"We believe Amazon's current share price now implies a long-term revenue growth rate that will be increasingly difficult to achieve."
The rationale:
Our free-cash-flow valuation model assumes Amazon can grow revenue at a 25% annual rate for 10 years while maintaining a 4.5% operating margin. These assumptions translate into a price target of $120.
The Needham analysts "assume" Amazon is worth $120. At $130, it's fully valued and perhaps a tad overvalued. Their suggestion: HOLD onto it.
Whatever you do, don't SELL. After diligent study and number crunching, Needham alas can ONLY justify $120 a share for Amazon. Beyond that, it gets a little dicey. After all, their basic assumption is that Amazon will increase revenues by 25 percent for 10 years!!!
In the last 4 quarters, Amazon has reported $21.7 billion in sales. At this assumed growth rate Needham expects AMZN to generate over $200 billion in sales by 2018. Are you laughing yet?
According to Fortune Magazine's Global 2009 Global 500 rankings, only 10 firms generated over $200 billion in revenues. They were (drum roll please):
Royal Dutch Shell
Exxon Mobil
Wal-Mart Stores
BP
Chevron
Total
ConocoPhillips
ING Group
Sinopec
Toyota Motor
Have numbers lost all meaning? Is Amazon in this league? General Electric generated sales of $183 billion in 2009 (and ranked 12).
To its credit, Amazon did make the Fortune list, coming in at number 485. Ironically, value retailer TJX (TJ Maxx andMarshalls) was next with a similar level of sales. It made $881 million in profits vs. Amazon's $645 million. Oops.
Thanks to the magic of expected growth rates, TJX has a $16 billion market value vs. $57 billion for Amazon. Imagine an analyst trying to justify a similar market value on behalf of TJX!? They'd soon be looking for work.
We are to suspend disbelief in the case of Amazon. It's virtual... none of those pesky bricks with mortar. It is going to (and must) leapfrog out of the land of Whirlpool (#488) into the world of Wal-Mart in 10 years. We are to HOLD the stock on the certain knowledge that this will happen. There is little downside, just the possibility of a limited upside. Pay $130 a share if you like, but Amazon MAY not generate MORE than the required $200 billion in sales.
The only doubt: whether or not growth rates will exceed 25%.
Here's how the report puts it:
it's the implications of a growth rate materially north of 25% that concern us. If Amazon were to grow 25% annually, for example, its revenue would increase over tenfold to $220 billion in 2018; the company would emerge as the second-largest retailer, trailing only Wal-Mart Stores (WMT)(not rated). We believe such an increase is a stretch but realistic given Amazon's competitive position in the world-wide retail industry.
"A stretch, but realistic"?
So a 10-year 25% growth rate is reasonable, but anything "materially north" of that becomes "a stretch". Yes, Amazon's valuation is "beginning to border on the improbable."
Sure, we understand.
Look, I love shopping at Amazon. Once could even say my love is "beginning to border on" an addiction. But come on. The 25% growth rate is absurd. Worse, it is already priced into Amazon's current market value.
Bezos and Friends MUST pull in $200 billion annually by 2018 to merely justify a $120 share price! And $131?
This analyst rates Amazon a SELL. Somebody has to do it.
Rather than just talk about it, I shorted Amazon shares today. It is admittedly a small position. Never underestimate the irrationality of the markets.
Anything is possible when analysts use the "pick-a-number-any-number" valuation method.
Disclosure: The author is SHORT Amazon.
Henry W. Schacht
[www.lonelyvalue.com]
_________________
Henry W. Schacht, CFA is the founder of Schacht Value Investors, an investment management firm serving individuals and institutions. He currently serves as President and Chief Investment Officer. He earned his MBA at the University Of Chicago Graduate School of Business and a BBA in finance from the University of Notre Dame. Mr. Schacht is a member of the Association for Investment Management & Research (AIMR), the Investment Analysts Society of Chicago (IASC), and the National Association of Corporate Directors (NACD).
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1. Sivaram says on Nov 20, 2009 at 11:05 AM:
Amazon is probably my dream stock but it has been wildly overvalued for what seems like forever... I'm not sure what the market sees... I don't think they will be able to grow sales so much but I wonder if they can increase their margins. Margin expansion is the only justification for the current price.
