Amazon (AMZN) is one of those stocks that either you love or hate. Bulls love it because of its dominance in e-Commerce, its cloud service offering, and Kindle's potential. Bears hate it because of its high valuation (150x 2012E P/E and 80x 2013E P/E), thin profit margins (1-2% net margins), and annual cash burn from investments ($4 billion in capital expenditures and $700mm in content costs a year). Let's do a deep dive into Amazon's business model and market opportunities to see whether Amazon is a buy or a sell going into 2013.
As always, let's first paint the big picture on Amazon's financials and valuation. As shown below, Amazon currently trades at 1.8x 2012 Revenue, 157.2x 2012 P/E, and 14.9x P/B. The P/E multiple comes down to 79.3x for 2013 (note, EPS expected to grow 98% in 2013 because analysts viewing 2012 as an investment year). Sales are projected to grow 25-30% over the next few years, and net profit margins are expected to remain around 1-2%. AMZN currently has $5.2 billion in cash as of Q32012, or around $11.60 per share.
Note that AMZN's cash was over $9 billion in Q22012, but is down to $5.2 billion in Q32012. The cash burn is due to AMZN's on-going investments in expanding its infrastructure (more warehouses for same day delivery and infrastructure buildout for new country markets), as well as broadening its online video content offerings, so that AMZN can continue to drive top-line growth (25-30% revenue grwoth). 2012E capital expenditures is $4.1 billion and 2012E content cost licensing rights add an additional $700 million. Note for annual content costs, AMZN's $700 million amount may continue to increase as it expands its online library, given that Netflix currently spends 3-4x that amount, or $2.5 billion a year on content costs.
So how does AMZN's valuation compare other competitors? The most comparable companies are probably e-Bay (EBAY) for e-Commerce and Salesforce (CRM) and Rackspace (RAX) for Cloud Services. Also, it's probably helpful to see what traditional retailers such as Wal-Mart (WMT), Target (TGT) and Costco (COST) are trading at, given Bears will argue that AMZN is really a retailer in tech clothing. Also, traditional retailers have all invested significantly in their own online website for e-commerce in recent years.
Amazon trades at 1.4x 2013E Revenue and 80x 2013E P/E
EBay trades at 4x 2013E Revenue and 18-20x 2013E P/E
Salesforce trades at 6x 2013E Revenue and 79x 2013E P/E
Rackspace trades at 6.5x 2013E Revenue and 68x 2013E P/E
Retailers (Walmart,Target, and Costco) trade around 0.6-0.8x 2013E Revenue and 15-20x 2013E P/E (note Best Buy (BBY) trades around only 0.3x 201E Revenue, but let's exclude them)
As you can see, AMZN seems to be trading closer to the cloud computing sector (Salesforce and Rackspace) than the e-commerce and traditional retail sector (Wal-Mart and Target). Next, let's dig into the revenue segments of Amazon to see just how much of their business is from e-commerce versus cloud.
As shown below, e-Commerce is around 89% of sales for Amazon, or $70 billion for 2013. Kindle (including hardware and software) is next at 7% of sales or $5 billion. AWS, which is Amazon's cloud service, is just 3% of sales or a $2.3 billion business. Granted AWS has higher gross margins than e-commerce (80% versus 23%), but even looking at gross margin contribution, AWS comprises just 10% of total gross profits.
In terms of geography, 57% of sales are from North America and 43% is from International markets (as of 3Q2012). International markets include U.K., Germany, France, Japan, Canada and China (note that Amazon currently has some tax disputes in Europe). Also note that operating margins (EBIT) is -1.7% for International versus 3.7% for North America. Basically, moving into new markets will lose money in earlier years, until you achieve sales scale to offset your infrastructure investment. Note, Bulls will argue that the International markets will eventually turn profitable, which will dramatically improve AMZN's overall company margins.
E-Commerce (85-90% of Amazon's Sales)
Exactly how big is the e-commerce market globally? Well, worldwide e-commerce is a little harder to measure, so let's first focus on the U.S. e-commerce market. In 2012, e-Commerce in the U.S. is about a $226 billion industry and represents 10% of all of U.S. retail sales ($2.2 trillion). Amazon's e-Commerce sales including 3rd party GMV sales is $56 billion, which would imply AMZN has a 25% market share of U.S. e-Commerce (eBay has 10% market share).
In terms of growth potential of e-Commerce in the U.S. going forward, e-Commerce has historically grown 25-30% a year, but is projected to slow down somewhat to 15-20%, which is still impressive, as it continues to take market share away from traditional retail. In addition, e-Commerce growth of 15-20% is 3-4x faster than traditional retail growth of 5% or less.
