Eight months ago Valuecruncher asked “What’s driving Amazon’s stock price?”, at the time the company was trading at a share price $72 and a forecast EV/EBIT multiple of 50. We valued the company at $59 with a sensitivity range of $53 to $65. As Amazon’s strong 1st quarter performance continued through 2007 the stock price climbed to over $100. In line with the wider market volatility Amazon has plunged from $97 in the New Year to $64.47 at the market close on February 29.

Incorporating the latest consensus analysts estimates Valuecruncher estimates Amazon’s value at $60.83 with a sensitivity range of $56.41 to $65.46. The Valuecruncher mid-point valuation represents a forecast EV/EBIT multiple of 25.3 compared to the 26.9 implied by the current price. This valuation is based on revenues and EBIT growing to $28.9 billion and $1.64 billion by 2010 respectively. These are aggressive growth forecasts that assume the current top line growth will continue and Amazon can achieve it’s elusive margin expansion. Valuation Summary.

Amazon’s core online retail business can be expected to continue to grow driven by an increasing number of online transactions and the introduction of new product lines. Offerings including WebStore, Associates and the Amazon recommendation engine contribute to Amazon being a platform for e-commerce rather than just a destination. This platform will allow Amazon to facilitate and monetise the expected growth e-commerce beyond the core Amazon.com property. As Amazon’s role as a platform continues to evolve it will increasingly be in competition with Google. The Associates program offers an alternative to Google’s Adsense and Amazon’s recommendation engine has the potential to offer an alternative to Google’s search functionality.

Although Amazon have done an outstanding job building their core business to where it is today the future of Amazon may be determined by the potential of the Web Services platform they are establishing. It is difficult to quantify the size of the opportunity and nearly impossible to place a value on Amazon Web Services today but this option has significant upside potential.

It is difficult to identify a direct comparable for Amazon. Evaluating the multiples of other leading technology stocks add’s a degree of context to Amazon’s forecast EV/EBIT multiple of 26.9. Google and eBay have forecast EV/EBIT multiples of 16.7 and 11.1 respectively. While all three of these companies have unique risk and growth profiles these multiples highlight the growth being factored into Amazon’s stock price.

Despite Amazon’s recent decline in stock price and the aggressive growth forecast (particularly at the EBIT line) the current share price is at the top of the Valuecruncher valuation range. The current valuation multiple is significantly higher than other leading technology companies highlighting the market’s strong growth expectations for Amazon. A significant unknown is the potential value of Amazon’s Web Services offering. Based on our analysis Amazon appears reasonably priced with the level of upside a function of the potential of Amazon’s growth options.

Last week New York-based venture capitalist Fred Wilson wrote a blog post on his decision to buy some Google shares which also linked to his Covester account where you can track actual investment transactions of members.  The blog and Covester posts outline the “back of the envelope” calculations that Fred did in deciding to buy the shares.  Fred’s calculations are pretty basic – which is what most people (including very smart people like Fred) do.  At Valuecruncher we try to take the analysis step a little bit further.

Here is our take on Google:

Valuecruncher places a mid-point valuation on Google of $511 per share.  This is based on annual revenue growth decreasing from 35% in 2008 ($22.4 billion in revenues) to 15% in 2012 ($50.2 billion) then decreasing to a 5% terminal growth in 2018. Valuecruncher projects a 35% EBIT margin being maintained over this period – $7.8 billion in 2008 to $17.6 billion in 2012.  Valuecruncher projects capital expenditure growing to $4.5 billion in 2012 and remaining at that level.  Valuecruncher uses a discount rate of 10.5% and a 30% effective tax rate in the DCF calculation.

Valuecruncher has then created three separate scenarios:

1. Growth – where Google’s current dominance of on-line search and advertising is enhanced and revenues grow faster than anticipated in the base case.  This scenario holds all the inputs from the base case constant except that revenues growth decreases at a slower rate from 35% in 2008 to 25% in 2012.  This scenario has a valuation of $631 per share.  This is 34% above the current share price and 23% above our valuation.

2. Disruption – where Google’s current market dominance is reduced by changes in the competitive landscape.  This scenario holds all the inputs from the base case constant except that revenues growth decreases from 35% in 2008 to 25% in 2009 then to a flat 15% to 2012.  This scenario has a valuation of $426 per share.  This is 10% below the current share price and 17% below our valuation.

3. Black Swan – where Google’s internal activities create a new growth business similar in value to Salesforce.com that is separate to the current business.  The new business grows from $250m in revenues in 2009 to $1.5bn in 2012 and from $250m in losses to 50% EBIT margins in the same period. This scenario has a valuation of $533 per share.  This equates to a 5% increase on the current share price or 4% on our valuation.

Valuecruncher greatly respects Google’s current market dominance in search and on-line advertising.  However – we can see both a situation where Google maintains this dominance and more advertising spend moves from traditional media to on-line and one where new methods of discovery on-line disrupt Google’s current dominant position.  We do not have a perspective on which of those might occur – but it is worth considering the impact of both scenarios from a valuation perspective.  These are scenarios 1 and 2.

Our third scenario looks at the valuation impact if one of the internal Google R&D activities produces a material new company ($1.5 billion of revenues by 2012 at 50% EBIT margins) that is separate to the current Google business.  The value of this new entity is $6.8 billion in the valuation – comparable to the current enterprise value of a Salesforce.com.

Details of the base case valuation and three scenarios are included in the attached valuation report.

Valuecruncher Valuation Report – Google 3 March 2008