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Rakesh "Rick" Parimi

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Amazon.Com Valuation


This is an excerpt from my NYU Stern School of Business Valuation paper on Amazon.com (AMZN) stock as of January 2015. This is copyrighted information and the reader is strongly advised to quote the author and this source should any reference be made to this paper, either directly or indirectly, and either completely or casual reference. 

Amazon.com


Analysis of Strategic Intent

Taking into consideration the evolution in the online retail industry that is fueled by Amazon, Google and eBay as the primary contestants, and also taking into consideration Amazon.com’s historic propensity for growth with an element of surprise in the market, this valuation report has chosen a Two Stage FCFF model. The constant evolution in the online retail industry is drawing economic rents from the relatively immature online advertising industry. The justification for the Two Stage growth model is that in its first stage (10 years) of growth, Amazon will witness significantly higher growth until the adjacent industries (from the Five Forces perspective) become mature, after which Amazon will move into the second stage of growth, which is be modest compared to the former. In the long-run, Amazon will continue to be a dominant force, but growing at the nominal US GDP growth rate.

Although it can be argued that within the next decade Amazon is likely to have a four or six stage growth model, it should be taken into account that the barriers to entry will get lowered over time and also, more significantly, the current CEO of Amazon – Jeff Bezos – is currently 51 years of age. This suggests that in slightly over a decade, Jeff Bezos, who is the master mind behind the untenable success of Amazon, will be replaced by someone else, who may not necessarily possess the same uncanny idiosyncratic value that can continue to provide Amazon an iterative multi-stage growth for eternity. Also, as seen with Apple, long-term market reactions are extremely unpredictable. This valuation also considers Amazon to be primarily a “retail company”, although the company will continue to flirt with introducing new consumer electronics products, which will primarily be to extract more economic rents from its own retail enterprise (similar to the Apple and Google models). Since Amazon is competing in the retail space, its competition is not only from the online models of Google and Apple, but also from the heavy weight Walmart. A key point about Walmart is that Walmart is currently operating with excess returns of just above 1%. This indicates that while Amazon will exhibit growth, its growth will be a function of how well it counters the new threats from Google and Apple but also how well it anticipates the new threats from Facebook (less from Twitter) and how well it steals market share from Walmart. Where Facebook will become a future threat is because of the bubble that has not yet exploded within online advertising. Facebook could very easily offer direct to customer service to the likes of Target, which are currently using Amazon as a channel for customer retail and delivery. The more the barriers are reduced, the more challenging it will become for Amazon to decide between reinvestment for efficiency versus growth.

Amazon.com Rating by S&P 500 and Moody's in Dec 2014

S&P comments:

Our ‘AA-‘ corporate credit rating and stable outlook on Amazon reflects our expectation for strong cash flow generation and that business conditions will remain favorable for online retailers over the next two years, with growth rates among the highest for the entire retail industry. Amazon’s conservative financial policies and good financial flexibility also support the rating and outlook. We anticipate leverage, pro forma for the proposed notes offering, to be below 1x on average for 2014 to 2016.

Moody’s comments:

The change in outlook to negative results from Amazon’s announcement this morning that it was issuing a sizeable, though amount to be determined, level of new senior unsecured notes. Proceeds are to be used for general corporate purposes in support of Amazon’s myriad growth initiatives, and it is Moody’s expectation that the funds will not be utilized for any form of shareholder returns. While the new debt will further exacerbate Amazon’s already weak interest coverage due to, among other things, the lack of visibility surrounding the cadence for deployment of proceeds, potential areas of future growth and investment utilizing these proceeds, and the timing of potential positive returns, Moody’s believes that the company’s excellent liquidity provides sufficient cushion to affirm the Baa1 rating.


Unreconciled Valuation Risks


Following are key operational and strategic risks that are not reconciled in this valuation report.

· Effective tax rate may be adversely impacted by the amount of pretax income, or loss, relative to income tax expense, nondeductible expenses, and changes in tax law such as the expiration of the U.S. federal research and development credit at the end of 2014.

· Amazon.com is under examination, or may be subject to examination, by the Internal Revenue Service (“IRS”) for the calendar year 2005 and thereafter. These examinations may lead to ordinary course adjustments or proposed adjustments to taxes or net operating losses with respect to years under examination as well as subsequent periods.

· Amazon.com has received Notices of Proposed Adjustment from the IRS for transactions undertaken in the 2005 and 2006 calendar years relating to transfer pricing with our foreign subsidiaries.

