1 Equity Mkt. Cap. $25BNet LT Debt./Mkt. Cap. 0.1% Total EV $19B 10 Yr. Treasury 2.8% ‘08 FCF Yield 4.0% Financial Statistics EPS P/E 2006A $0.45 111x 2007A $1.12 42x 2008A $1.52 33x 2009E $1.42 35x EPS FCF/ShareP/FCF 2006A $1.00 98x 2007A $2.10 78x 2008A $1.38 36x 2009E $1.50 33x Free Cash Flow April 8, 2008Brian Bolan(312) 345-1534 [email protected]Important disclosures appear on the inside cover and back of this publication. Amazon.Com Inc. (NASDAQ: AMZN ) Long T erm Rating: Market Underperform Long T erm Target Price: $60 Mid-Atlantic Institutional Research EXECUTIVE SUMMARY . Investment Summary: Amazon.com performed very well in 4Q08 despite very challenging macro environment conditi ons. After hitting the nail on the head last quarte r, we moved to a more cau- tious stance for our revenue es timates. Operating expenses cont inue to be a priority for t he com- pany but will not likely be the source of any outperformance in the quarter. We believed that weakguidance and disappointing m argins would keep buyers on the sidelines, but we were wrong. We are maintaining our rati ng of Market Underperform and increasing our target pric e to $60. Key Points Revenue in line with our aggressive expectations. For 4Q08 we had projected $7.032B on the topline and after adding back the negative impact of foreign exchange the company would have reported sales of $7.024. For the first quarter, we are project ing revenues of $4.7B.Potential for outperformance in the quarter is coming margins, not cost containment. We were impressed by the discipline the company showed in 4Q08, as every line item of op- erating expense ca me in below our estim ate. In 1Q09 we are expecting costs to be more i n line with expectations and any outperformance to come from the gross margin line. Weak gross margins were a non factor as market looked to market share gains. Gross margins came in about 30 basis points below our estimate of 20.42%, down from a 23.4% level in the previ ous quarter. For 1Q09 we have modeled in gross margi ns of 22%, down over 100 basis points from la st year, but up significantly from a discou nt heavy 4Q08. The general belief was the lower gross margins allowed the company to expand its market share. Outlook is challenging and margins show small chances of growth. Recent economic con- ditions have taken a t oll on Amazon.com’s competitors. We believe that Am azon.com will gain market share from many smaller competitors as well as its main competitors throughout 2009. Our target price has increased t o $60, a 33% increase from the beginnin g of the quarter. The stock has increased 43% since the beginning of the quarter, and may be trading more on momentum than fundament als. Increasing our EPS estima te from $1.42 to $1.50 and renewed expectations of higher margins helped push our multiple to 40x 2009 earnings estimate. • “4Q08 Earnings updateSource: BigCharts, Company Reports and Sturdivant & Co. Estimates. Relative Daily Price 1/30/09Price 1/30 $50.00 52 Wk Lo-Hi $34.68-91.75 Div Yield - Avg. Volume 10M Insiders Own 34% S&P 500 845.14 Share Information
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Important disclosures appear on the inside cover and back of this publication.
Amazon.Com Inc. (NASDAQ: AMZN )
Long Term Rating: Market UnderperformLong Term Target Price: $60
Mid-Atlantic Institutional Research
EXECUTIVE SUMMARY
. Investment Summary: Amazon.com performed very well in 4Q08 despite very challenging macroenvironment conditions. After hitting the nail on the head last quarter, we moved to a more cau-tious stance for our revenue estimates. Operating expenses continue to be a priority for the com-
pany but will not likely be the source of any outperformance in the quarter. We believed that weak guidance and disappointing margins would keep buyers on the sidelines, but we were wrong. Weare maintaining our rating of Market Underperform and increasing our target price to $60.
