Thursday, November 19, 2009

Even AMZN Bears are Bullish

Did anyone see the Needham & Company research note on Amazon? The report entitled Amazon's Improbable Valuation starts with real promise:
"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
ING Group
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 and Marshalls) 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.

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.

1 comment:

  1. Classic case of unrealistic expectations and greed winning out over common sense.