Valuation of Amazon Inc. as a high-growth company

McKinsey Valuation of Companies (Amazon Inc.)
Selection of Company & Firm-Specific Information
The three classifications of companies given include emerging markets, high-growth companies and cyclical companies. The group selected is the high-growth company. In delineation, high growth companies allude to those that perform better or are anticipated to perform better compared to their industry of operation or the market in its entirety (Ang and Chng, 2013). High-growth companies encompass firms that generate a return on equity that is higher than 15 percent. More often than not, the stocks in these corporations usually pay minimal dividends owing to the reason that they opt to reinvest the earnings generated (Ang and Chng, 2013). In addition, such high-growth companies have a preference of investing their earnings into research and development of products. These corporations are mostly riskier as compared to other kinds of corporations, but their stocks offer the opportunity to generate high returns. Imperatively, these returns come about in terms of capital gains instead of dividends (Thomson, 2010).
A high-growth is a company whose business results in significant positive cash flows or earnings, which rise at substantially faster or quicker rates compared to the economy as a whole. These corporations have a tendency to have largely profitable reinvestment prospects for their own retained earnings. Therefore, the main objective is to recompense minimal dividends or no dividends at all to its stockholders and rather opt to place majority or all of its profits into expansion of the business operation. Growth companies generate value by continuing to develop above-average earnings, free cash flow, and placing expenditures on research and development. Growth investors are less concerned regarding the dividend growth, and financial ratios such as high price-to-earnings ratios and high price-to-book ratios that growth corporations experience owing to the reason that the emphasis is on sales growth and upholding industry leadership. Generally, growth stocks recompense lesser dividends as compared to value stocks for the reason that profits are reinvested in the business to drive earnings growth (Chen, 2018).
The high-growth company selected for this analysis is Amazon. Amazon has become the biggest retailer in the United States evolving from brand experiments in outdoor furniture in over a decade ago, home merchandise, electronic appliances, diapers, and presently delving into perishables. Remarkably, Amazon is one of the most innovative corporations in the world in the present day. According to Lidsky (2018), the company is adding muscles in areas and fields that people did not even know the company had muscles. Amazon has become the second biggest retailer of apparel in the United States evolving from brand experiments in outdoor furniture in over a decade ago, home merchandise, electronic appliances, diapers, and presently delving into perishables. Moreover, another competitive edge of the company, especially over major corporations such as Apple and Google, Amazon is not obsessed or engrossed in a stringently designed ecosystem of intertwining and linking apps and services. Rather, the company lays emphasis on platforms on which every one of them provides services to its individual set of consumers in the most ideal and efficacious way possible. One of the main business strategies that Amazon has undertaken to facilitate its enormous success is the level of innovation and diversification in different areas of business. The significant growth that Amazon has experienced in Bezos’ leadership is associated to his capability of envisioning, inspiring and innovating even in periods and spells when others failed to believe and have conviction in his vision. Bezos has incessantly ensured that consumers are satisfied at all times and has also inspired and encouraged employees within the organization to believe in his vision through creative and innovative products and service. Consequently, Amazon has experienced significant growth and is one of the major companies in the U.S and also in the world in the present day (de Andres, 2017).
From its modest initial stages as an online book retailer, Amazon presently dominates the online retail industry. In addition, the corporation is a huge cloud services provider, a key player in the movie and content streaming sector and is anticipated to be a key player in the healthcare industry as well (Ciura, 2018). Amazon has experienced significant growth in the past years and reported profitability consecutively. In particular, the company reported sales figures that grew by $15 billion year after year, beating its peers and market rivals by a significantly huge margin. In the past year, Amazon surpassed the $1 trillion mark in terms of market capitalization. However, akin to high-growth companies, Amazon continues to make an investment in its growth and facilitate its online retail platform and therefore has yet to pay a dividend to its shareholders (Forbes, 2018).
Research Problems
There is minimal doubt that valuing a corporation is more often than not a complex task. To some extent, this complexity is owing to the fact that corporate evaluation is subjective. The basic actuality is that the value of a usually left to the discretion of the individual undertaking the evaluation. In addition, another issue that compounds the intricacy is the fact that the individual undertaking the valuation has no other option but to make suppositions regarding whether all of the information provided is, in fact, correct and accurate. These sorts of assumptions usually give rise to information and figures that might be imprecise and therefore bring about incorrect results. Valuation of high-growth, high-uncertainty corporations such as Amazon is a significant challenge. In fact, a number of experts have considered this process of valuation to be hopeless. Nonetheless, Koller, Goedhart, and Wessels (2010) have come up with valuation principles that are sensible and effective with regard to high-growth companies. The main objective of this research study is to conduct a valuation of Amazon Inc. for the forthcoming financial years.
