Jul 23, 2009
A look at the Zappos / Amazon Deal
Whenever a shareholder hears of a big deal being done by a company they own, they usually get worried. Acquisitions often end up fizzling. The expected synergies never materialize and the company suffers from a drag in performance as they try to integrate acquisitions. With that in mind, how well priced is Amazon’s (NASDAQ:) acquisition of Zappos? It depends. Zappos is a private company, so it’s impossible to say with certainty what their margins and sales figures are but we can take some guesses:
The consensus appears to be that Zappos did $1.1B in sales for 2008. Now the trick is to peg an approximation of their earnings is to figure out what their margins are. This is difficult. I’ve read online that Zappos has margins of 50%, something I do not believe is true. For one thing, such margins as a retailer in the online space seem like an impossibility. Secondly, it would mean that Amazon purchased Zappos at approximately 2X earnings, which I doubt its VC-backers would stand for.
So a more sensible number that I’ve seen thrown around is $40M pre-tax earnings. Doing $40M on $1.1B of sales probably looks really bad. It means that Amazon would have bought Zappos at something like 23X earnings. A huge and unlikely valuation.
We know though, that Amazon has a pretty efficient shipping change and is a much bigger company than Zappos. It’s possible that by plugging Zappos into their shipping chain, they may be able to reduce costs. I’ve seen a figure thrown around that the average Zappos order costs $25 in shipping (due to overnight shipping plus returns). Let’s say that hypothetically, out of those $1.1 billion sales, the average order is $50. You end up with 22 million. 22 million orders at $25 an order comes out to a huge aggregate shipping cost of $550M.
Imagine taking just 10% of that $550M off, via cost savings. You end up with $55M that can be added to earnings. Earnings now becomes $95M. That means the valuation for Zappos comes out to about 10X earnings, which would be a good deal for Amazon.
That might be a risky jump to conclusions to make, but it seems like the people at Amazon would have really analyzed the potential savings that could be made on the supply chain end. I think though that there are a number of intangibles to look at here too, which add value to the deal. First, Amazon tried to move in on the footwear market with their brand Endless, it didn’t work out too well. The brand really didn’t get the kind of awareness or following that Zappos has, it simply was not very visible in the marketplace. Zappos would give Amazon a great arm in the retail-footwear market. Moreover, the Zappos brand could be leveraged to move into new areas like clothing. They have a good reputation among customers and retail clothing is an area where that would help.
Keeping Zappos as a standalone company would probably allow its management to remain entrepreneurial. This is probably a good move. A lot has been made of the management by Tony Hsieh, who many people recognize as one of the main drivers for Zappos’ success because of his continuous focus on improving customer service experiences.
He cultivates an openness with employees and the public which I really like. Take some time to read about the acquisition:
We plan to continue to run Zappos the way we have always run Zappos — continuing to do what we believe is best for our brand, our culture, and our business. From a practical point of view, it will be as if we are switching out our current shareholders and board of directors for a new one, even though the technical legal structure may be different…
We are excited about doing this for 3 main reasons:
1) We think that there is a huge opportunity for us to really accelerate the growth of the Zappos brand and culture, and we believe that Amazon is the best partner to help us get there faster.
2) Amazon supports us in continuing to grow our vision as an independent entity, under the Zappos brand and with our unique culture.
3) We want to align ourselves with a shareholder and partner that thinks really long term (like we do at Zappos), as well as do what’s in the best interest of our existing shareholders and investors.
If the above is true, I think there’s potential for this working out really well. Amazon is acquiring a company is run by entrepreneurs who really love their business and are willing to pour their heart into it. That’s basically the blueprint to many of Berkshire Hathaway’s most successful acquisitions. If you wanted to learn even more about Tony Hsieh, I’d direct you to this cool presentation at SXSW 2009:
Also, the letter also includes this great video with Jeff Bezos:
Both Bezos and Hsieh appear to be really sharp operators in the retail industry. Investors often shy away from retail because it’s so cutthroat and your customer can walk in and steal your business model. So whenever I come across people in that business, who appear to be executing really well I take notice and study how they run their businesses. Bezos and Hsieh are both two businessmen worthy of such attention.
Further reading:
The Zappos Way of Managing (Inc.com)