Is Amazon the Multitrillion-Dollar Monopoly Hiding in Plain Sight?

Call us crazy, but investing to us means buying a predictable long term cash flow stream at a discounted valuation or an asset that you can accurately value below that price.

In our minds you need to first be able to accurately value something before can invest in it, and then only if the price you are paying is less than your valuation.

That doesn’t mean that you can’t invest in a high-multiple rapid growth stock. The future cash flow from high growth companies can more than make up for a high multiple.

It also doesn’t mean that we won’t consider investments outside of the traditional value area.

We are willing to be flexible because we don’t invest in anything unless a world class investor has put that stock, bond or commodity into his or her portfolio. We swallowed out egos a long time ago and were willing to admit that the best investors in the world are actually better than we are.

Instead of trying to compete with this better resourced, bigger-brained, proven and successful managers, we invest with them. We cherry pick what we think are the best investment ideas from the portfolios of the best investors on the planet.

It is an investment approach that makes sense.

Is Amazon the greatest company in the world?

Stanley Druckenmiller is one of our very favorite investors to follow. When perusing his portfolio, we were reminded that Druckenmiller owns a bunch of Amazon (AMZN, Financial) shares.

As at Dec. 31, 2015, he had $128 million of the $977 million of reported investments in shares of Amazon. That is a pretty hefty position.

We will admit to being more than a little surprise to see Druckenmiller owning so much of Amazon. We have looked at the company many times in the past and have been struck by what many others are, that being that the company makes virtually no money, while it has an enormous valuation.

Here is the last Amazon quarterly report if you want to take a look for yourself. In it you will see the following key numbers for the past 12 months:

Net income - $1.1 billion

Cash flow from operations - $11.2 billion

Capital expenditures - $4.9 billion

For that financial performance, investors currently value the company at $347 billion.

Nasdaq.com

That would be 347 times earnings, 55 times owner earnings (cash flow less capex) and 34 times cash flow.

That seems expensive, but we are okay with paying up for growth. The question we can’t help but ask is how much can the market value of a company valued at $347 billion increase?

Well, a lot if you ask one pretty successful professional investor.

Amazon… a 10-bagger from here?

At the recent Ira Sohn Conference, Social Capital’s Chamath Palihapitiya suggested buying shares of Amazon. That didn’t shock us, as we mentioned Druckenmiller owns Amazon, too.

What is a little more shocking is that Palihapitiya suggested that this $347 billion company could ultimately be a 10-bagger for investors. Yes, he is aware that means a $3 trillion market capitalization.

For some perspective on how outrageous that suggestion might be, we thought you might enjoy the table below, which shows the market capitalizations of 10 of the largest companies today:

Three trillion would put Amazon’s market cap at six times the size of Apple (AAPL, Financial) today.

Palihapitiya is an interesting story. He emigrated from Sri Lanka as a young child to escape civil war. He grew up on welfare in Toronto and ended up going to the University of Waterloo. He made his dent professionally as the head of Facebook’s (FB) user growth team. Starting in 2007, he took Facebook from 50 million users to 700 million users when he left in 2011.

After Facebook he started a Venture Capital firm called S23P with a focus on technology in healthcare, financial services and education. S23P has had tremendous success investing early in companies like Yammer (bought by Microsoft) and Slack (now worth $3 billion).

Apparently S23P is one of the fastest Venture Capital firms to ever reach a billion dollars of assets under management.

To date he has been very successful.

His valuation of Amazon as a $3 trillion company breaks down as follows:

Amazon’s retail business

He sees the retail business growing from 6 billion in units sold to 30 billion in units sold by 2025.

With an average selling price of $34, that would result in $1 trillion of sales. At a 5% margin that would be $51 billion of EBIT (earnings before interest and taxes). Slap a Costco (COST) like multiple of 20 times on that and you have a $1 trillion valuation.

Amazon Web Services

Palihapitiya thinks Amazon Web Services has already established a near-monopoly on internet storage and cloud services. He expects that the company will be able to generate revenue of $432 billion by 2025 and generate a 30% margin on that.

That would result in $129 billion in EBIT. He then says an Intel (INTC) like multiple of 12 should be applied to this, which would be a $1.5 trillion business.

It all sounds so easy!

Palihapitiya thinks Amazon Web Services is in a dominant position. His opinion that as every company evolves to cloud infrastructure over developing their own systems, Amazon Web Services will basically own a “tax on the internet.”

Bezos will work some magic

Palihapitiya has assigned $1.5 trillion to Amazon Web Services and $1.0 trillion to the retail business. Where does the other $500 million come from?

Amazon’s CEO Jeff Bezos. Palihapitiya adds another $500 billion to Amazon’s valuation because he thinks that Bezos will reinvest all of the free cash being generated by the other business into yet to be determined higher growth businesses.

For some perspective on that Bezos $500 billion assumption, be aware that is basically the market cap of the largest companies in the world today.

We can’t get our head around this one

We only invest in stocks that have had the blessing of an investment great. Is Palihapitiya an investment great? Probably not yet, but his performance to date has been awesome.

But we wouldn’t follow anyone into Amazon. We only buy picks from the star’s portfolios, but we don’t buy all of their picks.

Our opinion is that everything has to go right for Amazon to be a successful investment from the valuation it already has. To create the kind of value that is laid out above would require something other worldly.

That doesn’t mean it can’t happen, we just don’t think it is an unlikely outcome.

There are other big names invested in Amazon. We mentioned Druckenmiller but there is also Andreas Halvorsen (Trades, Portfolio), Steve Mandel and others. There are skeptics, too.

David Einhorn (Trades, Portfolio) is short Amazon for the valuation concerns that we have raised. We aren’t going to short it. We will, however, be very happy not to own it.