AMZN - Amazon.com Inc.

[LongTermView]

while 3p trades at the eBay multiple of 2.7x sales showing a value of $108B.  AMZN's 3p is certainly a better business than eBays, but let's forget this. 

Why should we forget the fact that AMZN 3P is a better business than eBay and that it is growing much faster?

I'm not trying to be critical here. Overall I think this is a great post, especially some of the points about AWS and advertising.

[Liberty]

while 3p trades at the eBay multiple of 2.7x sales showing a value of $108B.  AMZN's 3p is certainly a better business than eBays, but let's forget this. 

Why should we forget the fact that AMZN 3P is a better business than eBay and that it is growing much faster?

My reading is he's just being conservative and not giving it a higher multiple.

[dwy000]

Walkie - where are you seeing 52% growth in subscription revenues?  Was that in the conference call?

I found it interesting that Unearned Revenues seems to have stopped growing.  That's been a huge source of cash for the past few years as Prime membership grew.  With a 20% increase in Prime price, I'm wondering if that implies a flattening or reduction in Prime membership, either now or going forward.

It will be interesting to watch the stock price as the company's growth slows.  At 30% y-o-y revenue growth, the market is willing to forgive minimal profitability in the name of growth.  At 10-20% growth (projected for 4Q) and considering AWS should be much higher than that it suggests product growth at the lower end.  At some point investors will switch from momentum growth (GARP) to earnings based valuation.  Interesting to see if those can rise fast enough to satisfy or offset growth slowing.

I'm not sure this is the right way  to look at it. Though what I'm about to write some might consider a little crazy?  Thoughts appreciated.

There are many moving pieces.  This morning, we see a lesser company to AWS (RedHat) being bought by IBM for $33B.  The sale will consumate around 11x sales.  While IBM is not the poster child of success for this decade...

If AWS weren't the leader, this would likely be a fair multiple.  Backwards looking, this values AWS at $294B.  At some point growth in this business will slow down from 46% Y/Y, but the runway is much longer than most believe as the number of companies still using mainframes (shocking but true) move to cloud and/or hybrid solutions.  The shift is inevitable since AWS is pricing out client-server (the next logical step), and it's likely that AWS gets most new business as prima facie. Doubling and even tripling the size of this market is not out of order from here over the next decade.  That said, you are correct in saying that multiples are likely to contract over time.

Say AWS triples in size over a decade (substantive discount to 46% Y/Y) and the multiple contracts to 5x inline with other companies that have lesser growth prospects but high margins (Ferrari, WDFC, etc), AWS is then worth 5 x $26.7B x 3 = $400B. 

Advertising is a very valuable business.  $74B would make sense if AMZN had the same information as FB, but AMZN likely will eat FB's lunch since the former can verify.  Including growth q/q and AMZN's advantage, $100B is not out of line. 

Maybe the online retail business (mingling domestic and int'l) should trade in line w/WMT (0.6x sales).  This doesn't makes total sense but it's the best comp.  1p (incl physical stores) could be worth $81B while 3p trades at the eBay multiple of 2.7x sales showing a value of $108B.  AMZN's 3p is certainly a better business than eBays, but let's forget this.  We also forget that AMZN's web business has more intrinsic value than any other etailer's due to networking effects.

Subscription services isn't part of this calculation, but this "division" adds $13.4B of very high margin fees.  While a slower grower, this bucket is an indicator of growth down the line outside of AWS.  Since it's intermingled, I have trouble assigning a value to this other than perhaps weighting according to sales--back of the env I see 1.9x valuing this piece at $25B.  The problem with this figure is that other subscription businesses can trade at multiples to this multiple. 

Adding all pieces up, you get a figure around $714B...discount for conglomerate at 10% = $643B of value backwards looking or ~$1315/sh. 

Any material growth to sales and/or margins obviously brings this figure higher, and should the whole pie grow at 10% for the next 7 years, underlying value should double.  Should AMZN continue to show 30% sales growth, well...


The following is more for academic purposes:

Markets are public auctions and turning back to a relatively healthy company like a John Deere for example, you'll find a high of $175 and a low of $130...25-35% price deviation over the course of a year while the business has not changed materially

Using 1315 as a midpoint, the range could be from 1000/sh to 1775/sh...funny enough, looking at AMZN's chart, you see a 52wk range from 1086-2050...just a little more volatility than the combine/tractor manufacturer!

I just read quickly but didn't you use the value of AWS a decade from now?  Shouldn't you discount that $400bn for 10 years?

Using this sum-of-the parts would suggest the company is still fully or slightly over priced even after recent sell off.

[walkie518]

while 3p trades at the eBay multiple of 2.7x sales showing a value of $108B.  AMZN's 3p is certainly a better business than eBays, but let's forget this. 

