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Amazon.com. cuddle up with a DCF model critically evaluate a valuation model what is the analyst assuming about profitability, efficiency and leverage? are the pieces put together in a logical way? consider the option value of owning a share of AMZN

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amazon com
Amazon.com
  • cuddle up with a DCF model
  • critically evaluate a valuation model
    • what is the analyst assuming about profitability, efficiency and leverage?
    • are the pieces put together in a logical way?
  • consider the option value of owning a share of AMZN
  • how to adjust the value estimate for employee stock options
why is the default valuation of amzn negative
Why is the default valuation of AMZN negative?
  • ROE is HUGE positive amount. Why?
  • Why can’t the stock price be negative?
hitting the analyst forecasts clean up the financial statements
Hitting the analyst forecasts -clean up the financial statements
  • Restate financials in 2000 by moving 84460 of depreciation out of SG&A and into depreciation. Makes EBITDA really before DA!
slide6

Income Statement AssumptionsSales Revenue Growth Rate

Per analyst model, 24% in 2001, constant at 25%through 2010, and terminal growth rate (beyond 2010) of 7%.

…Is this reasonable?

income statement assumptions ebitda margin
Income Statement AssumptionsEBITDA margin
  • EBITDA = “earnings before interest, taxes, depreciation and amortization”

= gross margin – R&D – SG&A

  • keep CGS/Sales at constant 76.3% and adjust SG&A/Sales to hit EBITDA margins
    • SG&A/Sales is 9.7% in terminal period
    • EBITDA margin improves from -8% to 14%
income statement assumptions depreciation and amortization just a stop on the way to capx
Income Statement AssumptionsDepreciation and Amortization(just a stop on the way to CapX)
  • goodwill and intangibles written off in 2001
  • 2000 depreciation ratio = 84460/(317613+366416)/2 = 25%
    • implies that the useful life of fixed assets is between 4 years and 8 years.
  • hold constant
income statement assumptions non operating income interest and taxes
Income Statement Assumptionsnon-operating income, interest and taxes
  • Set non-operating income to –12% in 2001 to write off Investments, Intangibles and Other Assets (total is $407624)
  • set interest rate to 7.75% to value debt approximately at its book value
  • enter tax rates as given (although taxes are not, generally, expressed as a % of EBITDA, as in analyst report)
balance sheet assumptions cash
balance sheet assumptionscash
  • what does the analyst report assume about cash?
  • set operating cash to 0% for all future periods
    • what is the valuation implication of doing this?
balance sheet assumptions working capital
balance sheet assumptionsworking capital
  • what does analyst model assume?
  • adjusted Other Current Liabilities to hit WC assumptions (shown on FCF computations on Cash Analysis sheet)
  • in 2001 decrease in WC is 1220837 (=1100522 cash liquidation plus 120315 WC reduction in analyst report)
  • WC turnover ratio goes from +8 to -8.
balance sheet assumptions pp e
balance sheet assumptionsPP&E
  • PPE end = PPE beg +capX– depreciation
    • can forecast depreciation and PPE (as % of sales), so two degrees of freedom to get to capX
    • forecast fixed depreciation at 25% and adjust the PPE/Sales ratio to get capX on SCF
    • should you forecast CapX/Sales or PPE/Sales?
balance sheet assumptions leverage
balance sheet assumptionsleverage
  • nothing in analyst report about leverage
    • what is the present value implications of future debt issued at its cost of capital?
  • leave debt at approx. 100% of assets
  • OR trend from 100% of total assets to 50%
    • very little impact on valuation, unless….
valuation assumptions
valuation assumptions
  • set cost of equity capital to 22.6 so that WACC is 20%.
  • set valuation date to 6/30/2001
  • change # of shares to 370,000K to match analysts’ # of shares.
  • P = $15
  • But check out ratios!
option value for amzn
option value for AMZN
  • 1/3 chance EBITDA/Sales is .20 higher
    • P = $ 41.03
  • 1/3 chance that EBITDA/Sales is as forecast
    • P = $ 15.00
  • 1/3 chance that EBITDA/Sales is .20 lower
    • P = $-11.13
  • value = (41.03)/3 + (15.00)/3 + (0.00)/3 = $18.68
  • OR value = (41.03)/100 + (15.00)10/100 + (0.00)89/100 =$1.91
amzn what happened
AMZN – what happened

excluding cash liquidation

key takeaways from amzn
Key takeaways from AMZN
  • ALWAYS forecast complete income statements and balance sheets in order to arrive at free cash flow forecasts.
  • Always conduct a ratio analysis on your forecast financial statements to check they are plausible.
  • When a firm is in financial distress the equity has option value!
new accounting for stock options
new accounting for stock options
  • value option at grant date and record

compensation expense 100

PIC – options 100

  • at exercise

cash 50

PIC – options 100

PIC – regular150

  • if not exercised

do nothing

amzn option income effects
AMZN option income effects
  • Years Ended December 31,
  • 2003 2002 2001
  • --------- ---------- ----------
  • Net income (loss)-as reported $ 35,282 $ (149,132 ) $ (567,277 )
  • Add: Stock-based 87,751 68,927 4,637
  • compensation, as reported
  • Deduct: Total stock-based (94,525 ) (148,083 ) (400,445 )
  • compensation determined under
  • fair value based method for
  • all awards
  • - ------- - - -------- - - -------- -
  • Net income (loss)-SFAS No. $ 28,508 $ (228,288 ) $ (963,085 )
  • 123 adjusted
  • - ------- - - -------- - - -------- -
  • Basic earnings (loss) per $ 0.09 $ (0.39 ) $ (1.56 )
  • share-as reported
  • Diluted earnings (loss) per $ 0.08 $ (0.39 ) $ (1.56 )
  • share-as reported
  • Basic and diluted earnings $ 0.07 $ (0.60 ) $ (2.64 )
  • (loss) per share-SFAS No. 123
  • adjusted

For S&P 500, expensing options would lower EPS by 20% in 2001. (Bear Stearns)

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