55 into Warren Buffett with B-School Students Interview from India)

The Manager’s Most Important Thing: Widening the Moat

What’s the most important thing to do as a manager of a business? According to Warren Buffett it’s all about “widening the moat.” Nothing more, nothing less.

“Well, I send a letter to the managers and I talk to them about widening the moat. I say it isn’t the question of the earnings per share this quarter or anything like that. Any business that has a widening moat is gonna make a lot of money over time. They are guardians of the moat. I say a great business is like an economic castle. And if you have an economic castle in capitalism, there gonna be a bunch of people that are going to try and take it away from you. So I need a knight in that castle, the manager, who worries about protecting that castle all the time. And then I want this moat around it, and I want that moat to get wider. It may be service, it may be better product design, all kinds of things. It can be what’s in their mind about the product, a consumer product. But I want that moat to be widening. And I want people to toss sharks and piranha, octopus, everything into that moat to keep away those competitors because they’re gonna be coming and our managers are charged with that. I tell our managers, pretend that this is the only business that you and your family can own for the next hundred years, you can’t sell it and you’ve got to make this one work. And that means every day thinking about what’s going to make it a great business over a 100 years.”

(Source: 8:46 into Warren Buffett with B-School Students Interview from India)

For some input and ideas about what makes (or breaks) a moat, check out this slide deck from Pat Dorsey.

Bill Ackman Betting on Zero

“A couple time we come across a company we think is causing harm, we can make money betting against that company.” —Bill Ackman

“Herbalife stock goes down, we make money. Herbalife stock goes up, we lose money. And that’s short selling.” —Bill Ackman

“[Interviewer] What are you accusing Herbalife of? [Bill Ackman] Of being a pyramid scheme.” —Betting on Zero, 2017

About the Movie

“From ‘Darfur Now’ writer/director Ted Braun comes a riveting docu-thriller following controversial hedge fund titan Bill Ackman as he puts a billion dollars on the line in his crusade to expose Herbalife as the largest pyramid scheme in history. Herbalife claims Ackman is simply a market manipulator out to make a fortune from short-selling their stock, but Ackman insists Herbalife deliberately targets low-income and immigrant communities and robs them of their life savings. Herbalife is joined on the counterattack by longtime Ackman nemesis (and fellow Wall Street billionaire) Carl Icahn, while Ackman finds an unlikely ally in Chicago activist Julie Contreras, who rallies the Latino community to get the Federal government to intervene. Blending tales of high-stakes corporate intrigue with working-class people caught in the crossfire, Braun paints a stirring picture of the American Dream gone wrong.” (Source: iTunes Preview)

The Betting on Zero documentary is available via iTunes.

Disclosure: I am not receiving any compensation for any of the links provided. I have no business relationship with any company or individual mentioned in this article. I have no position in any stock mentioned. 

#WeeklyInvestorReader | wk. 24

Note to readers: #WeeklyInvestorReader contains a few of the articles I read during the week. Visit my Twitter @HurriCap for any other articles that may not have been included. 

Another Swedish Company Aims to Be the Spotify for Books – Fortune, June 15, 2017 | “Fast-growing audio books company Storytel will expand into several new markets in the coming years while steering clear of English-speaking countries where rival Audible dominates, the Swedish company’s chief executive said.”

Mo’ Margins Mo’ Problems – Eric Cinnamond, June 14, 2017 | “Investors have a tendency to gravitate towards leading brands and high margins. Such traits are often an indication of a high-quality business and meaningful intangible assets. While brands can be very valuable, they are not free. Brands require considerable investment and ongoing maintenance. Furthermore, similar to many things in business, there are cycles, trends, and risks associated with even the best brands.”

HomePod – Above Avalon, June 14, 2017 | “Apple unveiled a brand new product category last week at WWDC: HomePod. On the surface, HomePod seems like an unusual product for Apple. The company’s most recent new products (Apple Watch and AirPods) form the foundation of an expanding wearables strategy. How does a stationary smart speaker fit into such a product strategy?”

Market Folly’s Summer Reading List – Market Folly, June 14, 2017 | “If you’ve got a vacation / holiday coming up and need some reading material, here are some recommended books on investing, hedge funds, business, decision making, and life in general. Some are newer books, others are classics you might have missed and should catch up on.”

