Amazon Valuation Report
Amazon is currently one of the largest online retailers in the world with a retail product line that covers books, audio and video products, software, consumer electronics, household appliances, food, toys, cosmetics, daily chemical products, sports equipment, clothing and jewelry. Amazon has opened retail websites internationally like the United States, Canada, United Kingdom, Japan, China, India, Mexico, Australia etc and some of its products are sold through international shipping logistics. Amazon operates various kinds of products and services like consumer electronics, product digital, content publishing, computing services and supermarket chains. In order to value the company’s sales precisely and accurately, we looked into different sources of the company and adjusted our evaluation by different aspects, such as potential of its major business, customer survey and report. We think amazon will be able to maintain its growth in sales by acquiring new business. We also consider the performance of amazon in different countries like europe and japan. Moreover, the competitiveness of Amazon Web Services (AWS) is also taken into consideration. Many assumptions are involved in Constructing Pro Formas due to limited information. For example, we assumed the miscellaneous accounts will grow with inflation rate. Regards to common stock and long-term debt, they will remain constant. In building the Income statement, we use regression to analyze the relation between sales and cost of goods sold and selling, general & administration cost. WACC is 12.65% after calculation. We use mid-year discounting in calculating the cash flow for intrinsic value and stock price. We estimate the final stock price will be $2069.37.
We began our project with a desire to value Amazon to take advantage of the stock market based on the current price versus what we calculated. If the current price was higher than our calculated price, we could short the stock. On the other hand, if the current price was lower, we could buy the stock. Our expectations were Amazon would be unpriced because of their growth over the past ten years along with their growing market share.
Early this year Amazon acquired Whole Foods. They moved into another industry with retail groceries after partnering with Kohl’s earlier to sell their tech products in stores. Amazon has continued to expand its vast range of industry and we do not see Amazon stopping anytime soon. With their eyes set on the new mobile grocery store, Amazon will continue to revolutionize the United State’s economy.
Amazon was a good idea to research, because as we believe Amazon will take over the economy until antitrust laws stop them. With no end in sight of Amazon’s domination, we believe Amazon would be a good investment in the long run. To confirm our suspicion we began analyzing the past ten years of Amazon’s financials.
Data & Analysis
To perform an accurate valuation on the firm, we first started by forecasting its sales growth for the next ten years. Since Amazon provides detailed financial statements from 2008 to 2017, we used its past sales data and CPI index we found on the St. Louis Federal Reserve’s web site to adjust the nominal sales to real sales in 2017 term. In order to estimate future sales correctly, we wanted to approach the problem from a macroeconomic level then gradually narrow down our scope. Thus, we ran regression analysis twice on U.S. GDP vs. E-Commerce industry sales and industry sales vs. Amazon sales respectively. However, both regression analysis generated R-square values below 30% and P-values above 0.1, which led us to conclude that we can’t rely on growth trends in the macroeconomic market to predict Amazon sales. Instead, we used segment sales data from Amazon’s financial statement and tried to estimate each segmented sales growth rate separately. Amazon divided its sales into three sections, North America, International, and Amazon Web Services. Because North America consists of over 60% of Amazon’s total sales, and our projections about major sales growth are mainly accounting to the North America market, we broke down the North America segment further into four subsections, Online, Physical Store, Retail Third-party Seller Services, and Subscription Services. According to two surveys named “Who have an Amazon prime membership” and “Who shopped at Amazon in the preceding 90 days” conducted by Prosper Insights & Analytics on around 7733 adults over 18 between 2013 to 2017 in each period, “Shoppers who have incomes in the $35,000–$74,999 range track the typical customer very closely in terms of tendency to shop at Amazon, as they do for Prime membership”. Thus, when we are analyzing Amazon’s main business, the online sales and subscription services revenue, we assume that they will continue to follow this trend. In order to calculate the specific numbers, we found the next ten year’s estimated population of middle class, whose income range from $35,000 to $74,999 falls in and calculated their growth rates. However, we think Amazon will have a slightly higher growth rate than the 2.69% growth rate of the middle class we calculated before in the Online and Subscription Services section due to Amazon’s business activities in recent years. First, Amazon released Echo, a brand of smart speakers, in 2014. Although smart speakers are a relatively new concept to consumers, it is a big market with potential. According to the website Voiceboat.ai, by 2022, 66 million households will have smart speakers. This signals that Echo will have substantial sales growth in the future because of Amazon’s first-mover advantage (Amazon’s current market share in smart speakers is 70%). Second, Amazon opened