Equity Research Consumer | E-commerce November 16, 2016 Ryan Domyancic +1 312 364 5412 Update Report (16-098) [email protected] Bhavan Suri +1 312 364 5341 Amazon.com, Inc. [email protected] Comprehensive Pricing Survey Underscores the Value of Prime Stock Rating: Outperform Company Proile: Aggressive Growth We randomly selected 100 items from 32 retailers to compare their in-store assort- ment and pricing with Amazon. We concluded that Amazon’s assortment remains Symbol: AMZN (NASDAQ) strong, the Prime eligible selection has increased signiicantly since 2014, and its Price: $719.07 (52-Wk.: $474–$847) Prime eligible selection is priced at a discount to brick-and-mortar retailers. Market Value (bil.): $347 Long-Term EPS Growth Rate: 20% Prime eligible selection priced at a 4% discount to physical retailer locations. Dividend/Yield: None Our 2016 pricing survey found items sold by Amazon or by third-party sellers that Fiscal Year End: December utilized Fulillment by Amazon (FBA) were priced at a 4% discount to identical items in physical retail locations. For our comparison, we did not include shipping cost, because Prime eligible items ship for free as part of Amazon’s Prime program Estimates 2015A 2016E 2017E or if the order value exceeds $49. Revenue (bil.) $107 $137 $168 EBITDA (bil.) $10.8 $15.3 $21.3 Majority of Prime eligible overlapping items were same price or less expensive EPS $1.25 $4.88 $9.37 than physical retail locations. For Prime members and order values that exceed the $49 free shipping threshold, we found that 67% of Prime eligible overlapping Valuation items were the same price or less expensive on Amazon versus retail stores. For EV/Revenue 3.2x 2.5x 2.1x items that have a retail price greater than $25, we found 77% of Prime eligible items EV/EBITDA 32.1x 22.7x 16.2x were the same price or less expensive on Amazon. P/E NM NM 82.1x Amazon’s item overlap reached 46% in our 2016 survey. Identical item overlap Trading Data with retailers in our study increased to 46%, up from 44% in 2013 and 2014. We Shares Outstanding (mil.) 485 excluded Prime Pantry products from our overlap; if included, Amazon’s overlap Float (mil.) 390 would have been about 2 percentage points higher in 2016. Average Daily Volume 4,457,333 Prime eligible overlap increases 50%. Our survey found that 31% of products Financial Data in retail stores were Prime eligible on Amazon, up from 20% in 2014. First-party Market Value (bil.) $349 and third-party FBA items were both proportionately responsible for the increase. Total Debt (bil.) $16 Cash and Cash Equivalents (bil.) $18 Reiterate Outperform rating on Amazon. We reiterate our Outperform rating on Enterprise Value (bil.) $347 Amazon. Our survey demonstrates that Prime item selection has grown considerably and the majority of Prime eligible overlapping items on Amazon are less expensive versus retail stores. We expect the Prime program to drive strong unit growth as Prime membership increases and Prime member order frequency increases. Amazon is one of the largest global e-commerce companies and provides businesses cloud computing services. Please refer to important disclosures on pages 63, 64, and 65. Analyst certifi cation is on page 63. William Blair or an affi liate does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the fi rm may have a confl ict of interest that could affect the objectiv- ity of this report. Investors should consider this report as a single factor in making an investment decision. William Blair Contents Report Summary and Conclusions ....................................................................................3 Survey Process Overview ..................................................................................................6 Analyzing Amazon’s Selection ...........................................................................................7 Analyzing Amazon’s Prices ..............................................................................................12 First-Party Gross Margin Expanding Despite Competitive Prices ..................................16 Retail Website Offering Versus Brick-and-Mortar Store ................................................16 Screening Retailers’ “Amazon Risk” ................................................................................18 Changes in Overlap by Retailer .......................................................................................22 Assessment of Retailers’ Risk by Retail Segment ...........................................................23 Appendix A .......................................................................................................................24 Appendix B .......................................................................................................................31 2 Ryan Domyancic, CFA +1 312 364 5412 William Blair Report Summary and Conclusions This report, along with overlap data from similar reports published in 2012, 2013, and 2014, compares the product assortment and pricing of leading U.S. hardlines retailers, mass-merchants, drugstores, and specialty retailers with that available at Amazon.com. Our research objective was to evaluate the consumer value proposition of Amazon’s e-commerce offering by extensively surveying its relative price and selection. Using this data, we were also able to evaluate which retailers face a relatively higher risk of disruption by Amazon. For this study, we randomly selected 100 items from 32 retailers’ in-store assortment (3,200 total store items) and compared the product selection and pricing with that of Amazon. Combined with select data from previously published reports, our data set contains nearly 12,000 SKUs for overlap comparisons and 3,200 SKUs for pricing comparisons. Key Conclusions for Amazon.com • Identical item overlap increased to 46%, with largest increases at $200-plus price point. Our study revealed that Amazon has 46% of the items (1,464 of 3,200) found at surveyed retail stores, up from 44% in 2014. Overlap for items $200 or more increased considerably, reaching 67% in 2016 (190 of 283 items), up from 52% in 2014 (122 of 235 items). For supporting details about overlap, see the section titled Analyzing Amazon’s Selection, on pages 7-11. • Prime eligible overlapping items increased 50% from 2014. We found that 31% of surveyed retail items were Prime eligible on Amazon, a signiicant increase from 20% in 2014. First-party and third-party FBA items each accounted for about 5 percentage points of the increase. Exhibit 3, on page 7, summarizes item overlap across Amazon’s three seller types. • Prime eligible items priced 4% below physical retail locations. Our pricing survey found that prices on Prime eligible items were 4% lower, on average, than the prices offered in physical retail locations. For supporting details about pricing, see the section titled Analyzing Amazon’s Prices, on pages 12-15. – For third-party items fulilled by the seller (non-FBA), which accounted for 15 percentage points of the 46% overlap, prices were 10% higher than prices offered in physical retail locations. For this comparison, we used a landed cost (which includes applicable shipping) because consumers cannot qualify for free shipping. – Combining all three seller types, prices on Amazon were 2% higher than physical retail locations, on average. The slight premium is driven by third-party non-FBA sellers. For our survey, we matched identical items. For most items, we suspect a consumer could ind a comparable (but not identical) irst-party or third-party FBA product to purchase rather than a third-party non-FBA product that is slightly more expensive. – We suspect that items sold on a irst-party and third-party FBA basis were more in line with ofline retailers as sellers compete for the buy box, or default seller position, on Prime items. – In addition, we believe irst-party and third-party FBA items are sold more frequently than third-party items. An Amazon survey found that more than 71% of FBA seller respondents reported their unit sales increased by more than 20% on Amazon since joining FBA; when a seller joins FBA their wares become eligible for Prime and super saver shipping. Therefore, we believe investors should focus more on the pricing comparisons with Prime eligible products rather than all products. Bhavan Suri +1 312 364 5314 3 William Blair • We believe ϔirst-party gross margin continues to expand despite low prices. While we acknowledge that there are a lot of assumptions, we believe Amazon’s gross margin from irst-party product sales steadily increased from 2013 through 2015. We believe Amazon has managed to expand margins by driving more volume through its fulillment infrastructure. Further, as Amazon becomes a bigger customer of both product and shipping vendors, it could be beneiting from more favorable pricing terms. Our gross margin framework is on page 16. • Reiterate Outperform rating on Amazon. We continue to believe that Amazon’s cloud com- puting business and retail business are addressing large markets, and we expect each will continue to grow as its addressable market expands. Further, as addressed in this report, we found that items sold on a irst-party basis and by third-party sellers that utilized FBA (Prime eligible selection) are priced at a discount to brick-and-mortar retailers. As more consumers join Prime, and ind Amazon’s Prime eligible selection is priced at a discount to brick-and- mortar retailers,