WAL-MARTORAMAZON

BRICK-AND-MORTARORE-COMMERCE

RAVPRITPALSINGHKOHLIZHEXIGU

YONGXIAOCHEN

Johns Hopkins Carey Business School

TableofContents

STRATEGY..........................................................................................................................3

INTRODUCTION.................................................................................................................4Amazon (NASDAQ: AMZN)..........................................................................................................4Wal-Mart (NASDAQ: WMT).........................................................................................................7

MISPRICING?.....................................................................................................................8

DOES PROFITABILITY MATTER?.................................................................................12

WHY WALMART THEN?.................................................................................................13STRATEGIC INTERACTIONS...................................................................................................17

CONCLUSION....................................................................................................................19

Appendix1............................................................................................................................20

Appendix2............................................................................................................................27

References and Bibliography...............................................................................................31

STRATEGY Through our careful study of the firms and their projected growth, the industry and its future

prospects and the adaptability of each firm to the dynamics of industry, we choose to invest in

Wal-Mart and thus, long Wal-Mart at its current market price as we expect an 80% upside on

Wal-Mart’s prices. We have calculated a 13% downside correction on Amazon and will thus

short Amazon at current price and cover at $580. We formulated this strategy after carefully

analyzing both exogenous and endogenous factors affecting the firms and industry. Additionally,

we assume that Wal-Mart further make moves to interact strategically with companies that have

core competencies in digital computing.

This strategy was made taking into consideration 3 main points, which we have elaborated more

in our report.

• Brick-and-mortar or e-commerce: One thing investors need to ask is whether it will be

easier for an E-Commerce giant to build a network of physical stores and create customer

relations culture at large like Wal-Mart or will Wal-Mart be better able to leverage their

existing domineering network of stores to build digital and online retailing capabilities.

We believe, through our analysis, that the latter is more plausible.

• The Asian market: Another risk that Amazon faces is from the Chinese online retailing

giant Alibaba (NYSE: BABA). However, Wal-Mart had already established its foothold

in the Chinese e-commerce market when it acquired Yihaodian, an online Chinese

groceries shop, this past July. With full ownership of Yihaodian, Walmart plans to invest

in both accelerating e-commerce and creating a seamless experience for customers across

online, mobile and stores.

• Valuation: Our calculation of the Intrinsic Value of the shares of both firms yielded

results that show Wal-Mart is undervalued by 80% with a forward PE ratio of 13.

Amazon, on the other hand, has an intrinsic value that is far lower than its current market

price of $655. Also, Amazon currently trades at a forward PE ratio of 900 whereas the

industry averages at 46.i We believe that this forward price multiple will not be

sustainable in the future and thus through our valuations(See Appendix) we believe

Amazon is expensive by 51%.

INTRODUCTION Amazon (NASDAQ: AMZN) Amazon and Walmart, 2 industrial giants having different business models enjoy an Enterprise

Value of more than $230 Billion for Walmart and more than $300 Billion for Amazon. One

shows little or no profit and pays no dividend to shareholders whereas the other shows constant

profits and gives high dividend to shareholders. AMZN reports revenues of its 3 segments,

namely; Media, Electronics and General Merchandise(EGM) and Other, which is essentially

Amazon Web Services (AWS). AMZN is a giant in the e-retailing industry with its turnover

increasing from just under $75 billion to $89 billion from FY 2103 to FY 2014. This rapid

growth can be attributed to the growth of share of the Merchandise in the Sales mix, which

accounts for 68% of the total (see chart below). Whereas Wal-Mart would be considered a

competition for Amazon in General Merchandise, Amazon competes with Apple, Time Warner

Cable, Google and Netflix in its Media Segment. Not surprisingly, because of heavy competition

from Apple and Microsoft, Media sales growth for Amazon has been decreasing every quarter.

Even though Amazon acquired Twitch for $950 million in cash, the revenue growth in Media

Sales has only been 4%.

