Amazon’s Free Cash Flow

Why Jeff Bezos has 3 different definitions

This is the fourth and (relief!) final instalment of our mini-series looking at Amazon’s cash flow.

Part 1 looked at Operating Cash Flow

Part 2 looked at Cash from Investing plus a few little quirks.

Part 3 looked at the Cash from Financing Section and some issues with the cash flow.

Part 4 now looks at Free Cash Flow, where Amazon has some unconventional but interesting practices.

Before we get to that, an apology to those who complained that they were unable to sign up for our Forensic Analysis Bootcamp. This is a cohort based course on Zoom and we limit the number of participants so that everyone has the chance to ask questions and contribute. If you missed out, I apologise and if you email me, I shall let you sign up for the next cohort at the same discounted price. We had a fantastic first session on Monday night and I just booked Russell Napier for a special extra bonus session.

Free Cash Flow

Jeff Bezos prioritises free cash flow. It’s the first slide in every Amazon investor deck on earnings calls. Here is the Q3 2022 slide:

Amazon Free Cash Flow (1)

Source: Company

This is defined in the 10-K as “Free cash flow is cash flow from operations reduced by ‘Purchases of property and equipment, net of proceeds from sales and incentives’.” But such is Mr Bezos’ enthusiasm for Free Cash Flow that he also provides two alternative definitions:

Amazon Free Cash Flow (2) after Lease Repayments

Source: Company

This shows the free cash flow after the repayment of principal in finance leases. They then also show the principal repayment of other leases and similar financing:

Amazon Free Cash Flow (3) after Lease and Other Principal Repayments

Source: Company

Luckily Amazon is required by GAAP to explain how it derives these customised measures and ther are reconciliations in the deck. The first is straightforward and it shows the Operating Cash Flow number less the capex:

Amazon Free Cash Flow (1)

Source: Company

This is straightforward and is perfectly in line with most companies’ practice. The $59,351m is simply the gross capex in the first table above, $65,988m, less the disposals of $6,637m. But Amazon then goes on to flag that in addition to assets bought for cash, it has also bought assets on finance lease and a true measure of the free cash flow should reflect that it has used this alternative method of financing:

Amazon Free Cash Flow (2) after Lease Repayments

Source: Company

This is defined in the 10-K: “Free cash flow less principal repayments of finance leases and financing obligations is free cash flow reduced by “Principal repayments of finance leases” and “Principal repayments of financing obligations.” Principal repayments of finance leases and financing obligations approximates the actual payments of cash for our finance leases and financing obligations.”

You can see the $8561m and the $233m in the cash from financing section in the initial cash flow table above. But Amazon then provides a third definition which further refines the calculations:

Amazon Free Cash Flow (3) after Lease and Other Principal Repayments

Source: Company

This is defined in the 10-K as “Free cash flow less equipment finance leases and principal repayments of all other finance leases and financing obligations is free cash flow reduced by equipment acquired under finance leases, which is included in “Property and equipment acquired under finance leases,” principal repayments of all other finance lease liabilities, which is included in “Principal repayments of finance leases,” and “Principal repayments of financing obligations.” All other finance lease liabilities and financing obligations consists of property. In this measure, equipment acquired under finance leases is reflected as if these assets had been purchased with cash, which is not the case as these assets have been leased”.

I apologise for all these tables and also that in order to make sense of all this , we need to refer to another supplemental table in the 10-Q (from page 8 of the PDF if you are following along):

Additional Cash Flow Notes

Source: Company 10-Q

Here Amazon is excluding the principal repayments of $8,561 as some of these relate to assets acquired in earlier years. Hence, I believe that it is showing a cash flow calculation reflecting only assets acquired in the current year. It also appears to exclude property acquired under finance leases from these calculations: the $868m appears to be the equipment element of the $8,149m in the supplemental table above “Property and equipment acquired under finance leases”.

In the same supplemental table from the 10-Q, there is an additional disclosure of property acquired under build to suit leases which Amazon also excludes from this third free cash flow calculation. I haven’t yet found the explanation for this, if one has been disclosed, but I would guess that Bezos originally felt that property acquired under a finance lease could equally be acquired under an operating lease or normal rental; it’s also readily realisable and convertible back into cash. Perhaps that is the rationale, but to be clear, if I were to calculate the Amazon FCF I would include these outflows on property as capex too. So my calculation would be as follows:

Amazon FCF Calculation

Source: Behind the Balance Sheet from company data

Two additional notes are necessary. This FCF number does not reflect the $17.7bn ($11.6bn) of cashless stock based comp. My FCF definitions assumes that SBC is paid in cash.

Amazon FCF Calculation Post SBC

Source: Behind the Balance Sheet from company data

The cash outflow looks much worse now and should be a concern to investors. I still have not adjusted for assets acquired under operating leases. Some practitioners would also adjust for this and in the extract form the 10-Q above this was $19,839m in the period ($23,908m). This would take the FCF to negative $70bn.

I know all this is more complicated than would be ideal, but hey, please don’t shoot the messenger. And I should highlight that I am still trying to understand Amazon’s rationale for its disclosures and without interaction with the company’s IR, that’s not so easy. I shall send them this article as I have previous articles and hope it solicits a response, but so far, I haven’t been able to initiate a conversation. I emailed Jeff Bezos too, but he was busy,

So, this is still a work in progress for me. But I would highlight that Amazon is rigorous about its disclosures and tells you more than most US stocks about its capital expenditure and its free cash flow. Given the importance investors assign to

-          The calculation of free cash flow as a valuation parameter and

-          Capital allocation as a measure of management skill

I think it’s extraordinary that disclosure in this area is generally so poor.

I am sending paying subscribers the model I have used for all these calculations under a separate email. If you are enjoying the content, please subscribe and allow me to spend more time on this type of article.