10 Business Books For Your Summer Reading List – Dr. David Kass, June 14, 2017 | “The University of Maryland’s Robert H. Smith School of Business is excited to announce some favorite books in the 14th Annual Top-10 Summer Reading List for Business Leaders for 2017, as recommended by faculty members.”

How Adobe Got Its Customers Hooked on Subscriptions – Bloomberg, June 8, 2017 | “The switch to the cloud was risky, but revenue is way up.”

Is Wall Street Giving Netflix a Pass on Sky-High Content Costs? – The Hollywood Reporter, June 14, 2017 | “Netflix CEO Reed Hastings caused heart palpitations in Hollywood on May 31 when he said he wants to cancel more of his original shows. “Our hit ratio is way too high right now,” Hastings told CNBC.”

New: The Behavioral Economics Guide 2017 – Behavioral Economics, June, 2017 | “At the beginning of this year, I came across an attention-grabbing headline: “Behavioral Economics Isn’t Dead Yet”. It was written by Noah Smith on Bloomberg View. Despite some voices that may have questioned the future of behavioral economics (BE), Smith pointed to evidence that behavioral models may be slowly infiltrating macroeconomics.”

A U.S. Shoe Town Tries to Rebuild From Warren Buffett’s ‘Worst Deal’ Ever – Bloomberg, June 13, 2017 | “Two decades after Dexter Shoe closed, $325 hand-sewn penny loafers may hold the key to keeping the craft alive in Maine—and U.S. jobs onshore.”

P&C Insurance – A natural hedge against rising interest rates – S&C Messina Capital Management, June 11, 2017 | “The general consensus is that interest rates will rise. But the key question is when.”

Alibaba Stock’s Peculiar Legal Structure – The Conservative Income Investor, June 7, 2017 | “To receive capital from American investors—or investors anywhere outside China for that matter—Chinese business executives have begun to create variable interest entities (VIEs) that are designed to mimic the effects of foreign stock ownership.”

We Need to Talk About Uber: A Timeline of the Company’s Growing List of Problems – Longreads, June 10, 2017 | “In a piece for the Financial Times titled ‘Fire Travis Kalanick,’ Kadhim Shubber wrote of the founder of Uber: ‘One day we will look back at what will hopefully be the smouldering wreckage of Kalanick’s career and ask how a person so lacking in basic human and corporate ethics was allowed to run a company for so long.'”

2016 Financial Restatements Review – Audit Analytics, June 12, 2017 | “The annual Audit Analytics report on financial restatement trends is now available. This report provides a detailed analysis and comparison of trends in financial restatements over a sixteen-year period.”

JIM ROGERS: The worst crash in our lifetime is coming – Business Insider, June , 2017 | “Legendary investor Jim Rogers sat down with Business Insider CEO Henry Blodget on this week’s episode of “The Bottom Line.” Rogers predicts a market crash in the next few years, one that he says will rival anything he has seen in his lifetime. Following is a transcript of the video.”

Free Shipping Is A Lie – Fast Company, November 1, 2016 | “Free shipping is a top priority for online shoppers, but many merchants are struggling to keep up with the costs.”

Who Will Survive the Retail Reckoning of 2017? – Knowledge@Wharton, June 2, 2017 | “Legacy retailers’ ongoing struggle to stay relevant in a landscape increasingly dominated by Amazon and online upstarts has come to a head in the past year. Companies will close thousands of stores this year – and some may not survive at all. While it may seem that retail is headed for an apocalypse dominated by dead malls, in reality it’s a needed industry shakeout.”

Zalando’s Whizzy Website Doesn’t Come Cheap – Bloomberg, May 9, 2017 | “Online growth doesn’t come cheap. That has been the message from Europe’s big online retailers lately.While internet shopping is outpacing that in physical stores, avoiding the burden of bricks and mortar is no guarantee of runaway profit growth. The cost of fulfilling orders, dealing with a high level of returns and the need to enhance customer service is inescapable.In addition, traditional chains are improving their digital offerings, while Amazon.com Inc. is pushing ever-deeper into clothing.Zalando SE is the latest online retailer to spell out just how much it is spending in an attempt to stay one step ahead. The danger for it, and its rivals, is that profit growth doesn’t keep pace with sales expansion.”

Is the Company’s Product Attractive – Investment Masters Class, June 13, 2017 | “Charlie Munger has long reiterated the need to have multiple mental models to aid the investment process. This short essay looks at some of the product attributes that appeal to the Investment Masters.”

