M&A Case Study: Amazon and Zappos

Street Of Walls Investment Banking Technical Training

In this Case Study module we will discuss three key aspects of understanding of a real-life Mergers &
Acquisitions (M&A) deal:

Company Overviews
Merger Deal Overview
Valuation Methods Used

We will take a deep look into the large M&A deal that took place in the eCommerce sector. In
November 2009, Amazon, Inc. completed a previously announced acquisition of Zappos.com Inc.
Under the terms of the deal, Amazon paid Zappos.coms shareholders approximately 10 million shares
of Amazon stock (valued at $807 million at the time the deal was announced) and $40 million in cash.
The M&A deal were advised by investment banking teams at Morgan Stanley (Zappos) and Lazard
(Amazon).
Company Overviews
Amazon.com is a customer-centric company for three kinds of customers: consumers, sellers and
enterprises. The Company serves consumers through its retail websites, and focus on selection, price,
and convenience. It also provides easy-to-use functionality, fulfillment and customer service. Amazon
is the largest retailer in the nation, with revenues exceeding $45 billion annually.
Zappos.com was the #1 online seller of shoes at the time of the deal, stressing customer service. It
stocks 3 million pairs of shoes, handbags, apparel and accessories, specializing in some 1,000 brands
that are difficult to find in mainstream shopping malls. Through its website (and 7,000 affiliate
partners), Zappos.com distributes stylish and moderately priced footwear to frustrated and shop-worn
customers nationwide. In 2008, one year prior to the deal, Zappos reported annual revenues
exceeding $630 million.
Merger Deal Overview
The following graphic illustrates the timeline of Amazons acquisitions of Zappos, from the birth of the
possible transaction until the deals closing:
M&A Deal Announced: In July 2009, Amazon announced that it had reached an agreement to acquire
Zappos in a deal that was valued at $847 million. The Purchase Price of the deal was financed with
approximately 10 million shares of Amazon common stock and $40 million of Cash and Restricted
Stock units on the Balance Sheet.
M&A Deal Closed: In November 2009, Amazon announced that it had closed the previously
announced acquisition of Zappos. Given the closing price of Amazon stock on the previous Friday
(October 30, 2009), the deal was valued at approximately $1.2 billion (including fees).
Financial Advisors
Two investment banks are enrolled in the merger process. In April 2009, Zappos formally engaged
Morgan Stanley as its lead financial advisor to a possible sale or strategic relationship. Throughout
April, Lazard met with Amazon and ultimately became the buy-side advisor for the transaction.
Rationale for the Deal
Shortly after the deal was announced, Amazon filed an S-4 registration document with the SEC
detailing the rationale of both parties for undertaking the deal. Their reasoning was as follows:

Amazon believed that there was a tremendous opportunity to grow the Zappos brand.
Zappos was interested in keeping its brand and culture intact, and Amazon supported its
vision as an independent company.

Zappos felt it was in the best interest of shareholders to sell based on current valuations paid
by Amazon.

Valuations Methods Used

Comparable Company Analysis
Morgan Stanley ran a Comparable Company Analysis as part of the valuation process when estimating
the value of Zappos. Comparable Company Analysis is based on the idea that companies with similar
characteristics should have approximately similar valuations. Morgan Stanley compared the financial
information of Zappos to that of publicly traded Comparable Companies in the eCommerce space.
eCommerce companies used in Morgan Stanleys Comparable Company Analysis included the
following:
Selected Comparable Companies

Amazon.com, Inc.
Blue Nile Inc.
Digital River Inc.
GSI Commerce Inc.
Netflix, Inc.
OpenTable, Inc.
Overstock.com Inc.
VistaPrint Ltd.

For the analysis, Morgan Stanley looked at trading multiples in the eCommerce space for two key
metrics of earnings: forward EBITDA (the ratio of Enterprise Value to the next years expected
Earnings Before Interest, Taxes, Depreciation & Amortization, or EBITDA) and forward Earnings 9ratio
of Equity Value to next years expected Net Income). Based on consensus estimates for calendar
years 2009 and 2010, Morgan Stanley applied these ranges to the relevant Zappos financials.
Discounted Cash Flow Analysis
Morgan Stanley also calculated Equity Value ranges for Zappos based on Discounted Cash Flow
(DCF) analysis. DCF models are often used in Investment banking deals to value a company or asset
using the time value of money concept. Expected future cash flows are discounted back to today to
give the Net Present Value of those cash flows, which should approximate the current value of the
underlying company or asset.
Components used in a DCF Analysis

Companys Free Cash Flow (Morgan Stanley projected out 10 years)