Figure1:RevenuesofdifferentSegmentsofAmazon

It is important to note here that the the growth of revenue, which was at 40% in 2010, was not

only because of the growth in overall retail market but also because of the Amazon’s ability to

change the dynamics of the retail industry. AMZN has been successful in luring customers from

the physical store and effectively making them switch to the online shopping, a trend that has

jeopardized businesses of many small retailers like Radio Shack and Circuit City. Moreover, the

Amazon Web Services segment has seen a sharp growth over the years and accounts for 50% of

Amazon’s profit in the Trailing Twelve Month. (See Chart) AMZN is further pushing Prime, a

premium service that provides members with faster shipping, unlimited photo storage, and

exclusive access to a range of Amazon movies, music, and Kindle books. The members pool

further increased by 53% this year even after the company announced price hikes in membership

fee for Prime.ii

0%

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2008 2009 2010 2011 2012 2013 2014

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Media EGM AWS

Table2:AmazonWebServicesRevenuesince2008

Not only this, their most recent development of providing door-to-door professional services is

one that investors think should be a key driver in their growth. Now maintenance/ repairs for

your household is just one click away.

Figure2:Amazon:OperatingIncome(Loss)fordifferentlocationsandsegments

542 653953

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OperatingIncomeofAWSasashareofTotalOperatingIncome

NorthAmerica International AWS

Wal-Mart (NASDAQ: WMT) When a company is at the top in a competitive industry, like that of Retail for several years,

investors eye on the company’s future prospects. WMT has been a retailing mammoth since the

90s and has put a lot of firms out of business. However, now it faces stiff competition from many

firms, one of them being AMZN. WMT has made its stance clear to compete with the e-

commerce giant in this digital age. Unfortunately, they do not receive the free pass from Wall

Street when it comes to the expected profitability. AMZN gets the benefit of doubt even when

Bezos’ company shows negative profit. On the other hand, WMT suffers on Wall Street as a

result of their announcements of increasing:

• Investment for e-commerce by $1.5 billion for FY 2016 and FY 2017iii

• Capital Expenditure by $12 billion.

• Net square footage growth by 26 million square feet.

• Minimum Wage and investment in training employees.

This in turn, as company projected, would decrease the EPS by 12% for the coming two years.

As a result of this update, WMT share prices plunged. However, after the periods of decreased

earnings, we estimate that WMT’s operating profits will grow at a higher rate. Our analysis

shows there is much more than the intrinsic value of WMT that makes it a must buy right now.

MISPRICING?

A PE ratio of 900 (TTM) should be considered an anomaly. And why not? Should investors pay

900 dollars for each dollar profit per share a company shows? The problem here is that Amazon

pays out little to no dividend to investors as it ploughs back most of its profits to reinvest, with

the reinvestment rate being close to 98% (see Appendix). Moreover, the trend of the sales growth

has been downward. (See Appendix) The growth peaked in 2010-11 at 40%, however, now it’s

at 19%. Then why would investors be willing to pay such a high premium even though the

industry PE for online retailing is just over 46? The simple answer would be their confidence on

Jeffery Bezos strategy of investing a large portion of their operating earnings for the growth of

their different Business Segments like AWS, which accounts for 50% of Amazon’s profits for

Q3 2015.

Figure3:PercentagegrowthofRevenueforAmazon

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2009 2010 2011 2012 2013 2014

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PercentageGrowthofRevenues

AMZN was trading at $304 in January 2015 and currently trades at $659.39 with a 101%

increase Year-to-Date whereas WMT trades at $58.78 with a 33% decrease Year-to-date. In our

calculation of fundamental value of both firms, WMT is undervalued and thus we forecast an

80% upside on WMT. We have calculated the fundamental value of both the firms using the

DCF model (See Appendix) using a 2 stage Model for Walmart and a 3 stage Model for AMZN.

Walmart’s undervaluation is evidence enough that the company is planning a buy back of $20B

shares in the next two years. Our analysis shows, given the assumptions stand, that AMZN is

highly overpriced. Because of the high Research Expense, which AMZN expenses in its income

statement (US GAAP), the Return on Capital for AMZN is highly distorted. While valuing

AMZN we adjusted the operating income for Research and Development Expenses and

Operating Lease commitments. This was the case for WMT too. We also adjusted the Book

Value of Equity and Debt in this regard (See Appendix). This provides us with the true value of

Equity and Debt adjusted for R&D expenses and Operating Lease commitments.