Judging GE’s Jeff Immelt Versus Jack Welch – Bloomberg, June 12, 2017 “The two chief executives of General Electric Co. were dealt very different hands.”

The Mall of the Future Will Have No Stores – Morningstar, June 12, 2017 | “As retailers close bricks-and-mortar stores at an accelerating pace, shopping-center landlords like Starwood Capital are facing a vexing question: What to do with all this empty space? Their solutions are varied but all have a common element: reducing, or even eliminating, retail from the equation.”

Going Private Possible for Nordstrom – Morningstar, June 12, 2017 | “Nordstrom’s (JWN) share price soared after the June 8 announcement that the Nordstrom family is exploring the option of taking its namesake company private. Combined, the family owns just over 30% of the department store.”

Amazon and Walmart’s all-out price war is terrifying America’s biggest brands – MSN Money, March 31, 2017 | “Grocery suppliers are feeling the squeeze — big-time.”

Can Retailers Escape the Scourge of Free Shipping? – Knowledge@Wharton, June 6, 2017 | “If retailers are hurting today, among the wounds — both self-inflicted and imposed from outside — is free shipping. On the demand side, customers are increasingly expecting free delivery and even free returns. The problem for retailers, of course, is that free shipping cuts deeply into profits.”

The death of brick-and-mortar retail – Axios, June 9, 2017 | “First, it was Main Street. Americans stopped going to their neighborhood diners, grocers, haberdashers and five-and-dimes, shifting their business to big malls, and blighting the central business districts of towns and cities across the country. Now it’s the malls’ turn: Americans are snubbing them, and flocking to shop on-line, mostly at Amazon. Will brick-and-mortar retail survive?”

Amazon’s Pivot to Poor People – The Atlantic, June 6, 2017 | “On Tuesday, Amazon announced that it will slash the price of membership to its Prime program by almost 50 percent for low-income shoppers on federal welfare. The move might seem like a unique form of private-sector charity for poor Americans, after decades of disappointing wage growth. But it’s also a direct challenge to Walmart, the reigning king of American retail, which relies heavily on low-income shoppers and receives nearly one of every five dollars of its revenue through SNAP, or food stamps, each year.”

Apple Spruces Up the App Store – Bloomberg, June 6, 2017 | “About halfway through Apple’s more than two-hour product demonstration on Monday was a moment that wouldn’t have raised the heart rates of die-hard technologists but may be the most significant of the announcements Apple made.”

Why Amazon Is Buying Whole Foods – Forbes, June 16, 2017 | “We all know Amazon is the most powerful retailer online. They have been marching like a conquering army to increased dominance every day. The customer experience they provide, a critical part in consumers’ judgment about their satisfaction with retailers today, is second to no one. So why would a company with so much power and potential online, invest over $13 billion to buy Whole Foods, a business that functions virtually entirely in physical stores?”

Free Research Report: Village Supermarket – Gannon on Investing, June 16, 2017 | “Supermarket stocks are a good area for value investors to research now. One way to learn about the supermarket industry in the U.S. is to read the report Quan and I wrote on Village Supermarket (VLGEA) back in 2014. That stock is now at roughly the same price – $25 a share – it was when we wrote about it.”

‘Betting on Zero’ documentary achieves desired results: Righteous outrage, moral superiority – Washington Post, March 16, 2017 | “When “Betting on Zero” was shown at the National Portrait Gallery’s 346-seat auditorium as part of last year’s Investigative Film Festival, half the seats to the screening of the documentary — a searing exposé arguing that the nutritional supplement company Herbalife is a Ponzi scheme — went empty. According to the festival’s organizers, several employees of Herbalife’s Washington lobbying firm, Heather Podesta + Partners, bought tickets in large batches, which were never used. Earlier in 2016, at the world premiere of the film at Tribeca, paid protesters handed out leaflets in an attempt to discredit the movie, according to the “Betting on Zero” website. Why all the fuss?”

In Swedish

Flera analytiker sänker riktkursen för H&M – färsk analys tror på en svag halvårsrapport – Veckans Affärer, 16 juni, 2017 | “Analyshusen väljer att sänka riktkursen för klädjätten och affärstidningen tror på dåliga försäljningssiffror framåt.”