Methodology
According to Koller Goedhart and Wessels (2010), the McKinsey Frameworks for Valuation can take up two ways including the enterprise discounted cash flow and the discounted economic profit approaches. Enterprise DCF continues to be a preferred choice for specialists and scholars for the reason that it only depends on the flow of cash in and out of the corporation, instead of on accounting-based earnings. On the other hand, the discounted economic-profit valuation model is attaining progressively more admiration owing to its close ties to economic theory and competitive strategy. In delineation, economic profit points out whether a corporation is netting its cost of capital and the manner in which its financial performance is anticipated to change in the course of time. Bearing in mind that Amazon is a high growth company and with a high debt ratio, the authors suggest alternative to WACC-based models, which is the adjusted present value (APV). In particular, this approach estimates and values any cash flows linked with capital structure independently, instead of entrenching their value in the cost of capital.
The most ideal methodology of valuing high-growth companies, that is, the corporations with organic revenue growth that surpasses 15 percent every year, is through a discounted cash flow (DCF) valuation, supported by economic basics and probability-weighted scenarios. In spite of the fact that this approach might seem questionably out-dated, it is functional and effective where other methodologies fail, owing to the reason that the fundamental principles of economics and finance are applicable even in the obscure areas (Koller, Goedhart, and Wessels, 2010). Substitute methods like the price-earnings multiples give rise to incorrect findings when the earnings are largely volatile, cannot be employed when there are negative earnings and give minimal understanding into what impels the valuation of the company. These approaches are unable to account for the distinctive features of every corporation in a fast-changing setting (Koller, Goedhart, and Wessels, 2010). Discounted cash flow (DCF) is an approach for valuation that is employed in the estimation of the value of an investment on the basis of its future cash flows. This approach has its basis in the present value rule, in that the value of any asset is equivalent to the present value of expected future cash flows on it. Imperatively, the cash flows are expected to vary and fluctuate from one asset or product to another. The discount rate encompasses a function of the riskiness of the approximated cash flows, with greater rates for assets that are riskier and lower rates for projects that are deemed considerably safer.
Unlike other companies, the valuation for high-growth companies is considerably different. More often than not, when conducting the valuation on established corporation, the initial phase encompasses analyzing the historical performance. Nonetheless, in regard to a high-growth company, these historical financial outcomes offer confined indications regarding future opportunities. As a result, the ideal approach is to start with the future and not with the past. The first step of the valuation of high-growth companies is to consider what the industry and corporation might appear or be as the corporation evolves from the prevailing high-growth, unclear condition to a sustainable, and moderate-growth position in the forthcoming periods. Thereafter, interpolation is undertaken back to the current performance. Imperatively, the future state ought to be delineated and confined by measures of operating performance, for instance penetration rates, average revenue generated per consumer and sustainable gross margins. Subsequently, an attempt is made to ascertain how long the hyper growth will prevail before there is stability in growth to normal levels (Koller, Goedhart, and Wessels, 2010).
The second phase encompasses laying emphasis on sizing the potential market, forecasting the level of sustainable profitability, and approximating the investments essential to accomplish scale. In accordance to Koller, Goedhart, and Wessels (2010), to make these approximations, it is necessary to select a point that is well into the future period of the company, a period when the corporation’s financial performance is probably bound to stabilize and then start forecasting. Subsequent to developing a long-standing future perspective, the next stage is to work backward and tie the future performance to the current performance. Accounting records of present-day performance are possible to blend together investments and expenses, therefore when conceivable, it is imperative to make the most of unseen investments, even those expensed under customary accounting rules. This is a daunting task, as the distinction between investment and expense is usually unobservable and subjective (Koller, Goedhart, and Wessels, 2010).
Taking into consideration the ambiguity that is linked with high-growth companies, it is imperative not to depend on a single long-standing projection. Therefore, this approach delineates the market’s development in regard to several scenarios. In this case, all of the forecasts made including revenue growth, profitability margins, and required investment will be in line with the fundamental suppositions of the scenarios taken into consideration. Thereafter, probabilistic weights will be applied to every scenario, making use of weights that are in tandem with long-term historical evidence on the growth of the company (Koller, Goedhart, and Wessels, 2010).
Data Analysis
Amazon has experienced gradual growth in revenue over the past 14 years. As illustrated in the diagram below, the revenues for the company increased from $6.92 billion in 2004 to $232.89 billion in 2018. This indicates the high-growth rate of the company over the years.