Wal-Mart’s Value per share is $105 where as it’s price per share is $58(See Below). As

mentioned above, we maintain our position of a strong surge in WMT’s prices as the company is

making productive capital expenditures and investments to compete in the e-commerce industry

whereas keeping moderate growth in Physical stores.

Figure3:ValueandPriceofStock

*Price for AMZN as of 30 January 2014.

Amazon’s high Research and Development expenses are likely to be productive in the near

future. It’s acquisition of 2lementary and and Element Technology for $15 million and $300

million cash respectivelyiv is highly likely to reap benefits in the future. This can be seen in the

growth of revenue from AWS. Not only has Amazon established itself in the e-commerce

industry with the help of its developers but also received a free pass from the Wall Street. No

wonder Investors are willing to pay a high premium on Amazon even though they how low or

negative income. The Chart below shows the the trend of Capital expenditure and Acquisitions

made by both Amazon and Wal-Mart.

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Figure4:Amazon:CapitalExpenditure,R&DandAcquisitionsince2008

Figure5:Wal-Mart:CapitalExpenditure,R&D,Acquisitionsince2008

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2008 2009 2010 2011 2012 2013 2014 2015TTM

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Amazon:CapitalExpenditure,AcquisitionandR&D

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MILLIONS

YEARS

Wal-Mart:CapitalExpenditure,AcquisitionandR&D

Figure6:Wal-MartprojectedCapitalExpendituretill2017

DOES PROFITABILITY MATTER?

Our analysis shows that Walmart’s Revenue has grown $170 B over a period of 10 years

whereas Amazon’s revenue has grown $80 B. This shows that Wal-Mart is still a retailing giant.

The Operating margins for Walmart have averaged 7.7% whereas for Amazon still averages at

4.5%. So if profit seeking sellers like Amazon earn the greatest profits by providing best quality

goods to its buyers and the lowest prices possible with the convenience of the fastest delivery,

then why has Amazon over the last decade underperformed in terms of income than Wal-Mart?

Is it true that Amazon has been sacrificing its profits for the purpose of growth of revenue?

13510

1289813115

1217412321

13183

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2011 2012 2013 2014 2015(TTM) 2016* 2017*

$MILLIONS

YEARS

WMT:ProjetedCapitalExpenditure,AcquisitionandR&D

What sets AMZN apart from its customers is the fact that their business principles are Industry

oriented. E-commerce is a customer oriented industry where customer satisfaction index can help

the firm grow rapidly.

According to the ACSI Federal Government Report 2015v Amazon holds the number one

position in the private sector, with a score of 88. Compared to the 2014 report, which yielded 85

on the index, Amazon appears to be expanding the enjoyment and fulfillment shoppers wish to

experience online.

WHY WALMART THEN?

WMT has been a dynamic company, incorporating changes in the Economy, accordingly.

However, now it is much more than just the economy. This time they have to embrace the

competition posed by the first movers in the digital age. AMZN currently has 100 million square

footage(See table below) of fulfillment centers whereas WMT, in addition to establishing 24

million square feet of physical location this year alone, will add 4.8 million square footagesvi for

fulfillment of online orders by the end of FY 2016. The 4 facilities will be each larger than the

older ones by 1 million square feet and to hold 500,000 more itemsvii .The total for WMT

including physical stores is more than 1100 million square footage..

WMT has already opened 1 of the above fulfillment centers in Atlanta covering 1.2 million

square footages with state of the art technology that makes assortment easier. As mentioned

above, we expect the supply chain to perform optimally and thus unlock faster speeds for

fulfillment of orders online.

AMAZON As of 31 December 2014 Description of use Square footage in thousand Corporate office 4,437 North America Corporate office facilities 3,371 International 7,808 Fullfilment and warehouse 57,633 North America Fullfilment and warehouse 43,241 International 100,874 Total 108,682

WALMART In thousand Square feet

Walmart US 662,474

Sam's Club 84,852

Total US 747,326

International 358,413

Walmart Total 1,105,739

It is time for investors to ask themselves if it will be easier for an E-commerce company, i.e.

AMZN, to build massive number of stores and create customer relations culture at scale like

Wal-Mart or if Walmart is better able to add digital and supply chain capabilities to leverage

their existing stores?

