February 19, 2015 2:56 pm

Amazon capital questions

Online retailer would rather focus attention on free cash flow
Abracadabra. Amazon does not make much profit and, perhaps for that
reason, likes to focus attention on free cash flow. This metric, which is
not a GAAP measure, is usually calculated as operating cash flow less
capital expenditure. That came to $1.9bn for Amazon last year.
A big number, with some sleight of hand: it understates Amazons
investment programme and overstates its cash generation. This is
because the company has increased investment by using capital
leases to buy assets. Last year $4bn in assets were acquired under
capital lease five times the level of 2012. This is nearly on a par with
capex, which stood at $4.8bn last year. Capital leases are like a
purchase that is financed by the seller. Amazon says the increase in
CLOs is mostly due to technology investment for Amazon Web
Services (read: server farms). About $2bn in principal repayments fall
due this year.
This is all in the annual filings in black and white. But capital lease
repayments are not included in capex they are considered financing
flows, not investing flows. Therefore these principal repayments
$1.3bn last year are not included when calculating Amazons
primary version of free cash flow. The depreciation and amortisation of
assets acquired under capital lease is included as a cost under
operating expenses, but this is netted out when calculating operating
cash flow, because depreciation and amortisation are added back in.
(About $1.5bn of Amazons $4.7bn in D&A last year was due to assets
acquired under capital lease.) All of this complies with accounting
rules. Yet it distorts common sense. If principal repayments on capital
lease obligations were treated like capex, free cash flow would have
been $500m last year, and $1.2bn the previous year. If the assets
acquired using capital leases were treated as capex, the free cash flow
figure drops to minus $2.2bn last year. The most recent earnings report
was the first time Amazon included these figures in its discussion of
free cash flow.
Amazon bulls will point out that negative free cash flow is nothing to
worry about for a company that is growing fast look at Walmart
during the 1980s. Fair enough. Yet Amazon itself states solemnly that
Our financial focus is on long-term, sustainable growth in free cash
flow per share. That trick has not yet been performed.