Mr. Blodget's detailed analysis about AMZN's valuation. Enjoy!
---------------------------------------------------------------
09:04am EST 10-Mar-99 Merrill Lynch (H.Blodget/T.Pankopf) AMZN
AMAZON.COM:Still Long-Term Upside...
ML++ML++ML Merrill Lynch Global Securities Research ML++ML++ML
AMAZON.COM (AMZN/OTC)
Still Long-Term Upside...
Henry Blodget (1) 212 449-0773
Tonia Pankopf (1) 212-449-1011
10 March 1999
ACCUMULATE
Long Term
BUY
Reason for Report: Opinion Reinstated
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: NA NA NA
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: NA
LT Liability % of Capital: 53.7%
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:
o We are reinstating coverage of Amazon.com with an Accumulate/Buy rating
and a 12-month price objective of $150.
o Amazon.com is the clear leader in business-to-consumer online commerce, a
potentially enormous market growing at better than 200% per year.
o Amazon.com's valuation is aggressive, but we believe a small position 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:
o 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.
o 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.
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, whether sold by Amazon.com or not) and then helping them get it
at a good price with little hassle.
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 enormous 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, it is less important to assess what the company is
than what it might become (valuation is not irrelevant, though; and the stock
is much less attractive than it was six months ago).
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.
Valuation
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.
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. This
yields a 2003 revenue estimate of $3.2 billion.
The risk in making conservative assumptions in this market, however, is missing
a big 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 an 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 for strong-stomached
investors with similar faith. |