Why should we forget the fact that AMZN 3P is a better business than eBay and that it is growing much faster?

I'm not trying to be critical here. Overall I think this is a great post, especially some of the points about AWS and advertising.

we shouldn't forget if we want to come up with a truthful number, I did this back-of-the-envelope to show that using backward looking figures and comparable multiples on sales, we can get very, very close to the pricing shown in the market before factoring in growth

in other words, the market is doing its job despite how "growthy" AMZN appears to most

certainly, if AMZN as a whole grows 10-20%/yr for 5 yrs then stagnates, the business is still double the size; if AMZN can keep it up for 10 years before stagnating, it will quadruple...

a conservative approach might be to model 5 years of growth at current rates than historical GDP growth at 2-3%/yr...this view still brings AMZN well over where it trades currently, and I would argue that those who put AMZN in the "growth" camp don't understand the company

[dwy000]

I guess the point I was trying to make was that at some point, especially as growth slows, it is likely that Amazon will switch to be valued based upon earnings and not revenues.  All of the parts you are summing are based upon revenue multiples and not earnings (eg the 0.6x WMT comp - Walmart throws off tons of cash and is valued as a multiple of earnings/cash so I'm not sure a revenue multiple using WMT is the right comp.  Same with EBAY).

Your revenue comps and values are very relevant as long as AMZN continues to grow rapidly and investors value it based upon growth and not earnings.  The point at which growth slows, a lot of the valuation argument switches from revenues to an earnings based approach (and you see a bit of that in the recent sell off which was because the revenue expectation is much lower than people were expecting).  That's a tougher way to back into rationale for today's price.

[Liberty]

The dynamics under the surface mean that top line growth will decelerate as bottom line growth accelerates (unless they can keep finding new things with good ROIC to invest into).

As e-commerce slows down (there's still a lot of runway, but it'll slow down), Amazon will have to invest less into it (fewer new FCs, fewer new countries to enter and invest at a loss for a while, etc). Also, 3P +FBA is becoming a bigger fraction of ecomm, and it's a lot more profitable than 1P, while at the same time also reducing top line growth (because, unless I'm mistaken, Amazon only counts its take on 3P in revenues and not the gross amount). This helps the bottom line.

AWS is rapidly becoming a larger part of the total, and it is very profitable. Good for the bottom line.

Advertising is growing very rapidly and is very profitable, good for the bottom line.

Subscriptions (Prime) won't grow fast forever, but over the past few years they are up a lot, and very profitable highly recurring revenue. Good for the bottom line.

In short: Low margin segment isn't growing as fast, but its margin should improve, while all the higher margin segments have been growing fast and are now very material.

[walkie518]

I guess the point I was trying to make was that at some point, especially as growth slows, it is likely that Amazon will switch to be valued based upon earnings and not revenues.  All of the parts you are summing are based upon revenue multiples and not earnings (eg the 0.6x WMT comp - Walmart throws off tons of cash and is valued as a multiple of earnings/cash so I'm not sure a revenue multiple using WMT is the right comp.  Same with EBAY).

Your revenue comps and values are very relevant as long as AMZN continues to grow rapidly and investors value it based upon growth and not earnings.  The point at which growth slows, a lot of the valuation argument switches from revenues to an earnings based approach (and you see a bit of that in the recent sell off which was because the revenue expectation is much lower than people were expecting).  That's a tougher way to back into rationale for today's price.

My point is that I think it's likely we fill 95% of the valuation before accounting for growth at today's price, and I'm more interested in economic value...

Given that the stock is tanking, with no end currently in sight, a good entry point to add or to buy may be opening.  That's the impetus behind today's post.

Using multiples in general is a shortcut to a full-blown DCF, which may be impossible to do accurately for each part as cost of equity should change from unit to unit. 

The multiples I used in that dirty SOTP valuation were at substantive discounts to a multiple that could be attributed to Amazon's businesses.  Certainly, Amazon's etailing business is first-class and it's unlikely to lose its footing by any incumbent, Walmart or otherwise, in the foreseeable future. 

Does this mean that Amazon's retail business should be valued at the same multiple as WMT?  Absolutely not, but we need guideposts.  Same for the 3p business, which likely has better margins than eBay's given the scale derived from the synergies of AWS and the 1p operation.

Another point is that the video business has value.  Every dollar invested?  Who is to say, but that Netflix has subsidized AWS, and now Amazon Video is outspending big media firms says something. 

If Amazon Video started selling content separate from Prime, what valuation do we ascribe?  While the sector is somewhat depressed, FOXA trades at 4.3x book.  If Amazon spends $4B this year in content, is it worth $16B more next year?  Is it worth $160B in 10 years if AMZN spends $4B every year?  What about the video content that used to be written off in past years?  It's new accounting to capitalize since the accountants realized that video will likely be earning rather than losing.