Key Points
Revenue in line with our aggressive expectations. For 4Q08 we had projected $7.032B onthe topline and after adding back the negative impact of foreign exchange the company wouldhave reported sales of $7.024. For the first quarter, we are projecting revenues of $4.7B.
Potential for outperformance in the quarter is coming margins, not cost containment.
We were impressed by the discipline the company showed in 4Q08, as every line item of op-erating expense came in below our estimate. In 1Q09 we are expecting costs to be more inline with expectations and any outperformance to come from the gross margin line.
Weak gross margins were a non factor as market looked to market share gains. Grossmargins came in about 30 basis points below our estimate of 20.42%, down from a 23.4%level in the previous quarter. For 1Q09 we have modeled in gross margins of 22%, downover 100 basis points from last year, but up significantly from a discount heavy 4Q08. Thegeneral belief was the lower gross margins allowed the company to expand its market share.
Outlook is challenging and margins show small chances of growth. Recent economic con-ditions have taken a toll on Amazon.com’s competitors. We believe that Amazon.com willgain market share from many smaller competitors as well as its main competitors throughout2009. Our target price has increased to $60, a 33% increase from the beginning of the quarter.The stock has increased 43% since the beginning of the quarter, and may be trading more onmomentum than fundamentals. Increasing our EPS estimate from $1.42 to $1.50 and renewed
expectations of higher margins helped push our multiple to 40x 2009 earnings estimate.•
“4Q08 Earnings update
Source: BigCharts, CompanyReports and Sturdivant & Co. Estim
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Analyst compensation is based on: (1) the analyst’s productivity, including the quality of the analyst’s research and the analyst’s contribution to the growth and development of ouroverall research effort; (2) ratings and direct feedback from our investing clients, our sales force and from independent rating services. Sturdivant & Co.’s Compliance and Re-search Departments are responsible for establishing these compensation guidelines and for reviewing and approving senior analyst compensation. Analyst contribution to our
investment banking business is not a factor in determining analyst compensation and compensation is not, directly or indirectly, related to the specific recommendations or viewsexpressed in the report.Research Analyst Certification
The senior research analyst(s) certifies that the views expressed in this research report and/or financial model accurately reflect such senior analyst's personal views about thesubject securities or issuers and that no part of his or her compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in theresearch report. Mr. Bolan does owns shares of Amazon. This is not a complete analysis of every material fact regarding any company, industry or security. The opinions ex-pressed here reflect our judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot guarantee theaccuracy. The Dow Jones Industrial Average, S&P 500, S&P 400 and Russell 2000 are examples of unmanaged common stock indices used to measure and report performance of various sectors of the stock market; direct investment in indices is not avai lable. A complete listing of all companies covered by Sturdivant & Co., Inc. and applicable researchdisclosures can be obtained from the Company. Price Target Risks
Investment risks associated with the achievement of the price target include, but are not limited to, the company’s failure to achieve our earnings and revenue estimates, unforeseenmacroeconomic and/or industry events that adversely impact demand for the company’s products or services, product obsolescence, changes in investor sentiment regarding thespecific company or industry, intense and rapidly changing competitive pressures, the continuing development of industry standards, the company’s ability to compete for talent,and adverse market conditions. For a complete discussion of the risk factors that could affect the market price of the company’s shares, refer to the most recent form 10-Q or 10-Kthat the company has filed with the SEC.
Source: BigCharts.com
RELATIVE STOCK PRICE PERFORMANCE
Rating and Price Target History for Amazon (AMZN )
Last quarter we projected revenues of $7.032B, which were high by a mere $8M after adjusting forcurrency. This quarter we expect Amazon to post revenues of $4.7B along with some improvement in
gross margins, as the company likely gained market share from offline competitors. We also took alook at the rest of the year and adjusted many of our numbers due to the recent strength in traffic andexpected contribution from MP3 downloads and the Kindle.
Our expectations for gross margins have improved, and we even believe there is upside to our 22%estimate. In the first quarter of 2008, Amazon reported 23.12% gross margin. We do not believe thatthe company will be able to achieve that level again this year.