The Line between physical and digital shopping is blurring. However, the allure of the old Brick

and Mortar will still remain in the future. American citizens still prefer shopping in physical

store because of the personal experience. Currently 8% of shopping happens online whereas 92%

still takes place at physical stores.viii This number is expected to grow to 17% in 2017 and we

analyze that both WMT and AMZN will be sharing this number. Seeing this high number,

AMZN decided to open its first brick-and-mortar store in Seattle.ix However, since WMT has a

well-established physical network of stores, we can expect WMT sales to grow after FY 2017, as

we expect the lag time to be 2 years. It is for this reason we have shown shown a slight decrease

in the growth of operating profit for FY 2016 and FY 2017 and assumed a relatively high stable

growth rate. Walmart is already in the top 3 online retailers in terms of traffic. With a physical

store within 5 miles of 70% of the US population,x WMT takes the aggressive stance of

competing with the E-commerce giant. We expect the competition to be in terms of price, faster

and convenient fulfillment and high quality products. Since both will provide a 3rd party platform

to sellers, we expect the prices charged for each sale by both WMT and AMZN to remain same

because of a virtual duopoly.

Figure7::Trendforonlineretailshoppingasapercentageoftotalretailshoppin

Chartbycensus.gov.

Also WMT is looking into the possibilities of finding faster delivery channels. One of them

include drones, which will carry deliverable goods to consumers. The company, currently, is

seeking permission to research drone use in deliveries to customers at Wal-Mart facilities as well

as consumer homes.xi

But while Wal-Mart is looking into technologically and legally intricate matters, it should devote

more time into recognizing the simpler yet more important areas of e-retailing. i.e. sophisticated

website and better delivery channels.

Several customers have shown dissatisfaction with Wal-Mart’s ability to provide user friendly

website for online shopping and the after sales customer services. In relation to Amazon’s

unprecedented customer services, Wal-Mart is planning to invest $2B in training its employees

and increasing their wages.

The most recent, and perhaps most dangerous, adversary Amazon faces is the lucrative Alibaba

Group (NYSE: BABA). The companies are currently viewed as the two giants in the worldwide

e-commerce market, but who has the upper-edge? With little exposure to the Chinese market,

Amazon is outdone there. Similarly, Alibaba's insignificant exposure to the U.S. market gives

Amazon the Western victory. Essentially, a carefully planned, innovative expansion into the

competitors' home markets will decide the true victory.

STRATEGIC INTERACTIONS However, WMT had already accelerated its move into the e-commerce industry in the Asian

region when it bought out Yihaodian, a Chinese online groceries shop. Through the buyout, they

have made their stance clear that they are willing to compete in the online retailing business not

in the US but in China.

We believe a strategic interaction between Walmart and Jingdong, an online Chinese computer,

communication, and consumer electronics retailer-company in China that is a huge rival of

Alibaba, another e-commerce giant in China can help Wal-Mart compete in the digital industry

of online shopping. Jingdong’s immense competencies in cloud computing and technology is

noteworthy, besides being one of the few companies having its own supply chain in China. Wal-

Mart can aggressively take advantage of its high cash reserves to have a vertical merger with

JIngdong (NASDAW: JD.com) We believe a vertical merger will bring Operating (Cost

Savings) and Technology Synergies. Jingdong has already established a Research and

Development office in the Silicon Valley as of October 13, 2015. xii Also the company recently

invested $700 M in cloud computing centers.

We believe the merger will bring synergetic benefits. Benefits to WMT include

• Better website: One of the reasons why AMZN has a competitive advantage over its

competitors is that it makes the order processing convenient, less cumbersome and faster,

WMT can use expertise from JD.com to bring in technology synergies.

• Cloud computing options: JD.com has established huge data centers for the purpose of

cloud storage and carrying out business processes through cloud computing, just like

amazon.

• Cost savings in China. Already, most items that WMT produces are manufactured in

China. WMT can use the existing supply chain of JD.com to deliver better quality goods

in a more cost efficient and effective manner.

• Algorithmic sorting for individual orders using Robots.

CONCLUSION We thus maintain that we will long WMT at the current market price as we estimate WMT’s

prices to increase. We analyze that our target price is $105 thus we project an 80% upside on

Walmart. As we estimate AMZN’s price to decrease, we short AMZN at $655 and cover it at

$580, expecting a 13% downside. We analyze that the expenditure Wal-Mart plans to make in

short term in E-commerce will reap benefits in the coming future. With the advent in e-

commerce doubled with the domination in physical locations and its undervalued stock, Wal-

Mart certainly holds a future of inexplicable gains to the investors.