its first cashierless grocery store Amazon Go in 2016 followed by the acquisition of the grocery chain Whole Foods for $13.7 billion in 2017. These two moves will not only generate sales in their own division, Physical Store, but also will boost revenues in the Subscription Services. Because customers who shop at Amazon and Whole Foods have a lot in common, most of them are middle class or above, along with the prime loyalty program Amazon has at Whole Foods, they will drive up each other’s sales and benefit from each other. Amazon will bring more customers to Whole Foods because prime members can have discounts and in-store benefits now, and vice versa, Whole Foods’ original customers may start their prime membership subscription. Not to mention Amazon’s own grocery store, Amazon Go, multiple articles and agencies have shown their confidence in believing Amazon Go is the future of retail. According to Forbes, the grocery segment is a $600 billion market in the U.S, even a niche of the market could bring in sizable revenue. Although Amazon only accounts for 1% of this market share right now, Amazon Go already showed its ambition to expand in the grocery segment. But for Amazon, Physical store is still in its introduction stage, so in the first few years, we believe it will maintain a 3% growth rate and grow to 8% in the following years. For the online section, we used weighted average to calculate its growth rate. Of the total growth rate in the online market, we assumed around 90% sales growth will follow the typical middle-class growth rate, the rest 10% will follow the growth rate of future households with smart speakers we obtained from online. We used a similar approach for the subscription services, because of the substantial size of the grocery market, we accounted for 20% of the physical store growth rate in the total growth rate of subscription services. The last section in the North America segment is Third-party Seller Services. Because of the limited sales data we found, we can only know its growth rate from 2015 to 2017, but it showed a relatively steady growth around 40%. Third-party sales accounts for almost half of Amazon’s total online sales, and from each sale Amazon receives a 15% commission. We think this is an established mature section and will continue to follow its historical growth, but we want to be conservative so we estimated the growth rate to be 38% in the first few years and gradually become steady at 30%. Putting all the data within the North America market together, we again used weighted average according to their historical weights in the total sales but slightly increased the weights of physical store and subscription due to their promising future growth.
Amazon’s international standing is relatively weak compared with its position in the North America region. Amazon right now is the second largest E-retailer in the world (Alibaba is the largest), and accounts for 13% of global E-commerce market share. The top sales by country in the international market are all developed countries. The middle-class population growth rates are not very high in these countries and so are the sales growth rates in the international market in recent years at Amazon. Also, Amazon’s future main growth drivers are all served in the North America region except Echo. But Echo won’t affect the market too much because it is served in limited countries and the only supported language is English. Thus, we think the international market growth rate will follow the weighted average growth rate of the middle-class population in Europe and Japan. The reason why we add Japan in the calculation is because it’s one of the top growth drivers in the international segment but is the only country within Asia big enough to consider it separately. The rest of international sales are all concentrated in Europe.
Last but not least, Amazon Web Services (AWS). It is another major sales growth driver for Amazon. AWS is a subsidiary providing web services and cloud computing, launched in 2006, recently becoming profitable enough for Amazon to separate it from its main businesses in its financial statement. According to Forbes, cloud computing is projected to increase from $67B in 2015 to $162B in 2020 attaining a compound annual growth rate (CAGR) of 19%. Within this promising market, Amazon is absolutely the dominant player. By itself, Amazon accounts for almost half of the market share. Using the historical sales data of AWS, we calculated its annual CAGR to be 56.27%. But Amazon only provided four years data with AWS, it is not enough to say AWS will continue this trend. However, the whole market is in its growth stage, so we can safely say AWS will still experience large growth and we estimated the conservative growth rate to be 40% for three years and gradually decrease to 30% and finally become stable at 25%. The table listed below shows the final outputs for the three segments.
Constructing Pro Formas
After forecasting sales, the next step in valuation is constructing the Pro Formas. We first used the real growth rate we calculated in the previous section to calculate the real sales in the 2017 term. Then we converted them into nominal sales using CPI Index and finally got nominal sales growth rate for each year. Next, to construct the income statement, we began by analyzing Amazon’s cost and expenses. We divided cost into two portions, fixed and variable, and obtained them by running the regression analysis on Cost of Goods Sold and Selling, General & Administration costs combined with sales. In this way, we were able to separate the fixed portion, which is the intercept of the regression result and attained the following function to estimate future operating cost.
