Amazon and its last mile shipping challenges - Impact of shipping costs on retailers

Three recent developments, all related to Amazon, are of great interest to retail industry and supply chain professionals. These developments are related to Amazon’s shipping costs and its attempts to reduce those costs.

In October 2-13 Amazon raised its free shipping minimum to $35[1]. Subsequently in January 2014 Amazon reported considering $40 price hike for its Amazon prime service[2] that provides free 2 days delivery and heavily discounted next day delivery[3]. There was another great buzz created by Amazon Prime Air – a futuristic delivery system using drones[4].

When we analyze these developments in light of data available from Amazon’s and industry sources, few observations can be made

1. Amazon’s shipping rate hikes were inevitable. In 2013 Amazon’s net income per sales dollar was only 0.368 cents[5]. Amazon’s shipping costs in 2013 were almost 8.9 cents per sales dollar. After accounting for shipping revenue from customers, Amazon funded 4.8 cents per sales dollar to shipping. In order to stay profitable, Amazon has to find a way to increase its shipping revenue and reduce its shipping costs.

 

2. Amazon Prime Air is an attempt to reduce cost of delivery. Amazon’s press releases show this drone delivering to home of a customer. Amazon is hoping to get it operational by 2015. In my opinion that release target is unrealistic. Amazon will need to resolve privacy, safety and legal concerns. Drone will require open and safe air corridors and landing areas. It will struggle delivering to densely populated areas and high rise buildings. I think that it will be successful if Amazon uses it to deliver it to small distribution centers or hubs from where delivery is made by traditional methods.

3. For several years Amazon has long been bane of brick and mortar (B&M) retailers. Its primary advantages have been convenience of ordering, wide selection, low prices and home delivery. It negated advantages of immediacy (immediate availability) and ease of returns enjoyed by traditional retailers by offering reduced price fast delivery and return services. As Amazon starts charging more for shipping and returns, its comparative price advantage over B&M retailers will start to disappear.

4. Another price advantage Amazon and other e-retailers enjoyed was no sales tax. As more states are paying attention to sales tax revenue from web business. This advantage is also disappearing.

5. These developments present an opportunity to B&M retailers such as Target and Walmart. They can leverage their warehouse and physical presence to their advantages.

6. A possible distribution model for future may be

a. Ship from large major warehouses to regional hubs

b. Ship from regional hubs to city wide hubs

c. Delivery via drones or small vehicles to smaller community wide hubs which can possibly be USPS post offices, grocery stores, gas stations or roofs of tall buildings

d. Delivery to end customers via USPS or small non-traditional mom and pop carriers

e. Or, customers picking it from community wide hubs

 

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[1] Amazon raises free shipping minimum to $35

[2] Amazon considers $40 Prime price hike

[3] Amazon Prime Was Too Good to Be True After All

[4] Amazon Prime Air - Amazon.com

[5] Amazon Form 10-K Year ending Dec 31, 2013, Page 24

Google’s sale of Motorola Mobility to Lenovo–Who lost?

A colleague forwarded me a link to “Google sells Motorola unit to Lenovo for $2.9B”[1], with an additional comment “That's $9.5B less than what they paid for it.”.

Did someone lose on this deal? If yes, who?

· Google purchased Motorola mobility for $12.5B[2]. (Motorola mobility was a spin-off of Motorola’s consumer business units that included cable modem, set-top box and consumer mobile devices[3]).

· On Dec 19, 2012, Google sold cable modem and set-top box business to Arris Group for $2.35B.

· On Jan 29, 2014, Google announced sales of Motorola mobility to Lenovo for $2.91B.

· Motorola Mobility, when it was acquired by Google, had 17,000 patents, with 7,500 more patents pending. Only 2000 of these patents will go to Lenovo and rest will be retained by Google.  Google had valued these patents at $5.5B. In order to put this valuation in perspective, consider July 2011 winning bid of $4.5 billion for 6000+ patents of Nortel[4]. That bid was won by a consortium of Apple, Microsoft and RIM. Google needs Motorola portfolio to counter patents acquired by Microsoft etc[5].

· Google is also retaining Advanced Technologies and projects unit[6]. This unit deals with cutting edge technologies such as ingestible technologies.

Looking at this data, Google appears to have lost nothing. Most probably, Google will use this transaction as a paper loss, adjust against its profits and reduce its taxes. So it will actually gain from this transaction.

In hindsight, it appears that Google’s primary interest in Motorola mobility was its patent portfolio. Google already has several cellphone manufactures on board with its Android operating system. Google would not have seen much value in owning its own mobile device business. Advanced technologies and projects unit was additional gravy Google got from that deal.