Another point is we can dig deeper and come up with fairly good margin assessments based on value of goods sold on a relative basis to get a better feel for the retail business.

For example, AmazonBasics relative to other large players.  Energizer, for example, generates a 46% gross margin and an 11% net margin.  Add back 50% of ENR's depreciation (capex was $25m last year and deprec was $50m), and net income grows from $200m to $225m.  $225/85m = 265% cash returns on equity?! ~13% owner's income margin?!  I don't see a reason why Amazon isn't doing just as well except those margins should be wider since AMZN can leverage its scale to cut out the retail chain to sell paper shredders and batteries.

Also, AWS @ a 5x multiple on sales is very conservative since RHAT is selling for 11x to IBM, and RHAT is not a leader by any stretch.  Maybe in this light, AWS could be worth 12-13x sales (or more) when taking runway into account.

Depreciation is an interesting item as well: TTM $14.6B.  How much is a cash loss?

Hardware depreciates on a faster schedule than the real life of said hardware.  And back-of-env shows that $14.6B of depreciation bumps from last year's years' investment in PPE of $10.8B.  In other words, a better DCF would also account for the difference between deprec and replacement. 

Considering how savvy the ppl at AWS are, my guess would be double the depreciation cycle (ie 6 years--could be longer) before becoming obsolete and requiring replacement would be somewhat conservative.  Switches can last a very, very long time...especially ones that are built to custom spec.  Also, it's likely that parts are "dumbed down" so that they are running ram, cpus, fpas using some figure under voltage requirements to reduce wear.  Since they have so many units working in tandem, increasing the number of threads can offset performance losses. 

That said, parts will depreciate over a 3 year period for tax but 6 in real life--the difference should get added back over the last 3 years, which every year has been growing along with AWS.  This logic could put $7B of deprec back into owner's earnings from last year TTM Sept 30, and another $5B from TTM Sept 2017, etc.

[walkie518]

One other item less to do with valuation but having to do w/volatility

given that AMZN is such a huge part of various indices, we should see greater vol rather than less given the inflows into various ETF and MF equity-linked products

historically, vol was characteristically on the small  and mid cap names, but today, we're seeing that big names might now suffer more than little names... the very products created to produce less vol (not talking risk parity though another convo altogether) has created more of it in the bigger names... ie, we're more likely to see mispricing among the top 10 in the S&P than the bottom 10 as selling begets selling

[dwy000]

I guess I keep coming back to "what is Amazon worth"?  What's the intrinsic value?  If you use comps, it's not really stating what the value is, it's looking at what the relative value is.  To determine intrinsic value independent of the market you need to make some real assumptions about size and timing of cash flows.

The stock is down 25% from it's highs a month ago.  Is it a screaming buy?  Is it a sell still?  Is it now fairly priced?  If you value it based upon comps of competitors who are also down a similar amount, then you're kind of in the same place despite a huge price drop.

I have no idea the answer which is why I've never bit on this despite it being a fantastic business.  Most of the valuations I've seen have almost been reverse engineering to justify the current stock price or why it should be higher.  But as a shareholder I'd be very scared that the market will suddenly go "oh revenue growth is now sub-15%? Okay, you should be valued at 25x earnings.  And that number relative to today could be pretty ugly." 

I'm happy to sit on the sidelines and be very wrong (I have been so far on this). 

[Spekulatius]

I guess I keep coming back to "what is Amazon worth"?  What's the intrinsic value?  If you use comps, it's not really stating what the value is, it's looking at what the relative value is.  To determine intrinsic value independent of the market you need to make some real assumptions about size and timing of cash flows.

The stock is down 25% from it's highs a month ago.  Is it a screaming buy?  Is it a sell still?  Is it now fairly priced?  If you value it based upon comps of competitors who are also down a similar amount, then you're kind of in the same place despite a huge price drop.

I have no idea the answer which is why I've never bit on this despite it being a fantastic business.  Most of the valuations I've seen have almost been reverse engineering to justify the current stock price or why it should be higher.  But as a shareholder I'd be very scared that the market will suddenly go "oh revenue growth is now sub-15%? Okay, you should be valued at 25x earnings.  And that number relative to today could be pretty ugly." 

I'm happy to sit on the sidelines and be very wrong (I have been so far on this).

It’s pretty easy to come up with a bloated valuation, when using bloated comps for a valuation or numbers from 10 years out. Alternatively one could put the same multiple that Mr Market gives to GOOG or FB right now (roughly a 20x PE) and get a $400/ share fair value. Take your pick.