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February 01, 2012

Analysis of Amazon's Q4 2011 Results - Third Party in the Spotlight

Note - for our preview on Amazon's Q4 report check here 

Drum roll please....

Tuesday (January 31, 2012), Amazon reported Q4 results and Wall St. puked all over them (second Q in a row, I might add) sending the shares down 10-12% flirting with a new 52week low.  

If you read some of the press, it sounds like gloom and doom -Amazon is making all these investments and they aren't paying off!  OMG the sky is falling!!! I think what's happening is the mainstream press isn't understanding the big shift in this Q - 3P surged and skewed the results (top line - down and bottom line - up) and for me that's actually a positive movement on many levels (both for Amazon and 3P sellers).

I think we'll look back on this Q as an important tipping point in the evolution of Amazon -the mix shift to 3P continues to change them from a retailer to a technology company and marketplace operator.  Given that weighty prediction, I wanted to spend a fair amount of time digging into the Q with our usual third-party (3P) focus, because it was a very important Q in that regard and gives us some clues to the mysterious missing $1b+ in Amazon revenue for the Q...

Note: for this post, unless explicitly called out - everything is what is know as ex-fx - it factors OUT any changes due to currency changes. 

Amazon's Q4 Results vs. Expectations

Here is a snapshot of Amazon's key metrics for the Q vs. both their earlier guidance and Wall St. expectations: (click to enlarge)

Amzn_q4_summary

From this table you can clearly see that revenue missed wall St expectations by about $1b and the bottom line exceeded (hmm, you'd think that wall st. would want expanding margins -but I suppose they want revenue growth and expanding margins).

Other highlights were:

  • Amazon announced they now have over 2m seller accounts
  • They introduced an exciting new metric - Service Sales.  this seems to include 3P, AWS and advertising revenues - we're going to dig into this metric in the future, but Amazon announced it grew 74% which is good.  This metric seems to be Amazon giving a bit of a peek into how rapidly MP/AWS/etc. are growing.
  • Prime instant video streams increased a whopping 300% - I think my family accounted for about half that growth ;-)
  • Amazon added 17 FCs globally in 2011
  • Kindle unit sales were up 177% y/y - that's almost a triple folks.
  • The category mix shifted hard to EGM - 63% EGM and 34% media - I remember when this was 50/50 just about 18 mos ago!
  • Number of employees was up 67% to a whopping 56,200 - it was 33,700 year ago - wow - that's a lot of new Amazonians. They did say on the call the majority of these were in call center and DC or 'retail ops' type roles which makes sense.
  • Paid units grew 46% vs. same time period last year
  • 3P grew 65%, was 32% last year Q4, now 36%

Digging into Amazon's segment/geography growth

One popular analysis we do every Q is to look at the dimensions of Amazons growth in what I call their segment/geo growth cube:

Amzn_q4_2011_cube

The cube helps conceptualize the Q, but it's also important to look at these trends over time which we do here: (click to enlarge)

Amazon_segments_line_chart


A couple of things jump out at you when you look at the data this way:

  • Remember e-commerce grew at 15% and eBay's GMV grew at 10% - those are the bars we measure Amazon growth against @ChannelAdvisor
  • The US Media segment was under a lot of pressure -putting up it's slowest growth since being reported - 8%.  Amazon specifically called out weakness in the video game (console and software/games) as a challenge in the Q.  Once you had COD, you were pretty done I imagine.  Some analysts also speculate that all the kindle sales in q4 didn't flow through to ebooks yet and we'll be seeing them in Q1.
  • Amazon's overall growth rate of 34% was the lowest since we've been tracking.
  • Media intl took an interesting tick up.

What's going on?  Amazon built 17 FCs last year, they should have accelerated their business?  Does this mean that e-commerce was just a fad and Amazon is looking at a tough couple of years?  Are we seeing recessionary headwinds?

I believe that the answer to all of the above is a resounding NO and the answer lies in an analysis of Amazon's 3P business.

