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The Details Behind Amazon’s Valuation of Zappos

Public filings with the SEC are a wonderful thing.  If you know where to look there is a treasure trove of information.  Amazon’s recently announced acquisition of Zappos is a classic case in point.  Yesterday, Amazon filed an S-4 for the transaction.  The S-4 is basically a proposal by Amazon to Zappos’ shareholders to approve the merger and the exchange of their Zappos stock for Amazon stock.  The document is about 150 pages long but in it you can find:

  • The timeline of Zappos’ discussions with Amazon. It was a 478 day process that began March 3, 2008 and ended on June 27, 2009. (Page 33 background of the merger)
  • The core valuation metrics Morgan Stanley, Zappos’ investment banker, used to determine that Amazon was offering a fair price for Zappos. (Page 38 Opinion of Zappos’ Financial Advisor). It was interesting to note that the primary valuation factors were forward looking EBITDA and price/earnings multiples. These multiples really assess the profitability of Zappos’ business. Zappos’ revenue growth history / potential were not directly considered. Perhaps the fact that Zappos’ revenue growth had declined from 20%+ between 2007 and 2008 to 8.4% for Q1 2009 versus Q1 2008 had something to do with that.
  • The size of the infamous ‘liquidation preference’ (Note 8, Appendix E, page 12). $181 million dollars is a very nice liquidation preference. Liquidation preferences are a standard term in venture capital deals. When a liquidity event occurs, the investors have their initial investment paid off, then they get the value of their liquidation preferences, and then the remaining funds are distributed amongst the shareholders based on their ownership of the company. The net of all this is that in addition to the VCs getting their initial investment back, they received an additional $181 million, in addition to what they will receive for their actual shares.
  • Zappos’ Financial Statements for 2007, 2008, and Q1 2009 (Appendix D & E). Here’s where you can see a fairly detailed set of Income Statements, Balance Sheets, & Cash Flow Statements for Zappos’ business in 2007, 2008, and the first quarter of 2009. I’ve embedded the financial statements as a Slideshare file later in this post.Net net, Zappos ran a very good business. On a relative basis, Zappos had better gross margins and operating profit margins that Amazon. Amazon is about 20 times the size of Zappos. One key fact that was revealed was the actual size of Zappos’ revenues. As a private company, Zappos never had to release audited financial information. Tony Hsieh had commented in a section of Zappos’ website that in 2008 the company had done $1 Billion in revenue. While that may have been Zappos’ gross revenues, the actual net revenues Zappos reported was $635 million. Zappos defines net revenues as “We recognize revenue, net of estimated returns (calculated based on historical experience and current trends), upon delivery of products to customers which is the point at which risk of loss passes to the customers. Revenue from our retail stores is recognized at the point of sale. Revenue for gift certificates is recognized upon redemption of the gift certificates.”

The question at the end of the day is did Zappos make the right decision to sell now and did they receive a fair price?  The answer is clearly yes.  As noted in Zappos’ Reasons for the Merger (page 37), the Zappos team felt that a deal with Amazon now was going to be superior to any other alternative, including an IPO.  When you look at traditional, private equity-oriented valuation metrics, the Zappos deal is well within the range of what an investor would pay today.  Take a look at the following table that summarizes the key metrics for Zappos, Amazon, Ebay, and Blue Nile:

 zappos-valuation-metrics

It’s important to note that in my private equity days I was always trained to value companies based on historical performance (i.e. trailing twelve months aka TTM) versus forward estimates.  The Morgan Stanley Fairness Opinion uses forward estimates but the metrics end up in about the same place.

There’s been a ton of commentary on this deal already.  I have included a few links to some of the better pieces below.

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