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July 24, 2009

Analysis and retailer impact of Amazon's acquisition of Zappos

At ChannelAdvisor, we've been fielding lots of questions around the implications of Amazon's acquisition of Zappos.  We've talked to a variety of retailers of all sizes and have some interesting perspectives to share and some integration scenarios to consider.

First, I wanted to provide an analysis of the acquisition  parameters and some of the tidbits that have come out you may not have seen yet.  Then we want to examine the 'why' of the acquisition to make sure everyone thinks about what's driving Amazon's thinking on the transaction.  Finally, we'll look at some of the possible integration scenarios and the implications for third-party sellers and internet retailers in general.

Zappos/Amazon M+A Analysis and Tidbits

There have been some interesting aspects of the acquisition that have come out that I haven't seen aggregated anywhere yet, so here they are:
  • From a revenue perspective, there is a lot of confusion out there about Zappos' revenues (specifically '08).  You see the $1b figure thrown around a lot.  But I've found several examples that say it was $600m.  This is important because one of the valuation metrics that pure-play ecomm companies look at is the revenue multiple.  To get some clarity on this, I talked to someone close to the transaction and learned: 
    • Zappos' GMV was $1b 
    • Zappos'  Revenue was around $625m
    • What's the difference? For most retailers GMV/revenue are one and the same.  Zappos isn't running an eBay-esque marketplace where revenue is derived (via a take rate) from GMV, so what gives?    
    • Turns out that Zappos' return rate is so high that the $375m difference in there is all returns (WOW!!).  So clearly Zappos pays dearly for their '365 free return shipping' policy, to the tune of a 37.5% return rate.   Keep this in mind because we'll circle back to this returns topic in the integration scenarios section.
    • While these are all '08 numbers, analysts I talk to see modest 08/09 growth  somewhere in the 15-20% range
    • If you use the $625m number, that puts the acquisition at the 1.3x revenues range which is better than the .8-ish you get with the GMV number. 
  • This is Amazon's largest acquisition ($850m-900m) - it is mostly stock and some cash ($40m)
    •  Scuttlebutt is that Zappos felt Amazon's stock is undervalued so wanted mostly stock to get some upside in the deal. 
  • Amazon paid 35-40x EBITDA, compared to their valuation of 25x CY09
  • Be sure to read Tony Hsieh's letter to employees here. Zappos will continue to operate independently
  • Zappos has 8m customers - 75% return regularly
  • The Zappos AOV (Average Order Value) is a whopping $130 vs. Amazon's $22
  • Amazon will have to collect taxes in NV now.
  • If you haven't seen the Bezos' video on the Zappos M+A, be sure to watch it here.  Bezos talks about the customer-centricty of Zappos making his knees go weak.
  • In the entrepreneurial/startup community, there is a lot of chatter that Zappos' investors (Sequoia/Mike Moritz specifically) forced Zappos to sell and the CEO was interested in staying independent, but no longer called the shots.  This makes for a wee bit of a soap opera outside of the topics covered here, but if you are interested here are some jump off points:
    •  PEHub (newsletter for private equity/VCs) - started with this piece that  pretty clearly says: "Moritz and Zappos CEO Tony Hsieh came into conflict about the company’s future. Moritz, the sources say, wanted Zappos to sell while Hsieh wanted to remain independent."
    • Zappos issued a statement saying that's not true at all here in the WSJ.   Highlight: "The articles and rumors of Sequoia forcing us to sell are simply not accurate."
    • Others are speculating that Zappos was losing $ with the recession and an increase in it's return rate from 37% to 50% and could not raise $ so was forced to sell.  This is all ecommerce water cooler talk and I don't have anywhere in 'print' to point you to.
  • I'm actually more interested to learn if there were other bidders (eBay?), but haven't been able to dig that out - if anyone knows drop me a line or if I find out, I'll be sure to update everyone.

The above analysis and tidbits should lay the framework for a deeper dive into the reasons for the union and the potential impact on retailers.


The 'Why' of Amazon+Zappos

To understand the integration scenarios and their impact on retailers, let's look beyond the financials and think about Amazon's probable thought process in the transaction:

  • Shoes are a $40b category (online and offline) and comscore reports that online apparel in 08 was $23b.  While Amazon doesn't disclose their apparel/shoe sales, they are definitely much smaller than Zappos. Thus this creates a clear leader in the category and gives Amazon mass in a third category (media, electronics, apparel).
  • Amazon's CFO said on the conference call last night: "...this (the Zappos acquisition) is not about synergies. This is about growing in categories that we think are interesting.”
  • Amazon did $4m in 08 revenues in EGM (non-media categories) - Zappos' approx $1b in GMV grows this 20% overnight.
  • Also, Zappos was a large competitor to Amazon's apparel business and forced them to come out with www.endless.com to counter the threat.  According to compete.com, Zappos has about 6m visitors/m and endless is stuck in the 1m range.  While amazon says they won't close this, they can definitely stop spending marketing dollars on it so there's going to be some savings there.
There are also some shipping synergies.  By injecting the Zappos' approx 10m shoe shipments into the Amazon fulfillment engine, Zappos could save as much as $1/shipment which would effectively grow their profits by 50%.  I also wonder if Amazon has any interest in the Zappos robotic fulfillment system and would consider moving that into their fulfillment centers to increase efficiency.

Some have suggested that one driver could be Amazon wanting to sell prime to the Zappos audience. That doesn't make sense to me as with the Zappos free shipping model, why do you need Prime at all?  I don't think Amazon would mess around with the Zappos model and move to something like normal S+H, free with Prime.