Lenovo also comes out as a winner. It had no presence in cell-phone market. Now it gets a reputed brand name and a reputed web property. It also gets 2000 patents and an established (though small) customer base.

I think actual loser is US economy. Motorola mobility had 19,000 employees[7] when it was created. In Q4 2013, employee count was down to 3,894. How many of these jobs will remain in US after Lenovo’s acquisition is anyone’s guess.

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[1] Google sells Motorola unit to Lenovo for $2.9B

[2] Google agrees to acquire Motorola Mobility

[3] Motorola Mobility Launches as Independent Company

[4] Big bidding: Apple, Microsoft, RIM nab Nortel patents for $4.5 billion

[5] When patents attack Android

[6] Google Keeps Motorola’s Advanced Technology Group

[7] Motorola Mobility Form 10K Dec 31, 2010

AAPL is NOT worth $460

I subscribe to a nice blog on value investing. Today they presented a financial analysis of Apple. Blog’s author’s conclusion is that even if one assumes zero growth in foreseeable future, Apple stock is working investing in.

To me this blog demonstrated how one can reach wrong conclusions by looking at partial data. Conclusion in that blog depended on current financial position of Apple and its cash in hand.

However you will reach a totally different conclusion if you take a look at quarterly reports for Q4 2012 and prior 2 years. These reports share Apple’s revenue by product for 5 primary product lines (Mac, iPod, iPhone, iPad and iTunes/Software services) plus accessories. Data provided in these reports also let you estimate revenue per unit for first 4 product lines.

Analysis of that data reveals that

1. iPod market is a declining market, even though revenue per unit is steady. It contributes only 4% towards total revenue.

2. Mac market remains steady, revenue per unit is steady. It contributes only 7% towards total revenue

3. iPad total revenue has remained stable; however revenue per unit has declined drastically. It shows that Apple is facing strong competitors and is really fighting on price per unit. This segment contributes 20% towards Apple’s total revenue

4. iPhone segment’s Qtr over Qtr revenue growth was 129% in Q4 2011. In Q4 2012 this growth is down to 28%. Price per unit remains steady. This segment contributes 56% towards Apple’s total revenue.

It is easy to conclude that Apple’s growth engine for last three years have been its iPhone (primary) and iPad (secondary) products. It is also very clear that significantly strong challengers in these segments have appeared during last two years. Samsung has in fact overtaken Apple in smart phone market.

Author’s comment, “With their management, pricing power and business strength, they are able to invest money in ways I cannot dream of”, is not really validated by any management decision that Apple has shown in last 2 years. Apple’s growth was due to its ability to create innovative products and define new markets. Current management has not demonstrated that. It is risky to assume even zero growth year over year.

A cash pile or large market cap is no guaranty of continued market dominance. Hewlett Packard is a good example. For last 10 years this once great innovative company is trying to find its way. Once valued at more than $110 billion, its today’s valuation is $33 billion. Another good example is RIM. Stock price of this company, once darling of corporate users, has tumbled from a peak of $225 to $14.58.

Apple perhaps has another magic trick up its sleeve and may come up with another great product. However that is only a speculation, and unless Apple management provides some proof, I will not be betting my money on Apple at today’s price.

I look forward to your comments on my analysis.

Design of Corporate Restructuring and Mergers

Recently I was going through JDA Software’s (JDAS) Form 8K dated Nov 2 2012. Something interesting caught my eye that I will like to discuss here.

“Item 1.01. Entry into a Material Definitive Agreement.

On November 1, 2012, JDA Software Group, Inc., a Delaware corporation (the "Company"), entered into an Agreement and Plan of Merger (the "Merger Agreement") with RP Crown Parent, LLC, a Delaware limited liability company ("Parent"), and RP Crown Acquisition Sub, LLC, a Delaware limited liability company and a wholly owned subsidiary of Parent ("Merger Sub"). Parent and Merger Sub are affiliates of RedPrairie. The Merger Agreement was unanimously approved by the Company's Board of Directors.

Pursuant to the Merger Agreement, upon the terms and subject to the conditions thereof, Merger Sub will commence a tender offer (the "Offer") no later than November 15, 2012 to acquire all of the outstanding shares of common stock, $0.01 par value per share, of the Company (the "Company Common Stock") at a purchase price of $45.00 per share, net to the seller in cash without interest (the "Offer Price"). As promptly as practicable after the expiration of the Offer, and subject to the satisfaction or waiver of certain conditions set forth in the Merger Agreement, Merger Sub will accept for payment, and pay for, any shares of Company Common Stock validly tendered and not validly withdrawn pursuant to the Offer, at which point Merger Sub will merge with and into the Company (the "Merger") and the Company will become a wholly-owned subsidiary of Parent.”