Analyzing Amazon's 3P business

First, remember a couple of datapoints from the release around 3P - foremost for me was that the infamous Bezos quote threw some major 3P love for the first time I can remember:

" Our millions of third-party sellers had a tremendous holiday season with 65% unit growth and now represent 36% of total units sold.” - Jeff Bezos, Amazon CEO

 

Here are the rest of the highlights/tidbits specific to 3P from the Q (release and conf call):

  • There are over 2m 3P sellers
  • 3P now represents 37% of units
  • 3P is growing at 65% 
  • Amazon cited challenges sourcing product (flooding in Taiwan) and also mentioned that 3P's really helped keep inventory ont he site.
  • FBA is seeing a lot of adoption
  • We think the primary reason for the 4Q revenue shortfall is due to a higher mix of 3P sales, which historically represent a much lower percentage of total sales during the holiday quarter. To illustrate, revenues came in $819mn below the Street while pro-forma operating income (CSOI) came in $174mn better than Street expectations. Assuming the $174mn operating profit beat primarily coming from third-party, we would get to $218mn in revenue assuming an 80% operating margin. At an average 13% commission, this would imply the shift of Amazon recognized retail sales to third party to have impacted Amazon’s top line revenue of $1.67bn.
This chart really summarizes what happened in Q4 between Amazon's 1P and 3P business:
Amzn_1p_vs_3p_growth
Here you can visually see that similar to Q1 2011, Amazon pulled back on 1P and let 3P fill in from a volume perspective.
The case of the missing $1B in revenue....guess where it is?

Now to tie this all together.  Amazon was about $1-1.7B short on revenue for the Q depending on who you look at.  The key to unlocking the lost revenue is to understand the differences between how Amazon reports revenue and the profitability of 3P vs. 1P.  This table shows an example of $1B in GMV and the two treatments side-by-side so you can see they truly are apples and oranges:

1p_3p_treatment_table

So for the same $1B of goods sold to consumers, in one scenario it counts as $1B and another $120m - a 88% decrease.  That same $1B flows through to call it $50m in one scneario and $100m+ in another - revenue is 88% less and profits 100% more.  Seems weird, but that's how it works.

Now let's apply this logic to Amazon's Q4 (tip of the hat to Herman Leung for blazing this trail).  Here's the logic:

  • Revenues were $819m below the street
  • Operating income was $174m higher
  • If you assume that 174m was largely 3P driven, apply the 12% take rate you get $1.67b in GMV in 1P equivalent.  Amazon would have BEAT revenue if all of this came 1P, but the profits would have been less. 

And there my friends is the missing revenue!  You can play games with this and look at - what if all of Amazon's revenue was 3P vs. 1P - revenues would be lobbed in more than half, but profit would shoot up.

To summarize, Amazon is switching from a retailer model (GMV=sales) to a marketplace model (revenue = TR * GMV) and that change makes it seem like revenue is growing slow (technically it is), BUT (and this is a big but) the overall Amazon GMV is actually under represented by revenue more and more as 3P grows.  The best proxy we have for that is paid items which were barn burning at 65%.  It would be great if Amazon could report GMV for the 3P piece - I think that would help everyone understand what is going on better. 

Why doesn't Amazon report that? Personally I think they are sandbagging a bit.  If you feel like you have some secret sauce here, game theory tells you to hide the success - what we call sandbagging in the biz.

The bottom line is:

  • Amazon really grew 46% GMV-wise
  • There was a hidden $1.5-$2b in GMV from 3P that made revenue look light, but flowed through to the bottom line.

This is healthy as it's more profitable and is not a smaller footprint in e-commerce or anything like that - all of that unreported GMV is out there in customers hands.

What does 2012 hold for Amazon? 

Amazon's guidance was light (top and bottom) and that is also weighing on the stock.  The body language on the call was full steam ahead on all fronts.  In fact, Amazon has already announced 10 m sq-ft in new warehouses for 2012 opening as detailed here:

Amazn_2012_dcs

What's your take?

What was your take on Amazon's results - are they playing a 'hide the gmv' game or are they slowing down and starting to feel competitive/scale pressures? Sound off in comments.

 

SeekingAlpha Disclosure - I am long Google and Amazon. eBay is an investor in ChannelAdvisor where I am CEO.

 

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