Given that U.S. industry growth for e-Commerce is 15-20%, but AMZN is projected to grow their revenues at 25-30% rate, Wall Street is also projecting that AMZN increases their U.S. market share from 25% in 20212 to 37% in 2015 (AMZN's market share of global e-Commerce is 17% by 2015).
Cloud (<5% of Amazon's Sales)
Amazon Web Services provides an IT infrastructure platform on an as needed basis for a monthly fee. AWS offers computing process capacity, content delivery, payment, storage and traffic measurement. Clients include Samsung, Adobe, Airbnb, Foursquare, Netflix, Yelp, Spotify, U.S. Department of State, NASA, Nokia Siemens, just to name a few.
AWS competes primarily in two markets: a) Infrastructure as a Service and b) Platform as a Service. Combined, the two markets globally total a $34 billion market opportunity in 2014. Platform as a Service is projected to grow 7% annually and Infrastructure as a Service is projected to grow 34% annually. Wall Street estimates project AWS captures 5.4% market share in 2012 and will grow that to almost 10% market share by 2014.
Now that we've covered revenue, let's dig into the cost components. As shown below, COGS is around 76% of sales, Fulfillment (for 3rd party sellers) is 10% of sales, Technology and Content is 7% of sales, and Others (including G&A and marketing) is 5% of sales. That leaves Operating Income margin, or EBIT, at around 2%.
Note that traditional retailers typically have 30% gross margins, however because AMZN has to incur shipping costs (average of 4% of sales) and typically price their items lower than traditional retailers (on average, AMZN prices are 4% lower than typical retailers and 1% lower than Wal-Mart), AMZN has a lower gross margin of 24%. Note also the concern of new online sales tax which gives online retailers an advantage currently, but may negatively affect e-Commerce growth if all states adopt online sales tax (AMZN currently subject to sales tax in 8 states only).
Capex and Content Costs
AMZN has significantly increased capex spend since 2009 and $4 billion (7% of sales) is projected to be spent in 2012. In 2012, AMZN will add 19 fulfillment centers to reach nearly 90 centers total and is also spending $1.4 billion on real estate in Seattle. AMZN will also spend $875 million on AWS capex (60% of AWS revenue compared to 25% for Rackspace).
Furthermore, AMZN will spend an additional $700 million on video content rights for their Amazon Prime Video and LoveFilm (Europe) online video business. AMZN has about 10mm Amazon Prime Members, or 5% of their 200mm total active members (but Prime Members spend 4x more than non-Prime members, or $1,000 vs. $250). The 10mm Prime members (who have access to Prime Video), compares to 2mm for Hulu and 30mm for Netflix.
Bears have some concerns over the cash burn related to these investments. Bulls will argue that these investments will pay off down the road as Amazon continues to scale and gain market share.
Let's perform a sum-of-parts valuation analysis, by placing different multiples on each of AMZN's different businesses. For e-Commerce, let's assume AMZN eventually get to 4% net margin on that their e-Commerce business (Costco has 2-3% margins and Wal-Mart has 3-4% margins). Let's then apply a P/E multiple of 20x to 25x for AMZN's higher growth potential, compared to 15x-20x for traditional retailers.
For Kindle, let's place a range of 1.0x-3.0x revenue multiple (note that Apple (AAPL), the dominate player in the tablet space, trades at around 2.3x 2013E Revenue). For AWS (Cloud) and Other Revenues, let's place a higher multiple range of 4.5x to 6.5x for its growth potential (Salesforce the dominant player in the cloud space trades at 6x). As the table shows below, the target price would indicate a $184 - $254 price per share range.
This article attempts to separate Amazon into its different business segments, look at the growth potential of each segment, and apply fair valuation multiples to each segment. In the end, I arrive at a valuation range between $184 and $254 per share.
At its current stock price of around $250, Amazon is trading at the high end of the valuation range. As much as I love using Amazon for my online shopping needs and will continue to do so, current valuation is just too high (too much growth expectation priced in). I would rate Amazon a Sell at current prices (but a Buy if they fall under $200).
High growth companies in high growth industries (such as e-Commerce and cloud services) are extremely difficult to project. Bulls of Amazon will argue that the two big themes of a) e-Commerce will continue to take market share from traditional retailers, and b) cloud services will continue to take market share from traditional IT, will remain in place for years to come. Current growth projections of those two high growth industries may prove to be too low (and therefore our valuation, even on the high end, may prove to be too low).
Disclosure: I am long AAPL.