Following a quarter that saw Amazon report lower than expected costs, we selectively trimmed someoperational expense line items. Going forward, we expect marketing to transition to include some pay-per-click (PPC) advertising. The recent changes in the affiliate program suggest that Amazon will
likely do its own direct to the merchant PPC ads which will be a savings on gross margin line but willbe offset by an increase to the marketing line item.
An upward trending stock may have benefitted from some of the $900M remaining in the stock buyback program, but it is unlikely that the company repurchased a significant amount of shares. Lastquarter, the company repurchased 2.2M shares at an average price of about $45. We expect the sharecount to hold steady at 436M.
Kindle continues to grab attention
The Kindle continues to be a source of upside for the company. Supply restraints helped ignite awildfire of hype as demand far outweighed supply. We have noticed that the Kindle is consistently atthe top of the bestsellers list for the electronics segment. We also believe that sales of the Kindle haveboosted and will continue to act as a tailwind for the sale of digital books. The company does not break out the sales of digital books, but we believe management will make positive comments pertaining tothe growth of sales of digital books.
Looking ahead, the sale of digital books could be the single highest driver of gross margin for thecompany. While we have been disappointed over the last several years with little to no marginexpansion, we now believe that Kindle is the light at the end of that particular tunnel. Consumers are just starting to embrace the Kindle and its adoption rates are encouraging.
We believe that the company could sell as many as 500K-750K Kindles by the end of the year, whichwill likely lead to a halo effect for the sales of digital books.
At the end of the year Amazon.com had $3.73B in cash, an increase of $615M from the prior quarter.The company has $468M in debt. Inventory increased 17% to $1.4B and turns were down by one half turn to 12.2 as the company moved to increase selection. Accounts payable increased 29% to $3.59Band payable days increased to 62 from 57 in the year ago period. Payables tend to increase in the firstquarter as the company pays off suppliers from the forth quarter and Holiday season.
Guidance
Amazon.com gave guidance of $4.525B—$4.925B for the topline, in line with our $4.7B estimate.Operating income guidance of $243M (midpoint) implies 5.1% margin, down 110 basis points fromthe year ago period.
Valuation
Posting a solid quarter in a very difficult macro environment denotes the impressive execution andsubsequent market share gains the company is seeing. Previous concerns that technology services werenot being well received by enterprises seems to be abating and could drive outperformance throughout2009. We also see the Kindle as having a break out year in the back half of the year.
FX had a significant negative impact last quarter. We believe that 1Q09 will not have as severe animpact but will still be subject to large swings in currency valuations. We tend to look at the broaderpicture and with 15% of estimated growth coming from international, we believe that currency willagain hurt revenue.
The basis of our recommendation was weakened by the performance in 4Q08. Gains in market shareand outperformance by the technology segment deserves a premium valuation. Fulfillment by Amazonand the increase in active users suggests that Amazon.com is widening the gap between itself and eBay.We believe that 1Q09 will show more gains in market share from smaller competitors.
We were hesitant to remove our Market Underperform rating on shares of Amazon due to the weak operating income guidance and the weaker than expected gross margins. The rest of the market,however, was not as hesitant to reward Amazon for the share gains it took and the gains it expected.Starting the quarter at $51.28, the stock zoomed higher after its earnings announcement on 1/29/09 androde that wave to end the quarter at $73.44. This translates to a 43.2% increase in the quarter.
We are increasing our target price due the positives in the quarter, not the least of which include sharegains, increase in active users and future potential of the Kindle. Our new target price of $60 is basedon a multiple of 40x our 2009 estimate of $1.50. A $15 (33%) increase to our price target is attemptingto keep pace with a stock that has renewed momentum interests and may no longer be trading solely off fundamentals. Keep in mind that management bought 2.2M shares for $45 in 4Q08, a level which isdramatically below present levels.
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