· Amazon.com continues to disagree with these IRS positions and intend to defend itself vigorously in this matter. In addition to the risk of additional tax for 2005 and 2006 transactions, if this litigation is adversely determined or if the IRS were to seek transfer pricing adjustments of a similar nature for transactions in subsequent years, it could be subject to significant additional tax liabilities.

· Amazon.com’s subsidiaries are under examination or investigation or may be subject to examination or investigation by the French Tax Administration (“FTA”) for calendar year 2006 or thereafter. These examinations may lead to ordinary course adjustments or proposed adjustments to taxes.

· While Amazon.com has not yet received a final assessment from the FTA, in September 2012, it received proposed tax assessment notices for calendar years 2006 through 2010 relating to the allocation of income between foreign jurisdictions. The notices propose additional French tax of approximately $250 million, including interest and penalties through the date of the assessment.

· In addition to the risk of additional tax for years 2006 through 2010, if this litigation is adversely determined or if the FTA were to seek adjustments of a similar nature for subsequent years, Amazon.com could be subject to significant additional tax liabilities.

In addition, in October 2014, the European Commission opened a formal investigation to examine whether decisions by the tax authorities in Luxembourg with regard to the corporate income tax paid by certain of Amazon.com’s subsidiaries comply with European Union rules on state aid. If this matter is adversely resolved, Luxembourg may be required to assess, and Amazon.com may be required to pay, additional amounts with respect to current and prior periods and taxes in the future could increase.

Valuation Outcome Excluding Fundamentals

Based on financials of Amazon.com but excluding fundamentals: (see Exhibit X)

All figures in Millions except per share data.

Below valuation is based on S&P Rating.

Present Value of FCFF in high growth phase =

$36,446.65

Present Value of Terminal Value of Firm =

$105,431.54

Value of operating assets of the firm =

$141,878.19

Value of Cash, Marketable Securities & Non-operating assets =

$13,746.00

Value of Firm =

$155,624.19

Market Value of outstanding debt =

$11,286.29

Minority Interests

$37.00

Market Value of Equity =

$144,300.90

Value of Equity in Options =

$387.54

Value of Equity in Common Stock =

$143,913.36

Market Value of Equity/share =

$309.82

  

Valuation Outcome Using Fundamentals

All figures in Millions except per share data.

Present Value of FCFF in high growth phase =

$9,238.62

Present Value of Terminal Value of Firm =

$37,619.28

Value of operating assets of the firm =

$46,857.90

Value of Cash, Marketable Securities & Non-operating assets =

$13,746.00

Value of Firm =

$60,603.90

Market Value of outstanding debt =

$11,286.29

Minority Interests

$37.00

Market Value of Equity =

$49,280.61

Value of Equity in Options =

$387.54

Value of Equity in Common Stock =

$48,893.07

Market Value of Equity/share =

$105.26

 

Valuation Assumption

Since growth rate of Amazon.com Inc. has been sporadic, this valuation is not following the method of using fundamental approach for growth (g=ROC*Reinvestment-Rate). This is also a valid assumption because Amazon.com Inc. is releasing new products into the market place, some of which are sticky, but generally with disparate growth factors.

Sensitivity Analysis

Sensitivity analysis has been performed for three overarching scenarios.

(A) Intrinsic Valuation based on varying growth and Reinvestment rates.

This utilizes interest coverage ratio for estimating synthetic cost of debt.

Parameter

I

II

III

IV

ROC

-49.05%

-49.05%

-49.05%

-49.05%

Reinvestment

27.75%

27.75%

27.75%

27.75%

EBIT Growth

15.50%

19.50%

23.50%

27.50%

ATCOD

7.60%

7.60%

7.60%

7.60%

Value

Per Share

$230.61

$285.89

$353.98

$436.69

 

(B) Valuation based on S&P Rating

S&P

Rating is AA-, which is 2.89% as COD

Parameter

I-A

II-A

III-A

IV-A

ROC

-64.13%

-64.13%

-64.13%

-64.13%

Reinvestment

24.38%

24.38%

24.38%

24.38%

EBIT Growth

15.50%

19.50%

23.50%

27.50%

ATCOD

1.88%

1.88%

1.88%

1.88%

Value

Per Share

$244.22

$303.97

$377.62

$467.12

 

(C) Valuation based on Moody’s Rating

Moody's

Rating is Baa1, which is 4.19% as COD

Parameter

I-B

II-B

III-B

IV-B

ROC

-60.59%

-60.59%

-60.59%

-60.59%

Reinvestment

25.02%

25.02%

25.02%

25.02%

EBIT Growth

15.50%

19.50%

23.50%

27.50%

ATCOD

2.72%

2.72%

2.72%

2.72%

Value

Per Share

$222.69

$281.56

$349.13

$431.19



According to fundamentals based DCF Valuation, Amazon.com Inc. is 194.84% overvalued. But Amazon.com Inc. is at par with S&P rating and growth rate of 19.50%.