This section of SEC filing describes how this reorganization is being accomplished. Design of corporate restructuring is a complex task and is accomplished by a specialized team of corporate lawyers and tax experts. Such designs are done to properly address issues related to liabilities, cost basis of assets, asset ownership, contractual obligations, financial obligations, capital gain taxation, licensing, customer support and country specific laws. Even though such design is usually transparent to most of us, it is still worthwhile to know how it gets accomplished.

In this bog I will describe three well known designs for corporate mergers.

Most simple and straight-forward of these structure is a direct sales and transfer of ownership. In such reorganization, called “A” reorganization, acquiring company (acquirer) buys shares of target company (target) from target company’s shareholders.  Payment can be in form of acquirer’s shares or equivalent cash.

Another commonly used approach for corporate merger is a “Forward Triangular Merger”. In this approach, Acquirer  created a fully owned subsidiary (Merger Sub). Target merges with “Sub” with “Sub” surviving as final company. Ownership of Target’s asset is transferred to Sub.

Third and most commonly used approach in USA is “Reverse Triangular Merger”. This kind of merger is also accomplished through a subsidiary of Acquirer. However, in this case, “sub” merges in to “target” and “target” survives as a wholly owned subsidiary of Acquirer. Ownership of target’s assets remain with “target” that is now a subsidiary. JDA-Red Prairie merger is a Reverse Triangular Merger.

Such structures become even more complex when you look at international mergers. For example, Eaton Corporation of Ohio USA recently acquired Cooper Industries of Ireland. This merger was accomplished through a complex set of subsidiaries in the Ireland, the Netherlands and the USA. First, a new company, called “New Eaton”, was created in Ireland. Cooper Industries got acquired by and became a wholly owned subsidiary of “New Eaton”.  New Eaton through a chain of wholly owned subsidiaries (Comdell Ireland: a subsidiary of New Eaton,   Turlock B.V. The Netherlands: a subsidiary of Comdell) established a subsidiary “Turlock Corporation: A subsidiary of Turlock B.V” in USA. Eaton Corporation USA merged with Turlock Corporation and surviving as merged company. In summary, both Eaton Corporation USA and Cooper Industries Ireland become wholly owned subsidiaries of the “New Eaton”. Subsequently “New Eaton” requested SEC to list its share on stock exchange in replacement of Eaton Corporation USA’s shares. Such complex structures are needed to stay in compliance with country specific rules and regulations.

 

I will update this blog and add few more real-life examples. I hope that you will also find design of corporate mergers an interesting subject and share your insights and other examples. I look forward to your feedback.    

RedPrairie JDA Merger

On November 1, 2012, JDA Software and RedPrairie announced that they have entered into a definite merger agreement, wherein, JDA Software Group agreed to be acquired by privately held RedPrairie for a total value of $1.9 billion. According to this agreement, RedPrairie will make an offer to buy all outstanding shares of JDA for $45 per share, representing a 33% premium to JDA stock price on Oct 26.

In this brief note I will share my perspective on JDA-RedPrairie merger and discuss few vital financials that caught my attention.

First item that we must examine is any redundancies & conflicts between solutions provided by JDA and RP. Following table examines overlap between software products of JDA and RedPrairie.

 

 

JDA’s products are more focused on supply chain planning, optimization and forecasting. RedPrairie’s strength is in Supply chain execution. JDA has some products in supply chain execution (JDA logistics) that directly compete with RP’s warehouse and transportation management products. Both companies have their own set of platform tools to handle message integration & business process management. In short term, JDA-RP combine will need to convince customers about future roadmap for such conflicting products. In long term, they will need to drop one of the offering, and provide upgrade path to impacted customers. Payback period on a supply chain implementation is approximately 5 years. Hence JDA-RP combine may need to keep supporting existing products for at least 5 and maybe for many more years. There is a risk that some of the new customer implementations of products in supply chain execution may be put on hold till new combined company provides clear direction to its customers.

Second, we must also pay attention to difference in underlying architecture & technology behind software products from JDA and RP. Any desire to leverage synergies of software development will require that JDA-RP combine must bring all products to a common architecture. Such process can take anything between 2 to 4 years. Till that time customers will see a collection of different looking products that they will need to integrate using complex tools. This scenario can be used as a weapon by competitors.