Bäddat för ännu ett svagt H&M-kvartal – Dagens Industri, 15 juni, 2017 | “Sveriges mest välmående krisbolag bjöd på en ny försäljningsbesvikelse i maj. Det är därmed upplagt för ännu ett svagt kvartal med sur lönsamhetsutveckling när H&M presenterar halvårsrapporten 29 juni.”

Så har det gått för årets nynoteringar – Affärsvärlden, 16 juni, 2017 | “Årets nynoteringar har följt två trender: de nya bolagen på Stockholmbörsen har i de flesta fall gått starkt, medan tillskotten på smålistorna har haft det tuffare.”

Getinge planerar nyemission på 4 miljarder kr – Privata Affärer, 14 juni, 2017 | “Getinge planerar en nyemission om cirka 4 miljarder kr i syfte att stärka koncernens balansräkning genom att sänka belåningen och därigenom skapa ökat handlingsutrymme.”

Så blev Gardell en beryktad aktieaktivist – Dagens Industri, 2 juni, 2017 | “Snabba räder under radarn, offentliga attacker för att snabbt höja värdet och ständigt en blick mot utgången. Det är receptet som har gjort Cevian så segerrikt och Christer Gardell så kontroversiell.”

Free Singular Diligence Issue: Village Supermarket (NASDAQ:VLGEA)

Want some good reading for the weekend? Check out this research report on Village Supermarket provided for free via Gannon on Investing.

You find the report here.

Disclosure: I am not receiving any compensation for any of the links provided. I have no business relationship with any company or individual mentioned in this article. I have no position in any stock mentioned. 

Jim Chanos Talks Tesla and Kidney Dialysis

I’m a great admirer of Chanos and I always try to learn something when I hear him speak. Here, an inter interview produced by Bloomberg. Two of the topics discussed, among others, were Tesla and the kidney dialysis industry.

To watch the interview, click here.

Below, two parts of the interview, the first one with a few words from Jim Chanos on the kidney dialysis industry (emphasis added).

*THE KIDNEY DIALYSIS INDUSTRY*

[12:45] Joe Weisenthal: Alright, to move it back from politics and theory for a second, I noticed you said there in your answer that you’re focused on some companies that may be in trouble with the potential rollback of the essential health care benefits. So, can you give us some insight into some specifics? Who’s vulnerable to a theoretical rollback there?

Jim Chanos: One area we would really focus in on, there’s only a handful public place, is the kidney dialysis business. I think that business is really heading for difficulties.

JW: Oh, we have a chart here of some different public companies…

JC: Oh, what a coincident.

JW: …in kidney dialysis. Amazing how that happened.

JC: There’s three of them, and I should say here that any companies that you either see a chart of or I mention, either intentionally or inadvertedly, you should assume that we are short that stock. Disclosure now done. And so, the kidney dialysis business is interesting because we have Obama care exchange insurance officials on record saying that kidney dialysis is almost single-handedly breaking the exchanges. Blue Cross of California has said that for every single kidney dialysis patient they have, they need 3,800 healthy lives to cover it. It is amazingly expensive, but not in the way you would think. In the way these companies have prospered, in a weird way, is they’re actually trying to push Medicare and Medicaid patients – where the reimbursement is much lower – into Obama care, and where they get two to three times the reimbursement rate, and under the essential health benefits factor, they gotta provide it. And so, taking an elderly person who’s on Medicare, why would they go into Obama care, right? It would costs them, an elderly person, a fair amount of money. Well, they get third parties to pay a big chunk of the premium, the former charities. And guess who donates to some of those charities? And so this is one of these sort of rent-seeking behaviours that I think is gonna go by the wayside. And I think these excess returns… one of those companies that you had up there actually has a slide in their investor dec that said 90% of their business is Medicare/Medicaid and that loses money. Ten percent of their business is commercial and that makes a 110% of their operating profit.

JW. So everybody can go search for that…

JC: Yeah, they can go search for one of those three companies. I think they quite figure it out.

Scarlet Fu: So has that gained momentum? Do you hear other people pressing the company on that? How that doesn’t seem to make sense?

JC: Well, there was a wonderful… I can’t mention networks, I know it’s no good on Bloomberg. But there was a wonderful Sunday night weekly news show on a cable network, chaired by a British guy, that actually did a 15 minutes segment about one of these companies about a month ago, and we were stunned when we saw it. We had no idea that anybody else cared. But they did a pretty good job at walking you through exactly what an issue this is.