Appendix1

The following table shows the fundamental value of Amazon. We have used a 3 stage model for

the calculation of intrinsic value of the share. We used data as of 31 December 2014 for

simplicity. All Values are in $ millions except number of shares and share price.

Assumptions:

• Marginal Tax rate: 35%

• We include stock based compensation in the calculation of the Operating Income, taken

as expenses.

• The Research and Development cost were capitalized as they’re likely to be provide

Long term benefits.

• Operating leases were taken off from the income statement and treated as debt.

• We take only non-cash changes is Net Working Capital as cash is mostly invested

Operating Income:

Operating income was adjusted for Research and Development expense and Operating Lease

expenses. We estimated the life of Asset to be 4 years and have amortized the value over the

same period. Please refer to Table 2 for the calculation of Research and Development

Expenditure.

Reinvestment Rate:

Reinvestment rate has been calculated by using the amount of Reinvestment, which was

calculated by using the following formula

𝑁𝑒𝑡𝐶𝑎𝑝𝑒𝑥 𝐴𝑑𝑗𝑢𝑠𝑡𝑒𝑑𝑓𝑜𝑟𝑎𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛, 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛𝑎𝑛𝑑𝑎𝑐𝑞𝑢𝑖𝑠𝑖𝑡𝑖𝑜𝑛 + 𝑁𝑒𝑡𝑊𝑜𝑟𝑘𝑖𝑛𝑔𝐶𝑎𝑝𝑖𝑡𝑎𝑙𝐸𝐵𝐼𝑇 1 − 𝑡

Here Reinvestment is

𝑁𝑒𝑡𝐶𝑎𝑝𝑒𝑥 𝐴𝑑𝑗𝑢𝑠𝑡𝑒𝑑𝑓𝑜𝑟𝑎𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛, 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛𝑎𝑛𝑑𝑎𝑐𝑞𝑢𝑖𝑠𝑖𝑡𝑖𝑜𝑛 +

𝑁𝑒𝑡𝑊𝑜𝑟𝑘𝑖𝑛𝑔𝐶𝑎𝑝𝑖𝑡𝑎𝑙

Discount Rate:

• The discount rate was calculated using Weighted Average Cost of Capital given by the

equation:

𝐶𝑜𝑠𝑡𝑜𝑓𝐸𝑞𝑢𝑖𝑡𝑦 ∗𝐸𝑞𝑢𝑖𝑡𝑦

𝐷𝑒𝑏𝑡 + 𝐸𝑞𝑢𝑖𝑡𝑦 + 𝐶𝑜𝑠𝑡𝑜𝑓𝐷𝑒𝑏𝑡 ∗ 1 − 𝑡𝑎𝑥𝑟𝑎𝑡𝑒 ∗𝐷𝑒𝑏𝑡

𝐷𝑒𝑏𝑡 + 𝐸𝑞𝑢𝑖𝑡𝑦

• To calculate cost of equity for Amazon we used a risk premium, as mentioned by Aswath

Damodaran, of 5.5%.

• The risk free rate was taken from the 10 Year US Treasury yield. Risk free rate averaged

at 2.4%.

• A beta of 1.33 was taken from Yahoo Finance and was unlevered. The following formula

was used to Unlever the beta. We then Re-levered the beta for the adjusted Book Value

of Equity and Book Value of Debt. We then “walked down” the beta to 1 over the period

of 3 years 𝛽H = 𝛽J 1 + 1 − 𝑡𝑎𝑥𝑟𝑎𝑡𝑒 ∗ KLMNKLMNOPQJRNS

• We then used Capital Asset Pricing Model to find cost of Equity.

