Price: $129 15/16
12 Month Price Objective: $150
Estimates (Dec) 1998A 1999E 2000E
EPS: d$0.50 d$0.90 d$0.25
P/E: NM NM NM
EPS Change (YoY): NM NM
Consensus EPS: d$0. 91 d$0.28
(First Call: 04-Mar-1999)
Q1 EPS (Mar): d$0.07 d$0.29
Cash Flow/Share: NM NM NM
Price/Cash Flow: NM NM NM
Dividend Rate: Nil Nil Nil
Dividend Yield: Nil Nil Nil
Opinion & Financial Data
Investment Opinion: D-2-1-9
Mkt. Value / Shares Outstanding (mn): $20,009 / 154
Book Value/Share (Dec-1998): $0.90
Price/Book Ratio: 144.4x
ROE 1999E Average: NM
LT Liability % of Capital: 53.7%
Est. 5 Year EPS Growth: NM
Stock Data
52-Week Range: $199 1/8-$12 7/8
Symbol / Exchange: AMZN / OTC
Options: Phila
Institutional Ownership-Spectrum: 32.7%
Brokers Covering (First Call): 19
ML Industry Weightings & Ratings**
Strategy; Weighting Rel. to Mkt.:
Income: Underweight (07-Mar-1995)
Growth: Overweight (07-Mar-1995)
Income & Growth: Overweight (07-Mar-1995)
Capital Appreciation: In Line (28-Jan-1999)
Market Analysis; Technical Rating: Below Average (28-Dec-1998)
**The views expressed are those of the macro department and do not
necessarily coincide with those of the Fundamental analyst.
For full investment opinion definitions, see footnotes.
Investment Highlights:
ú We are reinstating coverage of Amazon.com
with an Accumulate/Buy rating and a 12-
month price objective of $150.
ú Amazon.com is the clear leader in business-to-consumer
online commerce, a potentially
enormous market growing at better than
200% per year.
ú Amazon.com?s valuation is aggressive, but we
believe a small investment can be justified in
light of the company?s leadership position and
long-term opportunity. We believe the stock
will continue to be extremely volatile, but
trend higher long term.
Fundamental Highlights:
ú Amazon.com is one of the fastest-growing
companies in history. Five years ago, it
consisted of a man and a plan. Now, it has 6
million customers and a $1 billion run-rate.
ú In our opinion, Amazon.com is investing
money, not losing money (an important
distinction). Management is committed to
building long-term shareholder value at the
expense of the near-term bottom line?an
unsettling but, in our opinion, smart strategy.
Comment
United States
Internet - Electronic Commerce
9 March 1999
Henry Blodget
First Vice President
(1) 212 449-0773
henry_blodget@ml.com
Amazon.com
Still Long-Term Upside? ACCUMULATE
Long Term
BUY Reason for Report: Opinion Reinstated
Merrill Lynch & Co.
Global Securities Research & Economics Group
Global Fundamental Equity Research Department
RC#20106870
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Amazon.com Inc
Rel to S&P Composite Index (500) (Right Scale)
Amazon.com Inc ? 9 March 1999
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n Summary
AMZN is the most controversial stock in our universe.
Proponents say, ?The opportunity is enormous, the
company is blowing away expectations, and the
management team is great--own it at any price.? Skeptics,
meanwhile, remain concerned that ?land-based
competitors will whup them, they?ll never make any
money, and even if they don?t get whupped and actually
make some money, the stock is overvalued.?
Based on our analysis, we believe:
1) the business-to-consumer (B2C) electronic commerce
opportunity is massive?more than large enough to
support a few major players?and electronic retailing
is more difficult than it looks (having a strong real-world
franchise clearly does not guarantee success);
2) the leading B2C companies (namely, Amazon.com)
could make a great deal of money (note that AMZN?s
operating loss as a percentage of revenue is
declining?similar to AOL in the days when people
said it couldn?t make any money); we believe the
electronic model has enormous advantages over store-based
retailing in terms of profitability, return on
invested capital, and customer satisfaction;
3) AMZN?s valuation is justifiable, though expensive.
