Amazon - Positioned to Be a Superior Investment Over the Next Decade
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Decision 2025 Amazon - positioned to be a superior investment over the next decade. Team: Bluejays Bob Mills Reed Janousek Anthony Cerasoli To complete this case our team used Google Docs to collaborate, iPads to research, transcribed 10Ks on laptops in Starbucks and ultimately a 20 page paper materialized despite us having met for all of three hours in person. 10 years ago this effort would have had us locked in the library for the full 10 days. In 10Y the PESTEL environment surrounding a company can shift so dramatically an industry can literally disappear. With that in mind we approached with caution the notion of developing a relevant 10Y recommendation for two extremely different companies. THE FINANCIALS Because the Walmart business model and strategy produces stable transparent financial statements we chose the Dividend Discount Model methodology to value Walmart. The ten year time frame incorporated the recently announced investment in e-commerce and people with the subsequent expected rebound in earnings. Amazon was valued using a sum-of-the-parts approach with EV/EBITDA as the multiple. By splitting Amazon into North America, International and Amazon Web Services (AWS), forecasting EBITDA and applying comp-based multiples we were able to derive an enterprise value. After backing out net debt we arrived at a market cap that could be translated into a share price. We believe that Amazon will deliver a higher 10 year holding period return. Our financial models suggest Amazon will return 23.4% annualized versus 10.0% for Walmart. Recently their equity values have sharply diverged. Amazon spiked on the success of AWS while a deceleration in Walmart earnings followed by a 3Q15 surprise has sent its stock spiraling. Pricing each as of 10/26, and using our methodology, we believe that Walmart is currently mispriced by the market. With Walmart at $58.40 and our calculated fair value at $70.83 Walmart is trading at a 17.5% discount. Pricing Amazon at $602.30 and using our SOTP Page | 1 approach we calculated fair value to be $546.89 putting Amazon at a 10.1% premium. That Walmart is more mispriced is no surprise given recent guidance that the company will see a near term reduction in EPS as it invests for the future. Juxtapose this against Amazon which has introduced a business line (AWS) believed to be capable of producing mid-double digit top-line revenue growth. Given the relative performance metrics and frequency upon which equity investing is judged it is understandable why asset managers would sell Walmart and bid up Amazon. Taking for granted that modeling equities with a 10Y horizon introduces a near inappropriate amount of model risk we sought qualitative validation of our numbers. We thought deeply about the core competencies of each company, the challenge of providing a unique customer experience and which company can better diversify and surround the consumer. Our strategic analysis confirmed our belief that the Amazon model will deliver superior results. Page | 2 LEVERAGING CORE COMPETENCIES Amazon’s organization is better suited to dynamically apply their resources and core competencies to the external environment, allowing them to build and sustain a competitive advantage in the markets they choose to serve When comparing Amazon and Walmart, many resource and core competency similarities exist. Both have extensive distribution infrastructure, world class logistics capabilities, a deep expertise in IT/analytics and commitment to their customers. The strengths of these resources and core competencies are relevant and well documented, but it is Amazon’s ability to dynamically apply and even reconfigure its resource base that makes it the better investment. To establish context, let’s discuss the organization’s respective mission statements: Amazon: “Our vision is to be earth's most customer centric company; to build a place where people can come to find and discover anything they might want to buy online” 1 2 Walmart: “Saving people money so they can live better” Amazon’s mission states that it is centered on delivering the best customer experience, while Walmart’s is focused on the value of low prices. Although the difference is subtle, in practice the gap is wide as Amazon’s mission provides for a higher growth ceiling. Said casually, Amazon is less concerned than Walmart about what products, services, or even channels are part of their revenue stream. A specific example, AWS, can demonstrate this concept. A decade after Amazon launched their e-commerce business, they realized they needed an IT infrastructure to allow the employees designing the customer experience (application engineers) Page | 3 to be decoupled from the people providing the necessary technology. The result was a highly scalable web service that with a few customer-focused additions was marketable to others with a similar need. AWS is now Amazon’s fastest growing and most profitable segment. What created the environment that birthed AWS? Amazon has a unique atmosphere where their resources, core competencies, and mission create innovation. Their resources provided the assets for AWS – IT infrastructure and expertise. Their core competencies around customer service provided the leverage and momentum to move the initiative forward. Their mission played an active role in fostering a culture that encouraged experimentation, but more importantly didn’t act as a barrier in bridging the idea with the market. Subsequently, Amazon reconfigured their resources to gain a competitive advantage in the marketplace. This ability to build, leverage, and reconfigure core competencies into sustainable competitive advantages exemplifies why Amazon is positioned to succeed in a rapidly changing external environment. Examples include: o Amazon Restaurant - leverages their customer experience competency and grows their delivery infrastructure. o Amazon Fresh - higher margin business - leverages their distribution network and excellent customer experience and service. o Twitch - positions them at the forefront of the online gaming frontier (Twitch accounted for 2% of global Internet traffic in 2014) 3. Broadens product line and strengthens IT core competency. Page | 4 Amazon’s online model provides for basic but powerful advantages over a traditional retailer like Walmart and we believe two will drive performance in the next decade. First, while both organizations face a global execution challenge, Amazon is better positioned and organized for success. Their online model with third party marketplace enables them to partner globally with any vendor and any local logistics company and leverage their brand and first class customer service to grow their business. It’s unlikely Walmart can execute a similar global strategy given their current capabilities. Second, Amazon’s online model provides the framework to create a virtuous network effect. A new customer for Amazon generates a larger incremental benefit than a new customer at Walmart, as their products and services are integrated underneath one customer-centric mission umbrella. For Walmart to be successful in challenging Amazon they must surround the customer the way Amazon has. A single Amazon customer can run their small business through AWS, game on Twitch, store their music on Amazon Cloud and last minute shop on Christmas Eve. Currently, Walmart.com offers low prices on products with in- store pick-up. The two companies aren’t in different leagues in e-commerce, they are playing different games. When we step back and review the dynamic capabilities of both organizations, it is important to consider the external environment. The strength of Amazon is that it is relentlessly searching the external environment for opportunities to deploy its core competencies on behalf of the consumer which better positions it for growth independent of the evolution of the external environment during the next decade. Page | 5 CUSTOMER EXPERIENCE Amazon has developed a significant lead in delivering a world class customer experience. This first mover advantage is more likely to be enhanced and expanded than relinquished during our investment window. One need look no further than Craig’s List as proof that the consumption experience has dramatically changed. To grow share in a crowded retail market corporations must differentiate themselves; and in a world of unlimited choice, customer experience (CX) is becoming the deciding factor driving where individuals spend their dollars. CX is the interaction between an organization and a customer over the duration of a relationship and includes the customer's attraction, awareness, discovery, cultivation, advocacy and purchase and use of a service or product 4. ForeSee, a specialist in CX analytics, produced a survey in 2013 which generated an experience index. Of 100 corporations Amazon scored 1 st , Walmart 97 th . Within retail and apparel brands AMZN was 1 st , Walmart 21 st (last). 5 The ideal CX in consumer retail is easy, provides choice, is convenient and anticipates customer needs. Both Walmart and Amazon have utilized their core competencies to provide a unique customer experience betting their investments will protect their competitive advantage. The question is which CX will “win” the next decade. As a function of their mission statement, Walmart bet correctly that consumers would value the opportunity to one-stop shop at the lowest prices. They delivered by developing core competencies in logistics and the utilization of technology to enhance operational efficiencies.