Table6:

Stage 1 Stage 2 Stage 3 Pre-tax cost of debt 7.00% 7.00% 7.00% Cost of equity 8.71% 8.28% 8.00% WACC 7.173% 6.873% 6.685% Beta levered 1.33 1.15 1 Beta unlevered 0.94 Re lever beta 1.13 1.05 1

• Cost of debt was calculated using the formula, as mentioned by Aswath Damodaran,

𝑅𝑖𝑠𝑘𝑃𝑟𝑒𝑚𝑖𝑢𝑚 + 𝐷𝑒𝑓𝑎𝑢𝑙𝑡𝑆𝑝𝑟𝑒𝑎𝑑𝑜𝑓𝐶𝑜𝑚𝑝𝑎𝑛𝑦 + 𝐷𝑒𝑓𝑎𝑢𝑙𝑡𝑠𝑝𝑟𝑒𝑎𝑑𝑜𝑓𝑈𝑆𝐴

• Moody rated Amazon as Baa1 in January 2015, which has a default spread of 1.5%

Using the above formula, the pre tax cost of debt has been estimated as 7%.

Adjusted Capex:

The capital expenditure was adjusted for Research and Development expenditure, which we

capitalized, amortization, depreciation and average Acquisitions.

Table7:TableshowingadjustedCapitalExpenditureforR&DandAcquisitionforcurrentyear

Period Capex Depreciation Amortization R&D Acquisition Adjusted

Capex

December

2014

4,893 4,746 7,839 9,275 979 2,562

Amortization of research expense was done using an estimated life of 4 years and then reducing

it using Straight Line Method. The previous 5 years expenses are mentioned below.

For R&D

Years Research Expense

Amortized Value Unamortized Value

Current 9,275 0 9,275

1 6,565 1,641.25 4,923.75

2 4,564 2,282 2,282

3 2,909 2,181.75 727.25

4 1,734 1,734 0

Research Asset 17,208

Amortization 7,839

Adjustment in EBIT 1,436

𝐴𝑑𝑗𝑢𝑠𝑡𝑒𝑑𝐸𝐵𝐼𝑇 = 𝑈𝑛𝑎𝑑𝑗𝑢𝑠𝑡𝑒𝑑𝐸𝐵𝐼𝑇 + 𝑅&𝐷𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑓𝑜𝑟𝑐𝑢𝑟𝑟𝑒𝑛𝑡𝑦𝑒𝑎𝑟 − 𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛

Operating Lease:

Similarly, Operating Lease expenses were adjusted in EBIT and Book Value Debt. Operating

lease expenses were added back to Debt using the following formula

𝐴𝑑𝑗𝑢𝑠𝑡𝐸𝐵𝐼𝑇 = 𝑈𝑛𝑎𝑑𝑗𝑢𝑠𝑡𝑒𝑑𝐸𝐵𝐼𝑇 + 𝑃𝑉𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠 ∗ 𝑃𝑟𝑒𝑡𝑎𝑥𝑐𝑜𝑠𝑡𝑜𝑓𝑑𝑒𝑏𝑡

Table8:AdjustmentofOperatingLeaseexpenses.

Lease Obligation

Amount PV

1 2015 868 811

2 2016 791 691

3 2017 728 594

4 2018 634 484

5 2019 548 391

6to9 Thereafter 2,343 1,723.85

Average of 5 713.8 PV of leases 4,695

NO of years 3.282 Net Adjustment to BVD

Table9:AdjustmentsinEBIT,ROCandgrowth

Adjusted Capex 2,562 Period 2,014 Change in WC -650 BVE 10,741 10,741 Reinvestment 1,912 BVE ttm Reinvestment rate= 0.97 Adjust Debt 12,960 BE 10741 Debt 8,265 Adjusted BVE

27,949 ROC 0.1040

Adjusted Debt

12,960 Growth 0.1006

2019 onwards Reinvestment rate= 0.65 growth= 0.068 TV Growth of EBIT 0.025 Reinvestment rate 0.20

We then calculated the fundamental value of the firm and thus the intrinsic value of the stock.