Good luck with your short... it looks like a rational short but superstar stock investors are often irrational so it'll probably come down to how long you can maintain your position.
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2. Hschacht says on Nov 20, 2009 at 11:11 AM:
If Amazon was a such great company, lacking in competition, in a virtual world, it's margins would exceed 3.5% Margin expansion isn't going to happen. If anything, they are headed down.
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3. Sivaram says on Nov 20, 2009 at 11:21 AM:
hschacht Wrote: ------------------------------------------------------- > If Amazon was a such great company, lacking in > competition, in a virtual world, it's margins > would exceed 3.5% Margin expansion isn't going to > happen. If anything, they are headed down.
It's not necessarily that it is lacking in competition but, rather, I feel it has a massive moat. Although margins are indicative of competitive positioning, that is not always the case. For instance, Wal-mart has a huge moat and is the clear leader in low-end retail but its margin is small. Margins are often more indicative of the industry than the company. A technology company, even a secondary one, often has far higher margins than, say, a dominant oil & gas company.
Clearly investors are betting on greater margins from Kindle and their cloud computing initiatives. I lean more towards your conclusion and think they are over-pricing the herd is unpredictable.
It's not necessarily that it is lacking in competition but, rather, I feel it has a massive moat. Although margins are indicative of competitive positioning, that is not always the case. For instance, Wal-mart has a huge moat and is the clear leader in low-end retail but its margin is small. Margins are often more indicative of the industry than the company. A technology company, even a secondary one, often has far higher margins than, say, a dominant oil & gas company.
Clearly investors are betting on greater margins from Kindle and their cloud computing initiatives. I lean more towards your conclusion and think they are over-pricing the herd is unpredictable.
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4. Hschacht says on Nov 20, 2009 at 12:00 PM:
I would argue that the moats around WMT and Amazon are a lot shallower than is generally thought. Walmart is big, but that doesn't necessarily translate into a long-term competitive advantage. There isn't anything that Wal-Mart does that can't be duplicated... or ultimately done better. TGT and COST are living proof.
But, nonetheless, WMT's moat is deeper than Amazon's. Even eBay has more staying power (in my humble opinion) than Amazon... take a look at their margins.
But, nonetheless, WMT's moat is deeper than Amazon's. Even eBay has more staying power (in my humble opinion) than Amazon... take a look at their margins.
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5. Sivaram says on Nov 21, 2009 at 11:31 AM:
Hschacht: "I would argue that the moats around WMT and Amazon are a lot shallower than is generally thought. Walmart is big, but that doesn't necessarily translate into a long-term competitive advantage. There isn't anything that Wal-Mart does that can't be duplicated... or ultimately done better. TGT and COST are living proof. "
Of course anything can be displaced. Even the widest moat company will probably lose its moat in 30 years. Target, Costco and others are chipping away at Wal-mart but they are a long way away and cannot be considered to have done anything better. I forget the exact numbers but Wal-mart has sales of something like $300 billion while Target and Costco don't even have 1/4 of that. In terms of locations, regional penetration, and so on, they are nowhere near being dominant either. At that rate, it is going to take decades to get even half of Wal-mart's sales/locations/cash flow/etc.
Hschacht: "Even eBay has more staying power (in my humble opinion) than Amazon... take a look at their margins."
It's debatable but any discussion over "moat" or "competitive advantage" or "better company" is always subjective and is in the eye of the beholder :)
I would sort of agree with you that Ebay has a stronger moat than Amazon (but the gap isn't that wide IMO.) However, if I had the chance to own either of them (at comparable valuations) I would pick Amazon over Ebay any day of the week. Ebay has a huge moat--very difficult to establish another auction business like that (unless you are talking about foreign countries)--but it has probably saturated its market. Amazon, in contrast, doesn't operate in a market that it totally dominates (unless you are talking about narrow verticals like books or something.) This is clearly why investors are willing to buy Amazon for P/E ratio of 50 to 80 and P/CF multiple of 30.
Having said all that, this is mostly a theoretical discussion because Amazon is never going to trade at a P/E multiple around 12 to 15 (like Ebay) any time soon. Even during the market crash, near the lows, Amazon came nowhere near being cheap.
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