To show the specifics of the valuation process, between 2012 and 2018, revenues for Amazon increased from $61.09 billion to $232.89 billion, representing a compounded annual growth rate of 79 percent per year.

In accordance to the internal classification, Amazon’s revenue structure is categorized into three different segments including: Amazon Web Services, North America and International.

As illustrated in the chart above, 9 percent of the revenue generated by the company emanates from Amazon Web Structure (AWS), 32 percent comes from its international business operations whereas majority of revenues, 59 percent comes from the North American region (Seeking Alpha, 2017).
To approximate the size of a potential market, it is imperative to begin by conducting an assessment of the manner in which the corporation satisfies a customer need. Thereafter, it is ascertained how the corporation creates revenue (Koller, Goedhart, and Wessels, 2010). In the case of Amazon, the corporation provides the end consumer with retailing services and cloud computing services. Amazon is the largest online retailer in the world and the biggest one in terms of market capitalization. Whereas the core business model of the company is centered on its online store, they also unveiled physical stores, which brought in a reported revenue amount of more than $5 billion in 2017 (Desjardins, 2017). Subscription services through Amazon Prime also play a key role in the general business model of Amazon, owing to the reason that it provides content to consumers prompting them to spend more and become more loyal to the company. Lastly, there is AWS, where Amazon is a global leader and generates high margins. Furthermore, Amazon provides consumers with advertisement services. In overall, the company measures its success levels through a consumer experience obsession, decreasing prices, stable tech infrastructure and free cash flow generation (Desjardins, 2017).

 
2016 Revenue U.S Billions

Amazon Web Services
12.20

Retail third-party sellers
23

Retail products
91.4

Amazon prime and other subscriptions
6.4

Other (includes ad services and co-branded credit card agreements)
3


136.00




Hastening cloud adoption will drive growth in the public cloud services market. It is anticipated that the market will double in revenue by the year 2021 surpassing the $300 billion mark with progressively more companies embracing the cloud movement. Bearing this in mind, it is projected that the global spending on public cloud computing will be experiencing a compounded annual growth of 20 percent in the next 5 years (Market Watch, 2018). Based on these figures, the growth of the Amazon Web Services surpasses the growth of the cloud market in its entirety, and this situation is not expected to change in the forthcoming decade. According to Seeking Alpha (2017), the revenue for Amazon Web Services might get to $100 billion, showing a compounded annual growth rate of 24 percent.
Amazon Web Services
Revenue (million U.S Dollars)

2016
$12,219.00

2017
$17,459.00

2018
$23,395.06

2019
$30,273.21

2020
$38,023.15

2021
$46,654.40

2022
$56,125.25

2023
$66,452.29

2024
$77,682.73

2025
$89,801.24

2026
$102,732.61




Another key revenue driver for Amazon comes from the retail services. In accordance to projections undertaken by Seeking Alpha (2017), the retail e-commerce sales in the United States are expected to grow at a compounded annual growth rate of not greater than 5.7 percent in the forthcoming 10 years. In the past four years or so, the average growth rate of the company’s sales in the North American region has been surpassing the growth rate of e-commerce sales in the United States almost twofold. Making the supposition that Amazon as a company will probably continue its aggressive business policy targeted at dominating the market share, I forecast that the corporation’s revenue in North America will be experiencing a growth of 11 percent compounded annually for the forthcoming 10 years.
Retail e-commerce sales in United States
Billions of Dollars

