In 2019, Novartis – in its search to become a gene and cell titan, built a manufacturing facility through a 90 Billion CAPEX, setting the bar high for the entire pharma industry. It is the reason why CAPEX analysis is crucial.
In This Issue
CAPEX Analysis in Company Operation: Growth and to Stay Competitive
Expansion CAPEX
The only reason companies CAPEX is to make more money or at least, maintain its earning power. When Novartis spends billions of dollars to build new factories in Stein, Switzerland – the reason is simple. Profit. By having its own manufacturing facility, Novartis can scale up its product, reach more consumers. CAPEX gives Novartis the capability to fill the market demand when another has to scramble the third party resources to make the drug.
Or when Ferrari gets serious in developing its EV, the luxurious carmaker estimated to spend a behemoth 13 billion in capital expenditures from 2020 to 2030.
A surge in CAPEX, in some cases, means a smile for investors. It shows optimism in management. Because they are peeking a growth and expansion.
Operating CAPEX
But as with everything in this world, not all CAPEX are created equal. CAPEX with respect to overhauling or replacement of depreciated (degenerated, degraded, outdated) part is something that doesn’t bring a curve in the investor’s face.
It is when Schlumberger replaces its old rig or when CATERPILLAR haul its outdated excavator. Or when Airbus maintenance its aircraft. There are cases in that CAPEX is needed just to stay relevant with the industry.
We aren’t fans of this kind of business. You spend a lot just to survive.
The Big Fives: Is CAPEX analysis still relevant in Tech Business?
In the age of every company is a tech company, Do CAPEX analysis still relevant?
Amazon is e-commerce, it relies on the delivery and the network. Google, Facebook, Microsoft rely on intellectual property, software, platform, and cloud service as their core business. They need no CAPEX – so we don’t bother to check its CAPEX policy.
This assumption is true but only some part of it. Differ from common belief, Google, Microsoft, and Amazon have a large budget for CAPEX, even one the highest in the world. Despite we believe that acquisition plays an important part in Big Tech expansion, it doesn’t mean we can overlook the role of CAPEX, whether it is operation or expansion.
Amazon, for instance, needs to maintain its server facility to deliver its AWS well. Moreover, as we have explained here, the Seattle-based company plan to build its own fulfillment facility in order to get a better profit margin, integrity, and control over its services and product. All good news for investors.
And never think that cloud services are happening in the sky, no, the sky is how you access it. A grand rule for data is, it should exist physically somewhere. So it is the same for both conventional and cloud. The difference is in the transfer method. In cloud technology, your client access data from other physical devices via the internet. They don’t have to own that store. To make it clear, imagine your own 1TB hard drive. You separate that storage into 10 partitions, each has 100 GB. Then you rent it to your customer. They can access your drive remotely via the internet. The same also applies to cloud apps. In that case, you have to excel in computers and rent them to customers via the internet.
To illustrate the practical aspect of the cloud server, we encourage the reader to google with the Microsoft data center keyword. Spoiler alert, this may be the largest server room on the planet. 4 floors, 12,000 square feet each, military-grade treatment. When the temperature goes extreme, Microsoft needs 7.5 miles of water piping to prevent overheat.
Hope this perspective changes your opinion about CAPEX for the platform company.
CAPEX Analysis and its relation with Porter Fives.
Though we aren’t cheerleaders of the industry with high operation CAPEX, it has its unique edge. It set an ultra-high level of new entry. Take the aircraft industry as an example, they need to maintain the aircraft periodically to ensure that the flying body stays safe at optimum level. Or mining services industries like Caterpillar and Komatsu. Periodically, they have to overhaul their heavy equipment to give feasible productivity for mining owners like Freeport McMoraan or Rio Tinto. The cost is painful, but, at the same time, it prevents new players come easily, just looking into it mandatory CAPEX will make newcomers reluctant.
Economic Moat
In the case of Novartis, having a house production unit gives them economies of scale advantage. Novartis could pursue more markets and have the capability to reduce its product price if needed. The better case is Amazon, when Bezos-led company builds its own fulfillment center, it means better control and integration for its e-commerce segment. The CAPEX sent by Amazon strengthened more economies of scale advantage.
Into Financial Statement.
The most unwanted part, but we need it.
Officially, in a financial report or other SEC filings, CAPEX can be found in the Cash Flow statement under-investing cash flow. As you can see in the figure below for Amazon.
It will not be written as CAPEX. No. In the figure, it is accounted as Purchase of property and equipment. And you are right, It is a kind of fixed asset or tangible asset. We once again invite you to think that even for the Tech Giant, fixed assets or tangible asset consideration is still relevant.
Point To Remember
Ok, what we have:
- Like acquisition strategy, CAPEX could be a precursor of GCG assessment. The more CAPEX efficient, it will improve shareholder value.
- Investors care about money, about earnings. Any aspect they analyze will end to earnings, whether it is GCG, Financial statement, moat. All is about money and more money. CAPEX is no different.
- We warn investors to compose a wide and comprehensive perspective with regard to CAPEX. We say it should be efficient. The best case is when CAPEX is funded by depreciation or by company cash without relying too much on debt issuance. When a company requires an external resource, cough, debt, to fund the CAPEX, it means that management doesn’t predict. If they don’t make predictions and proper decisions, what do they do?