The growth rate was calculated using the formula:

𝑅𝑒𝑖𝑛𝑣𝑒𝑠𝑚𝑒𝑛𝑡𝑟𝑎𝑡𝑒 ∗ 𝑅𝑂𝐶 = 𝑔𝑜𝑓𝐸𝐵𝐼𝑇

For Stage 2 and Stage 3 we used reinvestment rate of 65% and 20% respectively. Because of this

assumption the growth rate in EBIT is calculated as 7% from 2019 onwards and 2.5% for

terminal value. The Free Cash flow was calculated using the formula

𝐹𝐶𝐹𝐹 = 𝐸𝐵𝐼𝑇 1 − 𝑡𝑎𝑥𝑟𝑎𝑡𝑒 − 𝐶𝑎𝑝𝑒𝑥 − 𝐶ℎ𝑎𝑛𝑔𝑒𝑠𝑖𝑛𝑁𝑊𝐶 + 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛

𝑂𝑅

𝐹𝐶𝐹𝐹 = 𝐸𝐵𝐼𝑇 1 − 𝑡𝑎𝑥𝑟𝑎𝑡𝑒 − 𝑅𝑒𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡

Period AdjustedEBIT(1-t)

Reinvestment FCFF PV

0 2014 3042 2941.538462 100.6943042 100.6943042

1 2015 3348.280806 3237.456674 110.8241321 103.4068187

2 2016 3685.117221 3563.144202 121.9730188 106.1924033

3 2017 4055.839315 3921.595834 134.2434814 109.0530262

4 2018 4463.855982 4316.107632 147.7483502 111.9907089

5 2019 4765.738944 3097.730313 1668.00863 1196.339723

6 2020 5088.037735 3307.224528 1780.813207 1195.104395

7 2021 5432.133044 3530.886478 1901.246565 1193.870343

8 2022 5799.498931 3769.674305 2029.824626 1192.637566

9 2023 6191.709146 4024.610945 2167.098201 1191.406061

10 2024 6610.443868 1322.088774 5288.355094 80326.97756 TV 126355.3443

EV $86827.67291

Debt $12960

CashandMarketablesecurities

$17416

EquityValue $91284

NoofShares 445

SharePrice $205.1318492

Thus the intrinsic value of Amazon is $205.13 and share price as of January 31 2015 was $309.

Appendix2As mentioned earlier, we expect a sharp surge in the price of WMT. Following is the DCF model

we used for calculation of intrinsic value of Walmart. We have used data as of September 30

2015 TTM for simplicity and comparability. All Values are in $ millions except number of

shares and share price.

Assumptions

• Growth rate for Sales for the next 5 years: 3.5%. Company’s projection at 4%. We are

expecting that the lag time for Capital Expenditure to kick in to be 2 years. Thus on an

average we used a 3.5% growth rate to be on the conservative side.

• Marginal Tax rate at Historic rate: 28.8%

• EBIT/Sales: 3% for the first two years (historical rate). We then expect Operating Margin

to be 6% as the Capital Expenditure is likely to increase the margins.

• Net working Capital/Sales: 1%

• PPE/Sales: 36.5%

• Depreciation and Amortization/PPE: 5.1%

• Capital Expenditure/Sales: As provided by the company for the next two years and 2.5%

thereon

Growth rate for next 5 years 3.50%

Marginal tax rate= 28.80%

EBIT/Sales(Average at 3%) 3.00%

NWC/Sales= 1%

PPE/Sales 36.50%

Depreciation and Amortization/PPE

5.10%

Capex/Sale 2.50%

Default spread of USA 0.00%

Risk Premium of USA 5.50%

Default spread of AA(as assigned by Moody

0.70%

Risk free 2.40% Stage 1

Stage 2

Cost of Debt 6.20% Cost of Debt 6.2% 6.2%

Cost of Equity 7.30% Cost of equity

7.3% 7.3%

Beta 0.89 WACC 6.07% 6.07%

Total Equity 81394

Total Debt 47981

Adjusted Debt for operating lease

48862

Stable Growth Rate 2.00%

• We used a beta as provided by Yahoo finance. The cost of Equity was calculated using

CAPM model with a risk free rate of 2.4% and a Market risk Premium of 5.5%. Equity

Cost of Capital comes out to be 7.3%.

• Cost of debt was calculated using the formula used for calculating cost of Debt for

Amazon.

• Total Debt was adjusted for Operating Lease Expenses. EBIT was adjusted for the same.