We should note that we don?t view Amazon.com as a
?book retailer.? We view it as an electronic customer-services
company in the business of helping its customers
figure out what they want to buy (whether books, music,
videos, or other products) and then helping them get it at a
good price with little hassle. As the industry develops,
Amazon.com is leveraging its early success in the book
market to 1) offer new categories of products to its
enormous customer base, 2) offer new search-and-refer
services to help its customers find anything on the web
they might want to buy (and, in the process, generate high
margin listing and commission revenue), and 3) make
significant investments in fledgling companies that could
dominate future categories (e.g., drugstore.com).
What this means is that it is very difficult to say for certain
how big or how profitable Amazon.com might be in three
to five years. The problem with making precise valuation
arguments, therefore, is that, if too conservative, they can
cause one to miss significant upside (the risk with open-ended
growth stories is not so much losing money but
missing multi-baggers). When analyzing an investment in
Amazon.com, we think it is less important to assess what
the company is than what it might become (valuation is not
irrelevant, though; and at current levels, the stock is much
less attractive than it was six months ago).
We believe the strength of the opportunity, the company,
and the team are such that AMZN still offers long-term
upside, but the company has to continue to execute well.
We are recommending the stock primarily for risk tolerant,
long-term investors.
n Overview
Amazon.com was founded in 1994, opened its online store
in 1995, and is now the third-largest bookseller in the
United States. The company first billed itself as ?Earth?s
Biggest Bookstore? and has since added music, videos,
gifts, and search-and-referral services to its virtual shelves.
Management often points out that historical rates of
revenue growth--more than 30% per sequential quarter
since inception--are not sustainable, but it is interesting to
note what would happen if they were: in March 2000,
Amazon.com would become the largest book and music
retailer in the world.
Amazon.com?s stock is one of the most controversial (and
expensive) in our universe. The company has a $20 billion
market capitalization?about 4X that of the two largest land-based
retailers of books and music, Barnes & Noble and
Borders, combined. Barnes & Noble and Borders, of course,
are profitable. Amazon.com?s GAAP losses, meanwhile,
have increased every quarter since inception and are now
chugging along at a run-rate of nearly $200 million a year (the
company is not, however, burning $200 million of cash every
year?not even close; on the contrary, it is generating cash).
Compared with future performance, moreover, Amazon.com
has not yet begun to lose money: we expect the company?s
accumulated deficit to balloon to more than $500 million
before it finally starts reporting profits in the spring of 2001.
And yet, amazingly enough, Amazon.com was cash-flow
positive last quarter; before financings, investments,
acquisitions, and capital spending, the company generated
$39 million (this is the beauty of a negative operating
cycle). In 1998, moreover, even after investing in
property, plant, and equipment and acquisitions, the
company added $3 million from operations to its now
massive $1.5 billion war-chest (talk about a financing?
Amazon.com recently raised $1.25 billion overnight).
At the most basic level, businesses are designed to provide
investors with compelling returns on invested capital. It is
interesting to note, then, that it wasn?t until Q2, 1998 that
Amazon.com even had any invested capital (and even
then, this was only the result of the sudden addition of a
boatload of goodwill). Thanks to a supremely cash-efficient
business model and a negative operating cycle,
the company?s current liabilities more than pay for its
ongoing operations.
Then there is the small matter of Amazon.com?s staggering
revenue growth. As far as we can tell, Amazon.com is the
fastest growing company in history. Since opening its
store in 1995, the company has grown from $0 to a $1
billion revenue run-rate?and even at this scale it is still
growing at better than 250% per year.
But most investors no longer worry about Amazon.com?s
ability to generate revenue. What they worry about is:
1) Whether the competition will squash it,
2) Whether it will ever make any money, and
3) Whether its valuation is preposterous.
Amazon.com Inc ? 9 March 1999
3
We analyzed these three concerns and concluded that
Amazon.com and its long-term investors should continue
to do well, provided the company keeps executing as well
as it has thus far.
We examined the competitive landscape and barriers to entry
and concluded that selling merchandise online is a heck of a lot
more difficult than it looks and that having a strong brand in the
physical world means next to nothing when it comes to
building a business on the Web. We also concluded that
merchant-customer relationships on the Web, once established,
are much stronger than those in the physical world.
