Since the end of January, Amazon's (NASDAQ:AMZN) share price has nearly doubled, closing at 72.29 on 6 June 2007. This dramatic increase followed the release of Amazon's first quarter results in late April in which Amazon announced $3.02 billion of revenue for the quarter, a 32% increase on the first quarter of 2006. Amazon also announced an increase in their second quarter guidance and full year expectations forecasting net sales of $13.4 to $14 billion for 2007 and operating income growing by up to 52% to $593 million.
Our DCF Valuation
We place a mid-point DCF valuation of $58.88 per share with a sensitivity range of $53.56 to $64.49 per share on Amazon based on consensus estimates and our own analysis. The DCF mid-point assumes revenues growing to $20.9 billion and EBIT reaching $1 billion in 2009; these are aggressive forecasts. These growth forecasts incorporate Amazon's potential to diversify into other online retail product lines and the DRM-free music sales opportunity. Although Amazon has been able to consistently produce strong revenue growth it has struggled to improve its profitability margins (EBIT margin of 3.5% in 2006), these forecasts represent an increase in Amazon's EBIT margin to approximately 5% by 2009. We assume a long-term growth rate of 5% and uses a cost of capital of 8%. This relatively low cost of capital reflects the dominant position Amazon currently holds in its core markets and product lines and success it has had expanding outside of North America. Despite these aggressive growth, profitability and cost of capital assumptions, our valuation is still significantly lower than the current market price.
Amazon's Growth Options
Amazon has a number of operations outside of it's core online retail business including www.a9.com, an e-commerce focused search technology, www.alexa.com, the traffic ranking site and www.imdb.com, the internet movie database. It is impossible to value these and the other growth options Amazon has explicitly due to the lack of information available, but it is difficult to imagine that these options account for the approximately $5.5 billion difference between our mid-point valuation and the current market valuation.
Comparable Company Analysis
It is difficult to identify a pure comparable company to Amazon so we have compared the forecast EV/EBIT multiple of Amazon of 50.3 with a number of high profile listed companies. eBay (NASDAQ:EBAY), Google (NASDAQ:GOOG) and Microsoft (NASDAQ:MSFT) have forecast EV/EBIT multiples of 16.5, 25.9 and 13.4 respectively. Admittedly these companies have a range of growth opportunities and have varying levels of risk but it puts into perspective the amount of growth the market appears to be pricing into the current Amazon share price. To take the comparison to the next level, eBay, whose core business is online auctions had EBIT of $1.4 billion in 2006 (over 3.5x Amazon) and has a number of growth opportunities, is being valued at only 1.4x Amazon based on the latest share prices.
Amazon has exhibited strong growth over the last two quarters and the market has responded positively to the latest quarterly result and revised guidance, but based on our analysis the stock appears over-priced. Even considering growth options potentially not captured in the DCF valuation it is still difficult to reconcile the current market price with our analysis. The current forecast EV/EBIT multiple of 50.3 suggest the market is overvaluing the growth potential of Amazon.
AMZN 1-yr chart