𝐴𝑑𝑗𝑢𝑠𝑡𝑒𝑑𝐸𝐵𝐼𝑇 = 𝑈𝑛𝑎𝑑𝑗𝑢𝑠𝑡𝑒𝑑𝐸𝐵𝐼𝑇 + 𝑃𝑉𝑜𝑓𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔𝐿𝑒𝑎𝑠𝑒 ∗ 𝑃𝑟𝑒𝑡𝑎𝑥𝑑𝑒𝑏𝑡𝑐𝑜𝑠𝑡

• Stable growth rate was assumed to be 2%

𝐹𝐶𝐹𝐹 = 𝐸𝐵𝐼𝑇 1 − 𝑡𝑎𝑥𝑟𝑎𝑡𝑒 − 𝐶𝑎𝑝𝑒𝑥 − 𝐶ℎ𝑎𝑛𝑔𝑒𝑠𝑖𝑛𝑁𝑊𝐶 + 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛

The Free Cash flow to Firm was then discounted using WACC (Weighted Average Cost of

Capital) as the discount rate.

Table10:Valuesin$millions

1 2 3 4 5

2014 2015 2016 2017 2018 2019 2020

Net Sales 476296 485651 502648.78

5

520241.4

925

538449.94

47

557295.69

28

568441.60

66

EBIT 26872 27147 15079.463

55

15607.24

477

32306.996

68

33437.741

57

34106.496

4

Adjusted EBIT for 2015

28028.16512

15960.62867

16488.40989

33188.1618

34318.90668

34987.66152

EBIT(1-t) 19132.864 19956.05356

11363.96761

11739.74784

23629.9712

24435.06156

24911.215

Non Cash NWC -3300 -4440 2513.243925

3901.811194

5384.499447

4179.717696

4263.31205

(Capex) net of disposal

12388 11604 12566.21963

13006.03731

13461.24862

13932.39232

14211.04017

Depreciation 8870 9173 9356.807133

9684.295382

10023.24572

10374.05932

10581.54051

PPE 175632 179770 183466.8065

189888.1448

196534.2298

203412.9279

207481.1864

Free Cash Flow to Firm

18914.864 21965.05356

5641.311194

4516.19472

14807.46886

16697.01086

17018.40329

Terminal Value 417799.1357

Present Value 20707.42033

5013.805964

3784.023773

11696.4955

12433.90063

11947.61464

PV of Terminal Value

311125.9243

EV $376709.1851

Debt $47981

Cash $9135

Net debt $38846

Equity Value $337863.1851

No of shares outstanding 3228

Share value $104.6664142

EV/EBITDA 10.12627384

The total of all 5 years and Terminal Value gives us the Fundamental Enterprise Value. We then

subtract Net Debt (Book Value of Debt – Cash) from Enterprise Value to get the Value of

Equity. This value is the divided by the number of shares outstanding.

𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒𝑉𝑎𝑙𝑢𝑒 = 𝐸𝑞𝑢𝑖𝑡𝑦𝑉𝑎𝑙𝑢𝑒 + 𝐷𝑒𝑏𝑡 − 𝐶𝑎𝑠ℎ

This gives us the Intrinsic Value of the Stock at $104.67 and this was trading at $58.78.

References and Bibliography

ihttp://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/pedata.htmliihttp://seekingalpha.com/article/2898286-amazon-fundamentals-dcf-valuation-and-algorithmic-analysisiiihttp://s2.q4cdn.com/056532643/files/doc_financials/2015/annual/2015-annual-report.pdfivhttps://www.crunchbase.com/organization/amazon/acquisitionsvhttp://www.theacsi.org/news-and-resources/customer-satisfaction-reports/reports-2015/acsi-e-business-report-2015vihttp://s2.q4cdn.com/056532643/files/doc_financials/2015/annual/2015-annual-report.pdfviihttp://www.wsj.com/articles/wal-mart-builds-supply-chain-to-meet-e-commerce-demands-1431016708viiihttps://www.census.gov/retail/mrts/www/data/pdf/ec_current.pdfixhttp://www.ft.com/intl/cms/s/0/678a8224-841a-11e5-8095-ed1a37d1e096.html#axzz3qvgoMaQGxhttp://www.npr.org/sections/thetwo-way/2015/10/26/452012328/ready-set-drone-walmart-joins-amazon-google-in-testing-delivery-dronesxihttps://onpoint.wbur.org/2015/11/04/amazon-walmart-e-commerce-economyxiihttp://ir.jd.com/phoenix.zhtml?c=253315&p=irol-newsArticle&ID=2096299