We compared three basic business models--direct selling,
land-based retailing, and wholesale distribution--and
concluded that Amazon.com?s model more closely
resembles the direct sales model of computer manufacturer
Dell than it does land-based retailer Barnes & Noble?s or
vast wholesale distributor Ingram Micro?s. For those
worried that the company will never make money, this is
encouraging: Dell has an 8% net margin; Barnes & Noble
and Ingram Micro make 2% and 1%, respectively.
We built a set of projections using number of customer
accounts and average revenue-per-account as revenue
drivers and concluded that, by any conservative, classical
measure, Amazon.com is extraordinarily expensive, but
depending on how it and the industry evolve, might
actually be worth more than its current price per share.
The bottom line is that AMZN?s valuation can be justified,
but only by making very optimistic assumptions about how
big the market opportunity will be, how much of it the
company will capture, and how much profit it will
generate. In the short history of the industry, however, the
big money has been made by investors who had the faith to
invest in the stocks of the best companies before their
business models were proven--stocks that had already had
strong runs and looked incredibly expensive.
We think Amazon.com?s opportunity?like those of the two
other industry leaders, America Online and Yahoo!?is
compelling enough to allow compelling upside from here.
Whether the opportunity is actually this large and whether
the company will continue to execute well enough to
maintain its dominance, of course, remain open questions.
n Valuation
The only thing anyone ever really wants to talk about with
regard to AMZN is valuation?so here goes.
We value AMZN the same way we value other Internet
stocks: we make three major five-year assumptions?
revenue, operating margin, and P/E multiple?and then
discount the resulting values back to the present. As with
all such valuation methodologies, the conclusions vary
enormously depending on the assumptions used. With
AMZN, for example, we can twist a few dials and knobs
and conclude that the stock is worth anywhere from $1 to
$200. The company is also evolving so quickly, we don?t
really know what its business model will look like in three
years. So rather than declare definitively what we think it
is worth, we will explain why we think there is still upside.
We build our revenue estimates on two basic assumptions:
1) the number of customer accounts, 2) the average annual
revenue per account. What is important about this
methodology, in our opinion, is that it allows us to treat
Amazon.com not as a book retailer but as a more versatile
electronic-shopping services company. We see no reason
why Amazon.com will stop with books, music, and videos.
Over the next few years, we wouldn?t be surprised to see it
add software, toys, credit cards, auctions, foods, or
whatever other products or services make sense. As long
as it maintains its ?relentless focus on the customer? and
the quality of each of its product verticals, we see no
reason why it couldn?t sell almost anything.
Our official five-year projections are similar to the Street?s
and assume 1) the customer base increases from 6 million
to 30 million by 2003 (approximately 35% per year), 2)
revenue per account increases from $98 to $130 by 2003
as customers buy a more diverse selection of products.
Do the multiplication and?voila!?a 2003 revenue
estimate of $3.2 billion (which, when combined with an
operating margin assumption of 10%, a 40X terminal
multiple, and a 15% discount rate, equates to a current
value of about $30 per share).
The risk in making conservative assumptions in this
market, however, is missing a gigantic opportunity.
Amazon.com has blown away expectations since its IPO,
so it seems reasonable to assume that it might continue to
do so. It also has the potential to generate Dell-like returns
on invested capital?which should lead to a higher P/E
multiple. So let?s tweak those assumptions and see what
happens. Let?s assume that the customer base increases to
55 million and the average revenue per account increases
to $170. Do that math, and suddenly, Amazon.com isn?t a
$3 billion company but a $10 billion company. Place a
12% operating margin on this revenue estimate (with the
additional scale, the company should be a bit more
profitable), use a 50X multiple, and discount the resulting
EPS back at a more aggressive 10%, and suddenly the
stock is worth $150.
We conclude, therefore, that AMZN is worth somewhere
between $1 (the value you generate when you assume that
the company can scrape together EPS of only $0.10 in
2003--a brighter version of the ?makes no money
scenario?) and $200, with the real value probably closer to
$100. We love the opportunity, the company, and the
management, so we are recommending the stock primarily
for risk tolerant investors with similar faith. |