2015
294.50

2016
322.20

2017
358.70

2018
389.40

2019
425.80

2020
459.20

2021
485.30

2022
505.20

2023
520.40

2024
535.00

2025
547.00

2026
546.00

2027
558.10




Different from the United States market, the international e-commerce market is presently at the stage of exponential growth and therefore it is approximated that the growth rate will get to the 18 percent mark in the next 7 years.
Retail e-commerce sales worldwide
$ Billions

2016
$ 1,859.00

2017
$ 2,290.00

2018
$ 2,274.00

2019
$ 2,753.81

2020
$ 3,282.55

2021
$ 3,856.99

2022
$ 4,458.68

2023
$ 5,114.11

2024
$ 5,809.63

2025
$ 6,547.45

2026
$ 7,333.14

2027
$ 8,213.12




Nonetheless, as pointed out by Koller, Goedhart, and Wessels (2010), when valuating high-growth companies, it is imperative to take into consideration the economic situations. Bearing in mind that in the international market Amazon will be rivaling with other major players such as Alibaba in the Chinese market, I project that the sales growth rate of Amazon’s sales ought to be equivalent to the growth rate of the market as a whole. As a result, my projections are that the compounded annual growth rate of the global segment will be 16.5 percent.
Amazon Revenue International
$ millions

2016
$43,984.00

2017
$54,000.00

2018
$63,592.00

2019
$75,801.66

2020
$89,673.37

2021
$105,276.53

2022
$122,647.16

2023
$141,780.12

2024
$162,054.68

2025
$184,256.17

2026
$208,025.21




By combining these three different financial projections, we obtain a general projection of Amazon’s revenue up until the year 2026.
Year
2018
2019
2020
2021
2022
2023
2024
2025
2026

Amazon Web Series
$0.02
$0.03
$0.04
$0.05
$0.06
$0.07
$0.08
$0.09
$0.10

Retail Sales U.S
$389.40
$425.80
$459.20
$485.30
$505.20
$520.40
$535.00
$547.00
$546.00

Retail Sales International
$0.06
$0.08
$0.09
$0.11
$0.12
$0.14
$0.16
$0.18
$0.21

Total Revenues
$389.49
$425.91
$459.33
$485.45
$505.38
$520.61
$535.24
$547.27
$546.31