Third, we should look at balance sheets of JDA for any obvious challenges that will hamper value creation. I am copying below an extract of balance sheet for Q3 2012

First item that caught my eye was $231M goodwill and $108M other intangibles on balance sheet. “Other intangibles” include three components and I will like to quote directly from JDA’s annual report for Q3 2012

“Customer-based intangible assets include customer lists, maintenance relationships and future technological enhancements, service relationships and covenants not-to-compete; technology-based intangible assets include acquired software technology; and marketing-based intangible assets include trademarks and trade names. Customer-based and marketing-based intangible assets are being amortized on a straight-line basis. Technology-based intangible assets are being amortized on a product-by-product basis with the amortization recorded for each product being the greater of the amount computed using (a) the ratio that current gross revenues for a product bear to the total of current and anticipated future revenue for that product, or (b) the straight-line method over the remaining estimated economic life of the product including the period being reported on.”

I will be wary of value placed on Goodwill and other-intangibles as they are prone to impairment. JDA owns lots of patents. However, in my opinion, these patents do not help JDA-RP in getting a virtual monopoly or dominant position in that business domain. Supply chain domain is well researched and a competitor with sufficient will and investment can create competing products that do not conflict with JDA-RP patents. In short, I will heavily discount values of these assets.

Second item on balance sheet that we should look at is $273M of long term debt. JDA-RP combine will need to also pay this debt.

RP’s private equity owners will need to find $1.9B upfront for JDA and $273M for paying debt. JDA’s (current asset – current liabilities) are $273M. It requires $270M annually as cost of revenue.

Hence, my conclusion is that road for JDA-RP combine is full of challenges.

Overall, in long run, reduction in competing software solutions should help customers. Market has now consolidated to 2 or 3 dominant players.

PS: Those aware of M&A activities will recognize this merger as a “reverse triangular merger”. Functionally it will be categorized a co-generic merger as merging companies are complementing each other in market space.

A nice blog on relationship between firm’s market price and its vision, strategy and goals

 

Today I came across a blog that nicely describes how a company’s clarity of vision and strategy influence its market evaluation.

That blog  analyzes Oracle, HP, Apple, Google, Microsoft and SAP to support and explain its arguments. Rather than I summarizing that blog here, I would direct you to original blog.

Evaluating Financial Statements– Few Important Metrics – Part 3– analyzing Beneish

We discussed three metrics, Altman-Z, Beneish M and Piotroski F, in my first blog on this subject. These metrics are very helpful in pointing out something unusual in financial statements of a company.  Companies will usually be able to explain flags raised by these metrics. One must carefully examine each factor contributing to red-flags. That is where an expert adds value.

For example, an analysis on Enron written by by graduate students of Cornel University is frequently quoted whenever Beneish M-Score is mentioned. However,  if you read that paper, students analyzed their results on Beneish M-score and concluded that “However, further examination of these indicators showed no cause for concern.” Now, in hindsight, we all know that there was a cause for concern.

Let me showcase another analysis that I did recently on Apple (AAPL). As you will notice in picture 1, Beneish analysis raises red flags for 2006, 2007, 2009 and 2010. You will need to analyze Apple’s annual reports to find causes of these red flags.

If you dig further into data for 2006 , you will notice a sudden change in AQI (asset quality index) and LVDI (Leverage Index). You will further find that apple paid $1.2 billion for prepayment of NAND memory modules, other current assets increased from 648M to 2270M and vendor non-trade receivables increase by $1B.

Data for 2007 tells us that receivables jumped from $1252M to $4029M. Also worth reading is a note in annual report

“The Company is exposed to credit risk on its accounts receivable and prepayments related to long-term supply agreements. This risk is heightened during periods when economic conditions worsen.

A substantial majority of the Company's outstanding trade receivables are not covered by collateral or credit insurance. The Company also has unsecured non-trade receivables resulting from the sale by the Company of components to vendors who manufacture sub-assemblies or assemble final products for the Company. In addition, the Company has entered into long-term supply agreements to secure supply of NAND flash-memory and has prepaid a total of $1.25 billion under these agreements, of which $208 million had been used as of September 29, 2007. While the Company has procedures to monitor and limit exposure to credit risk on its trade and non-trade receivables as well as long-term prepayments, there can be no assurance such procedures will effectively limit its credit risk and avoid losses.”

Beneish analysis also flags an unusual jump AQI to 4.46 in 2009. Annual report for 2009 indicates $16B increase in investment in long-term and short-term securities.

To summarize, examine results of these metrics for any red flags. Further analyze financial data contributing to these flags. That should lead you foot notes and explanations in financial statements. Remember that financial statements are prepared by firm and you should critically examine firm’s explanations for such changes. 

I will be delighted to hear your comments on my analysis and explanations. Any suggestions for improving this blog will be most welcome. If you will like to receive a copy of my calculator, please drop me an email.