Solving for Terminal Value of the Company (Morgan Stanley uses the Perpetuity Growth Rate
approach)
Weighted Average Cost of Capital (Discount Rate for the Companys Equity and Debt,
approximately weighted for the Companys relative mix of Debt and Equity)

Morgan Stanley calculated a Terminal Value as of July 1, 2019 by applying a Perpetual Growth Rate
range of 3-4% and a Discounted Rate range of 12.5-17.5%. The projected Free Cash Flows
(unlevered), Discount Rates, and implied Terminal Value were then used to solve for the Net Present
Value of Zappos expected future cash flows. Based on the DCF projections, Morgan Stanley implied a
Zappos Equity Value range of $1,555-2,785 million. The lower end of the sensitivity analysis implied a
Zappos Equity Value of $430 million, so the deal value was within the sensitivity range.
Precedent Transaction Analysis
As part of the due-diligence process, Morgan Stanley also performed a Precedent Transaction
Analysis to imply a value for the company using recent historical M&A transactions of similar

companies. Precedent Transaction Analysis is based on the idea that recently acquired companies
with similar characteristics should provide a solid guideline for a reasonable Purchase Price for the
given Target company (in this case, Zappos).
Morgan Stanley researched publicly available M&A transactions looking at deal multiples in the
Internet sector with a buyout of $250 million or more since January 2008. The following is a list of the
transactions that Morgan Stanley analyzed:
Selected Precedent Transactions (Target/Acquirer)

Gmarket Inc./eBay Inc.

Bill Me Later, Inc./eBay Inc.
Greenfield Online Inc./Microsoft Corporations
Bebo, Inc./Time Warner Inc.
CNET Networks, Inc./CBS Corporation
Audible, Inc./Amazon.com, Inc.

Using the transactions chosen, Morgan Stanley selected ranges of deal multiples and applied those
ranges of multiples to the appropriate Zappos financials. Morgan Stanley applied a next twelve-month
(NTM) EBITDA range of approximately 15-30x to Zappos financials, which implied an Equity Value
range of $530-1,120 million. Morgan Stanley applied a last-twelve-month (LTM) EBITDA range of
approximately 25-75x, implying an Equity Value range of $270-885 million.
Historical Stock Price & Next Twelve Months (NTM) Multiple Analysis
Morgan Stanley also reviewed Amazons stock price performance relative to an eCommerce index, an
Internet Bellwether Index, and the NASDAQ over various periods of time. The following companies
comprised the eCommerce index:
eCommerce Index Components

Blue Nile Inc.

Digital River Inc.
GSI Commerce Inc.
Netflix, Inc.
Overstock.com. Inc.
VistaPrint Ltd.

The following companies comprised the Internet Bellwether index:

% Price Change

Amazon

eCommerce

Internet Bellwethers

NASDAQ

Last 30 Days

12.50

10.50

15.10

8.50

Last 90 Days

12.40

7.90

18.10

16.40

Last 180 Days

78.20

115.00

62.20

30.80

Last 12 Months

30.00

23.00

(21.30)

(15.90)

Last 2 Years

24.30

(10.00)

(42.00)

(28.70)

Last 3 Years

168.20

41.70

(22.70)

(5.20)

Internet Bellwether Index Components

eBay Inc.
Google Inc.
Yahoo! Inc

The table below shows Morgan Stanleys analysis of stock price performance for these selected
metrics:
Morgan Stanley then looked at recent trading multiples compared to next-twelve-months (NTM)
Earnings Per Share and NTM EBITDA, as well as implied stock prices using these multiples, based on
current NTM financials for Amazon. Morgan Stanley commented that over the period Amazon stock
traded at an NTM Price/Earnings multiple range of 21.9-94.4x and an NTM EBITDA range of 8.232.5x.
Footnote: Selected Zappos.com, Inc. Financial Results
Zappos.com, Inc.

2007

Income Statement, in $ thousands

3 months ended June

30

12 months ended D

Net revenues

152,613

526,829

Cost of revenues

97,158

333,884

Gross Profit

55,455

192,945

Sales, marketing and fulfillment

37,862

123,260

General and Administrative

5,870

18,962

Product Development

6,154

18,224

Total operating expense

49,886

160,446

Income from operations

5,569

32,499

Interest and other income, net

133

731

Interest benefit (expense) associated with preferred stock

warrant

(5,771)

(10,825)

Other interest expense

(1,067)

(6,930)

Other financing charges

(121)

(335)

Operating expenses:

Income (loss) before provision for income taxes

(1,257)

15,140

Provision for income taxes

(1,562)

(10,288)

Net income (loss) from continuing operations

(2,819)

4,852

Discontinued operations, net of tax

(679)

(3,084)

Net income (loss)

(3,498)

1,768