Operating cost = 0.86*Sales + 2583.87
Another important factor on the income statement is the depreciation expense. Amazon stated in its footnotes to financial statements that it uses straight line depreciation on a 5-year schedule. Therefore, the depreciation expense is 20% of its gross fixed assets, which we assume will grow at the nominal sales growth rate. However, taking into consideration that most companies purchase fixed assets throughout the year so we averaged gross asset amount with the
amount in the previous year and multiplied this number with the 20% depreciation rate to arrive at the current year’s depreciation expense. For interest expense and interest income of Amazon, we found their interest rates in Amazon’s annual report and multiplied them by Amazon’s long-term debt and cash, respectively. The last major component on the income statement is the income taxes. According to Amazon’s historical financial data, its tax rate can range from 20% to 60%. The changes in tax rate are so large that we can not take the average tax rate. Instead, we use the industry tax rate of 28.41% to calculate Amazon’s income taxes.
The next chuck of pro formas is to build the balance sheet. We started by calculating the turnover ratios listed below and divided 365 by these ratios to arrive period terms.
365/Receivable Turnover = 365/(Sales/Acc_Rec)
365/Inventory Turnover = 365/(COGS/Inv)
365/Payable Turnover = 365/(Oper_costs/Acc_Pay)
We found inventory days from 2008 to 2010 are particularly lower than the following years. So when we were calculating the average days for sales in inventory, we excluded the first three years to make the calculation more accurate. By simply multiplying each account ratio with sales, we forecasted the above three accounts balance each year.
Because of limited information, we made a lot of assumptions when forecasting the rest of accounts on the balance sheet. We assumed other miscellaneous accounts such as intangible assets, investments at equity, other assets, etc. to grow at inflation rate because as they get replaced with similar amounts at future dollar value, it is logical to use inflation rates to forecast their balances. As for the common stock and long-term debt, we made the assumption that they do not change for the reason of simplicity.
Calculating FCF and WACC
After constructing the pro formas, we move to the free cash flow statement. To calculate the free cash flow each year, we use the indirect method starting from the income statement and adjusting for non-cash charges. Once we have the free cash flows for each year, we discount them back using weighted average cost of capital (WACC). We calculate WACC by first calculating Amazon’s cost of equity using capital asset pricing model (CAPM).
Re =Rf + β(Rm – Rf)
We use 10-year treasury notes as our risk free rate, and we obtained beta and market premium from Yahoo! Finance, so the final cost of equity is 13.14%. For the cost of debt, we use the rate found in Amazon’s annual report, and the tax rate, as we described in the pro formas, is 28.41%. As for the market value of equity, we use current stock price/share times the number of shares outstanding. We assumed the market value of debt equals Amazon’s book value. Then we calculate WACC using the formula below and get 12.65%.
WACC = WeRe + WdRd(1-T)
Calculating Intrinsic Value and Stock Price
In order to know Amazon’s stock price, we first need to calculate its intrinsic value. To do that, we need both the present value (NPV) and terminal value (TV) of depreciation tax shield and non-depreciation FCF. Depreciation tax shield can be calculated by taking depreciation expense times the tax rate, and non-depreciation FCF is simply the amount of deducting depreciation expense from FCF. And for calculating the NPV and TV of those cash flows, we use the following formulas.
The reason we use mid-year discounting is because cash flows happen throughout the year instead of the end of each year. Add these values together along with the cash and marketable securities in the balance sheet, we have Amazon’s intrinsic value. For the final stock price, we deduct the market value of debt from the intrinsic value and divide the result by the number of shares outstanding, and the output is $2069.37.
Throughout this paper and the report we have created a very detailed valuation of the future stock price of Amazon through projections of their finances based on historical data. Amazon has been a very high growth organization due to the expansion that has been led by the CEO, Jeff Bezos. Through the examination of historical data through the last 10 years we believe that this growth will continue as Amazon becomes closer and closer to a monopolistic enterprise.
While we believe that not much can stop this growth from occurring, government intervention through antitrust laws is the biggest reason that our analysis may become misconstrued.
Due to the projections of what the company’s net income will be within the coming years we believe that the stock of Amazon is extremely undervalued at the moment. Our projection of $2069.37 is double the current average price of the stock on an exchange. One of the largest factors behind this hike in pricing is that net income could move up to at least 100x what it currently is at. Expansion has created a large amount of expenses, but as these entities start producing their own revenue and other competitors go out of business the net sales should drastically improve. We can conclude from our valuation that Amazon is a strong buy and that in the coming years it’ll exceed the average of the market significantly.
Amazon Valuation Report
Amazon Valuation Report