US Retail Sector Regression for EV/Sales

EV/Sales = 0.8483 + 7.2295 * g-Revenue + 19.2914 * (Operating Margin) – 3.0829 * Effective Tax Rate                                                                                      

R-SQUARED= 75.62% (strongly correlated across the US retail sector)


Predicted EV/Sales Using Retail Sector

Based on US Retail sector regression (see Exhibit XI), EV/Sales for Amazon.com is:

EV/Sales Amazon = 0.8483 + 7.2295 * 19.30 + 19.2914 * (-0.05) – 3.0829 * 0

EV/Sales Amazon = 2.2298

Intercept

0.843400951

 

Amazon's Value

Coefficient

Predicted Values using Sector Regression

G Revenue

19.30%

7.2295

Predicted EV/Sales

Predicted EV

Predicted Value Per Share

Operating Margin

-0.05%

19.2914

Effective Tax Rate

0.00%

-3.0829

2.2298

 $  198,428.31

 $  410.03

Amazon.com Inc. reported sales of $88.988M in the last annual report.

Predicted Value per Share using EV/Sales Multiple is $410.03.

Amazon.com Inc. was trading at $310.35 a share in December 2014 – January 2015.

Amazon.com Inc. was 32.12% undervalued.


US Market Sector Regression Analysis

Input Variables for Amazon.com Inc.

gEPS

ln(gEPS)

gRevenue

Beta

Payout

ROE

NetMargin

ROIC

DFR

TaxRate

OperatingMargin

38.40%

-0.957113

19.30%

1.08

0.00%

-2.37%

-0.25%

-0.39%

4.91%

0.00%

-0.05%

Predicted P/E =

40.823

Differential with Predicted

Assessment based on Predicted vs. Actual

Actual P/E =

524.43

11.8463

times

 

Overvalued

by

1185%

Predicted PEG =

0.20

Differential with Predicted

Assessment based on Predicted vs. Actual

Actual PEG =

0.14

-0.3023

times

 

Undervalued

by

-30%

Predicted PBV =

2.8212

Differential with Predicted

Assessment based on Predicted vs. Actual

Actual PBV =

13.90

3.92785

times

 

Overvalued

by

393%

Predicted PS =

1.5537

Differential with Predicted

Assessment based on Predicted vs. Actual

Actual PS =

1.93

0.24221

times

 

Overvalued

by

24%

Predicted EV/Invested Capital =

1.7997

Differential with Predicted

Assessment based on Predicted vs. Actual

Actual EV/Invested Capital =

15.71

7.73097

times

 

Overvalued

by

773%

Predicted EV/Sales =

1.9632

Differential with Predicted

Assessment based on Predicted vs. Actual

Actual EV/Sales =

1.96

-0.0012

times

 

At Par

by

0%

Predicted EV/EBITDA =

22.527

Differential with Predicted

Assessment based on Predicted vs. Actual

Actual EV/EBITDA =

31.45

0.39601

times

 

Overvalued

by

40%

 

 

 

 

 

 

 

 

 

 

 

Used gEPS instead of gRevenue for all of the above

Amazon.com Inc. is classified as a retail enterprise and EV/Sales is the most commonly used multiple for retail sector. Within the US retail sector, Amazon.com Inc. was undervalued by 32%. Within the US market, EV/Sales evaluation suggests that Amazon.com is fairly priced.

 

 

 

 

 gEPS 

EPSS growth rate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amazon.com Inc. relative valuation across US market is split when inspecting across PE, PEG, PBV, PS and EV/InvestedCapital ratios.

 gRevenue

Revenue growth rate

 

 

 

 

 

 

 

 

 

 

This suggests that there is significant speculation regarding future performance of Amazon.com Inc. Market is evenly split about its growth in the next 5 years. However, since Amazon.com Inc. is performing as expected within the US retail sector and considering that US is predominantly a consumer driven economy, Amazon.com will continue to either meet or exceed analyst expectations in the force able future.

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Rick Parimi,
Jul 18, 2015, 6:55 AM
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