Koller, Goedhart, and Wessels (2010) point out that in order to ascertain the rate of transition from the prevailing performance to the future targeted performance, it is imperative to analyze historical advancement for companies that are alike. To determine the speed of transition from current performance to target performance, examine the historical progression for similar companies. Regrettably, examining historical financial performance for high-growth businesses is every so often misrepresentative, for the reason that long-standing investments for high-growth businesses have a tendency to be intangible.
In accordance to Koller, Goedhart, and Wessels (2010) a basic and straightforward approach for coping with uncertainty linked with high-growth companies is making use of probability weighted-scenarios. By basically developing just a small number of scenarios makes the critical suppositions and interactions significantly more transparent as compared to other valuation modeling approaches, for instance real options and Monte Carlo simulation. In order to establish probability-weighted scenarios, this analysis approximates a future set of financials for a wide range of results, with some of these scenarios being optimistic while others being pessimistic. In the case of Amazon, there are three potential scenarios that are established.
In the first scenario, I assume that Amazon progresses and performs financial better than expected. According to market analyses, Soper (2018) points out that projected results indicate that Amazon can grow and develop profitably. The rise of the cloud business, Amazon Web Services, and together with more-lucrative initiatives such as advertising has demonstrated that as the corporation expands it can become more profitable. This scenario assumes that by increasing the subscriber numbers for Amazon Prime, the company can significantly increase the revenues generated and profit margins. The current equity value for Amazon is $804,336 Million. In this scenario, it is projected that the equity value for Amazon is $1,040,000 million.
The second scenario is our base scenario, which is demonstrated in the analyses above. We project the Amazon Web Services revenues to increase from $23,395 million U.S dollars in 2018 to $102,732 million U.S dollars in 2016. We also project the retail e-commerce sales in the United States to increase from $389.4 billion in 2018 to $546 billion in 2026. Third, our base scenario also makes the projection that the international retail e-commerce sales for Amazon will increase from $63,592 million in 2018 to $208,025 in 2026. Bearing this mind, out scenario makes the projection that Amazon’s revenues will significantly increase to $546.31 billion in the year 2026. In this scenario, it is projected that the equity value for Amazon is $820,000 million.
The third scenario makes the supposition that Amazon generates solely $450 billion in the year 2026 owing to a dip in retail sales. As pointed out by the Street (2018), at the start of the 2018 financial year, the company reported $1.9 billion in net income on $51 billion in revenue for the first financial quarter. In spite of there being a profit margin, the indications were poor if the Amazon Web Services and Amazon Prime services are separated from the company’s retail business operation. In doing so, the company’s margins outside of the Amazon Web Services declined to 1 percent. The Street (2018) estimated the overall Amazon business devoid of Amazon Prime and AWS, experienced a loss of $2 billion in the financial quarter. In spite of incorporating the advertisement services of the company, all of this loss emanated from the retail side of the business operation. Remarkably, retail comprises of majority of the revenue, specifically 60 percent. Therefore, this indicated that 60 percent of the business was losing money. Based on this information, our third scenario assumes that the retail side of the business will continue to decline thereby hampering the overall revenues generated. In this scenario, it is projected that the equity value for Amazon is $800,000 million.
Scenario
Intrinsic Equity Valuation
Probability
Contribution to Equity Valuation

Business Expansion – AWS and Amazon Prime
$1,040,000
20%
208

Base Scenario Case
$820,000
50%
410

Retail Sector Fails and Deteriorates in Sales
$780,000
30%
260



100%
878



Conclusion
Amazon has been a remarkable high-growth company in the history of the United States. From the initial phases of the company in solely retailing books to advancing into one of the major corporations in the world today, Amazon has experienced huge financial performances. At the outset of the 2018 financial year, Amazon surpassed the $1 trillion market capitalization mark. What is more, the company was able to report sales figures that increased by $15 billion one year after the other. This paper conducts a market valuation of Amazon using the DCF approach combined with economic basics and probability-weighted scenarios. According to the analyses undertaken, it is projected that the Amazon Web Services revenues to increase from $23,395 million U.S dollars in 2018 to $102,732 million U.S dollars in 2016, the retail e-commerce sales in the United States to increase from $389.4 billion in 2018 to $546 billion in 2026, the international retail e-commerce sales for Amazon will increase from $63,592 million in 2018 to $208,025 in 2026. Finally, the analysis makes the projection that Amazon’s revenues will significantly increase to $546.31 billion in the year 2026.
Sizing the potential market for Amazon Inc. necessitates several inputs, and every one of them is uncertain. Taking this into consideration, minimal inaccuracies in individual forecast items can compound into significant errors in aggregate. Bearing this in mind, checks can be conducted to test these projections. To position Amazon’s revenue growth into perspective, it is imperative to compare such growth with the initial years of revenue growth for similar high-growth companies. Amazon’s high-growth status can be compared with Google, Facebook and Apple. In accordance to CSI Market (2018), Amazon had a revenue growth of 20 percent. This is in line with the revenue rise of similar corporations such as Facebook, which had a revenue growth rate of 30 percent and Google having a growth rate of 22 percent (CSI Market, 2018). The projections given indicate that the revenue for Amazon will increase from $389.49 billion in 2018 to $546.31 billion in 2026. Therefore, the projected increases in revenues for the company are well in line with similar high-growth companies.
From a financial standpoint, a corporation deserves a recommendation to buy of the discounted cash flow analysis undertaken based on the forecasted parameters and suppositions made shows a growth potential. Based on this analysis, I expect Amazon Inc. to experience the solid financial performance it has had in the past number of years.