So for all investors out there interested in the kidney dialysis industry, and for example DaVita Healthcare Partners (Ticker: DVA), a Berkshire stock investment, this might be something to dig deeper into to see whether Jim Chanos and his Kynikos is on to something here or not.

Following the chat about the kidney dialysis business is a discussion about Tesla, a company Jim Chanos has been talking about publicly before.

*THE TESLA AUTOMOBILE*

[15:49] SF: Let’s move on to another company that you have spoken publicly about which is Tesla. And as I imagined…

JC: Who?

SF: Tesla. T-S-L-A.

JC: Okay.

SF: The company is holding its annual shareholders meeting right now, so they’re probably applauding themselves for their five-year return. If you look at a chart…

JC: They’re probably launching themselves to March right now…

SF: Perhaps, perhaps. The stock has somewhat launched itself. It’s gone from less than $30 five years ago to more than $350. That’s a return of more than 1,000 percent despite the absence of consistent profits and incredible cash burn. So, Joe and I were talking about this, we know you’ve been public on Tesla for some while. What would it take for you to throw in the towel? What would have to happen for you to throw in the towel and say “I give up on this short, this is not gonna work”?

JC: I think that have to see the company actually begin to make money selling products. And I should point out that we were also short Solar City that he bought in. That one worked out a little better than Tesla. So, the fact of the matter is, that this is a company that, as you pointed out, burns a lot of cash and we think they’re gonna be burning close to 750 million to a billion a quarter for the next handful of quarters. It has not finished its Gigafactory, the batteries are made by Panasonic. But most importantly it has its big test ahead of it; the Model 3. It has been loosing money selling $120,000 cars, but it hopes to make money selling a $35,000 car, which we think it will be a lot more than that. You have an executive departure list, the only one I’ve seen longer in the last two years is Valeant’s. There just people are leaving left, right and center.

SF: It’s a freight train…

JC: Well something… I mean, I don’t know. They’re certainly… they’re not waiting around for the company of the future, the stock price notwithstanding. And so we’ll see. I mean the car is supposed to go into production in July. They’ll be competing with real companies in 2018. I noted with some interest as I got here the opening remarks by Mr. Musk were talking about transforming to an energy company, an energy solution company or something like that. So he’s trying to reposition the company as something other than an automobile company. But it is an automobile company with a money-loosing solar roof company subsidiary. In addition he’s got to raise a lot of money. Rule of thumb is it takes about 50 cents in capital for every dollar of automobile revenues. So if he’s gonna be doing a 500,000 Model 3’s and 100,000 of the Model S’s and Model X’s, he’s gonna need something on the order – that’ll be thirty some billion in revenues – he’s gonna need about another ten billion in capital to do that, and he’s gonna need it soon. So the Teslarian should just embrace themselves cause they’re gonna get the chance to buy a lot more stock or convert here I suspect in the coming months.

JW: What’s the most likely way, in your view, in which the Tesla story ends? Is it something that in the Model 3 doesn’t live up to the high…

JC: He actually starts making money. That’ll be what ends it.

JW: No, but I mean like in terms your thesis becoming validated. Would it be more of a sort of an investor strike, as in conditions changed, there’s a market downturn, people aren’t able to fund the…

JC: If the Model 3 isn’t gonna be popular, that’s gonna hurt, right. That’s the one everybody’s waiting for, the one that the average person who can’t afford an S or X and wants to be part of the Tesla revolution and if the car is a lemon I think that will be a problem. […] But at the end of the day he’s gotta make a car for the masses that is successful, so that’s what we’re gonna watch.

Some takeaways from the above talk that you may want to consider putting into your investor’s toolbox are:

  1. Are all customers contributing proportionally to the company’s profits?
  2. What’s the downside to the business from any current or future regulatory changes?
  3. How much capital is needed to support future growth (capital to revenues ratio)?
    • Who will provide the capital – debt or equity holder (any dilutive effects on current shareholders)?
    • Will the company be able to raise the capital needed?
    • How long is the business able to keep on going without further capital contributions?
  4. Does the industry in which the business operates make it possible for companies to gain and sustain any sustainable competitive advantages?

Disclosure: I have no position in any stock mentioned.