Amazon’s business model is to sell products through its online customer facing website to customers across the world. Amazon does this by selling items from its own inventory as well as those from third party seller’s. Apart from this Amazon offers services such as “compute, storage, and database offerings, fulfilment, publishing, certain digital content subscriptions, advertising, and co-branded credit cards.” (Amazon.com 10-K filing, 2017). In addition to this Amazon also manufactures and sells self-branded electronic products and accessories through its website.
Financial Highlights
Amazon’s focus, from inception has been on long term growth and has worked towards this by increasing operating income and managing working capital and cash capital expenditures efficiently. According to their annual 10-K filing they have done these by increasing sales of products and services, while managing operating costs, to achieve overall increasing operating income. Amazon also partially offsets operating costs by investing heavily in long term strategic plans aimed at improving efficiency overall.
Increase in sales is primarily driven by providing a far superior customer experience by offering a wide and increasing variety of lower priced goods, maintaining high availability, quick delivery times, improving reliability, and aiming to increase customer trust.
Amazon also works to reduce variable costs per unit – such as payment processing, transaction costs, picking, packing, customer service costs and marketing costs. Amazon also works to ensure that fixed expenditures are efficiently used, and their fixed costs include costs of building and running technology infrastructure; to build, enhance, and websites and web services, electronic devices, and digital offerings; and to build and optimize fulfilment centres. While variable costs vary with sales volume, fixed costs are dependent on strategic initiatives such as geographic or category expansion, capacity requirements etc. and are minimized by improving process efficiencies and maintaining a lean culture (Amazon.com 10-K filing, 2017).
Peers and competition
Amazon as a global e-retailer, is virtually unchallenged as no one has been able to replicate the success of its business model. However, Amazon operates broadly in 3 segments – media (Prime Music and Video), electronics (Fire line of products and Alexa speakers), and other merchandise. To compare its business model peers, a company of comparable market share in each of these segments has been chosen – Netflix, Inc., Alphabet Inc., and Alibaba Inc.
Netlfix Inc.
Netflix is primarily a competitor in the video streaming segment competing directly with Amazon Video and Prime Video. Netflix is a producer and distributor or original and licensed content. Its major costs are those associated with geographical licensing rights and those associated with their acquisition. Its income comes from membership fees that it charges its customers through three plans – basic, standard, premium. (Netflix Inc. 10-K filing, 2017)
Amazon’s content streaming business follows a similar model while also offering music in addition to video, with similar costs and revenues but there is one important distinction – Amazon bundles access to some of its streaming content with its Prime membership and sells and rents digital copies of other content outside of its Prime catalogue. Its income is derived from both, Prime membership as well as revenue from selling and renting digital content.
Alphabet Inc.
Alphabet is the holding company under which Google, Nest, Waymo and many other companies operate. Amazon competes against Google in many strategic areas however this report will specifically look at how Google and Amazon compete in the manufacture and sale of electronic devices. Google and Amazon both manufacture smartphones (Fire/Pixel phones), tablets (Fire/Google Nexus) and direct television viewing software and hardware (Fire TV and Google Chromecast). Googles revenues from these products come from the sales of the devices as well as a percentage from the sales of content available for these devices on its online app and media store Google Play Store.
Alibaba Inc.
Alibaba works in a space similar to Amazon, in that its major business is through its e-commerce platform, Alibaba started out serving enterprise customers in 1999 before launching a consumer focused platform Taobao in 2003. Both platforms primarily serve customers in the SEA region, unlike Amazon which is expanding globally. Alibaba however, has stake in numerous businesses around the world and is an active player in the global business scenario as well. It recently acquired and renamed to Altaba all parts of Yahoo Inc. which were not bought over by Verizon. Alibaba’s IPO in 2014 was the largest US IPO ever (Barreto and Thomas, 2013).
Figure 1: Amazon
Figure 2: Alibaba
Figure 3: Netflix
Figure 4: Google
As we can see from the graphs above the stock prices for each of the 4 companies have grown over the period of 5 years. The two companies here with the highest market cap – Amazon ($462.68B) (Yahoo Finance, 2017) and Google($600B) (Pullen, 2017) also have the highest stock prices of $968 and $929. Alibaba ($356.39B) (Yahoo Finance, 2017) is not too far behind in its market capita while its stock price is around $140.90, however Alibaba has been a public company for a lot less time and the graph above seems to indicate a sharp rise in its stock price. Netflix on the other hand has a market cap almost 1/5 that of Alibaba at $64.4B (Yahoo Finance, 2017) whereas its stock price is slightly higher at $149.
Financial Statement and Ratios Analysis
ROE and ROC
We see that except for a dip in 2014 end, Amazon’s ROE has seen an upward growth trend. This means in 2016 for every $1 invested in Amazon, Amazon could earn 14 cents compared to losing 2 cents in 2014. 2017 data is only up to date to march, so it has been ignored in all ratio calculations.
Like ROE, ROC follows an upwards trend. This indicates that Amazon can efficiently manage its funds to generate income, likely by increasing process and management efficiency as mentioned in item 7 of their 10-K filing.
ROA
We see a similar upwards trend in ROA as well, Amazon can efficiently manage its assets to generate earnings. Again, 2017 data has been ignored.
EBITDA Margin and Profit Margin
While EBITDA Margin is not regulated by GAAP, it nevertheless an important metric to analyse when studying the growth of a firm. We see that Amazon’s EBITDA margin follows an upward trend, this indicates that Amazon’s operating expenses have been increasing much slower than their revenues. This indicates better efficiency but also higher profitability.
Which leads us to the last chart, for the profit margin.
As the EBITDA Margin graph indicated, Amazon’s profitability has been increasing over the past 5 years which can be seen in the profit margin chart above.
Overall, the financial statements indicate an efficiently run company on a growth trend with increasing profitability.
Relative Valuation Analysis
Using financial and comparative data from S&P capitalIQ, Amazon was valued using Enterprise Value. The industry average TEV/EBITDA multiple was found out using the following competitors and peers in the tech industry – Alphabet, Expedia, Facebook, eBay
, Twitter, Netflix, TripAdvisor, Altaba, Zillow group to get a value of 58x.
TEV = Market Capitalization + Interest Bearing Debt + Preferred Stock – Excess Cash
The high industry average TEV/EBITDA multiple seems extremely high compared to other industries and this is because the market caps in the tech industry, especially the large cap companies that have been used here, are generally high while excess cash is low.
With the industry average TEV multiple, Amazon’s EBITDA, and a figure of 477,170,618 for the number of common stock shares outstanding from Amazon’s latest 10-K filing, Amazon’s implied share price was calculated to be $1484.53. Given that Amazon’s current share price is $968 (Yahoo Finance, 2017) this calculation seems to suggest that Amazon’s shares are undervalued by almost a third, however, it’s possible that if a true industry EV average was calculated this gap may change.
The reason behind using TEV and not P/E ratio is that since the P/E ratio only depends on market cap and profits public equity companies may look expensive without looking at each company’s financials and capital structures separately. However, it is never sufficient to look at just one metric to take such a call and since all the firms are large cap and in the same industry a high-level analysis of PE ratios of some of Amazon’s competitors is also presented here using data from Nasdaq’s website.
We can see from the higher values of Amazon and Netflix that investors are willing to pay more for their shares, this is most likely due to expectations of growth from both companies. Netflix is currently in the middle of a global expansion, in 2016 expanding to SEA regions (Netflix Media Center, 2015). Apart from this Netflix is also expanding its content offerings, a particularly in non-US markets (Dynamiclanguage.com, 2017). Similarly, amazon is also in the throes of an expansion, not only into new regions to serve customers but also in the depth of its product offering in existing markets. Therefore, investors’ expectations of growth are not misplaced and this is reflected in the P/E Ratio.
Amazon’s stock price could be undervalued, given the expectations of future growth and fine management.