The bottom line is Amazon gets a potentially 4-win scenario here: (1) good valuation, (2) eliminate a growing competitor, (3) grow EGM 20%, and (4) cement a leadership position on a big category (shoes+apparel).


Implications for other retailers in general

I keep in touch with the founders and CEOs of most of the independent private 'pure play' ecommerce companies and initially there was a lot of concern around the valuation.  Amazon buying Zappos for less than 1x sales was a big concern.  Hopefully the clarification I was about to find on the difference between GMV/revenue which bumps things up to 1.3x and the EBITDA multiple was healthier and helps folks look at the valuation in a more positive light.

Buy-side analysts (institutional investors in the sector) I've talked to frequently mentioned they are bummed that Zappos won't be on the IPO trail. This is interesting and I asked more about it, here's the general thought process from the buy-side:
  • ecommerce is on a 20% growth path into the foreseeable future as sales move from offline to online.
  • There are really only a couple of 'pure play' companies to play the trend: Amazon, eBay, Blue Nile (NILE), Overstock (OSTK), GSI (GSIC) and Digital River (DRIV).
  • Each of these has reasons that some institutions don't want to play or overinvest there (too vertically focused, too diverse, etc.)
  • Thus, I get the sense that institutional investors would love to see some more opportunities to play different ecommerce categories and get into smaller, potentially faster growing, ecommerce companies.
So in a way, by taking Zappos out of play for the IPO market, Amazon could have actually cleared the decks for a couple of other companies that are at the right scale+trajectory to get out (buy.com, art.com, ebags.com, newegg.com are names frequently mentioned) to make their public debut.

Bottom line: There are no negatives and maybe a slight silver lining here.

Implications for other retailers selling on Amazon via Merchants@/3P

The bulk of questions we've received from retailers are around possible integration scenarios and what they mean for sellers selling shoes/apparel on Amazon via Merchants@.  We've been walking folks through a couple of integration scenarios and then discussing the likelyhood and risk of each.  That's a good framework to work with so here are three different integration scenarios to consider.  Of course, there are near infinite combinations of these things, but at a macro level here are the three we think about:

Scenario 1- Light Integration
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In this scenario (which appears to be the path the companies are thinking about given Tony's post and Bezos video comments) there maybe light integration.  In the backoffice, certainly there will be easy synergies to be had that we've already discussed around fulfillment, customer sharing, etc.  On the consumer-facing side, I think the elements of a light integration would be what I would call 'traffic sharing' such as:

  • Amazon keeps the current shoe category and endless.com, but routes traffic to Zappos when appropriate.  For example, if you go to Amazon.com and search for a "new balance xx' shoe and they don't have it, Amazon is strongly incented to send you to Zappos or even to pull some of that inventory over and say: "available from Aappos".  To be clear, Zappos would backfill the Amazon existing shoe experience, not replace it in this scenario.
  • Conversely if someone is on Zappos and searches for something - say a Kindle to use an extreme example, that traffic should be 'routed' to Amazon, again through backfill.
  • The customer bases could be moved over to a common platform (Amazon).

Light integration is easy (for Amazon+Zappos) because it is 100% additive (no cannibalization at all) and doesn't change the structure of anything (e.g. Zappos is still free ship, generous returns, Amazon is still Amazon).

Scenario 1 impact: net neutral - not much impact to 3P sellers if this is the level of integration.  Likelyhood is high.

Scenario 2 - Deep integration
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This is the scenario probably most concerning to retailers that currently sell on Amazon.  There are a couple of flavors:

  1. Amazon completely nukes the shoe category and it becomes 100% Zappos.  Clearly if you sell shoes on Amazon you'd be effectively out of business in that channel.
  2. Zappos comes into Amazon as a third party -Sellers worry less about this one and many view it as a possible positive, here are some reasons why:
    • Zappos doesn't really discount, in fact they are generally 10-20% more expensive than other shoe retailers because of the big $$ in returns+customer service
    • Thus if you are a shoe retailer that can undercut Zappos, this could actually create a 'wave' you can ride.
    • By filling out Amazon's catalog, but at higher price points, Zappos on Amazon via 3P would be an opportunity for discounters, but a bad situation for in-season non-discount shoe retailers.

Scenario 2 impact: well if they shut off Amazon shoes, very high (but not likely IMO).  If Zappos sells on Amazon via 3p, then medium/low to possibly positive impact, depending on the retailer's business model.  If you are a shoe liquidator, you are probably ok here.  If you are a in-season shoe retailer, this could be bad, time to seek out other channels.

Scenario 3 - Returns integration
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It's not clear what Zappos does with the nearly $375m/yr returns (call it $30m/m) that they receive.  I'm sure there's some sorting that goes on and a large portion of those are sold again as new, but I'm sure a good chunk (30-50%) are not resold on Zappos as new.  Today, Zappos liquidates via a site they operate called www.6pm.com so I imagine a fair amount of that product goes through there.

My guess is they were looking at eBay as another 'returns liquidation' option (see below) and I think the worst case integration scenario for many 3P sellers is that they dump a lot of these goods on Amazon through 3P.  That would be pretty devistating for the current 'off price' 3P merchants and is something we'll keep an eye on.

Scenario3 impact - potentially bad for off-price 3P merchants, not bad for in-line 3P merchants.


Zappos and eBay

Quick one - Day 1 if I'm Amazon, I get rid of Paypal and BML as payment options.  For those readers that follow eBay as well, this is a small negative for eBay to lose a $1b merchant overnight on two of their payment offerings.

The definite positive of the Amazon+Zappos deal is it's clear that Zappos will not be selling on eBay.  Many eBay shoe sellers were concerned when Stephanie Tilenius (apparently jumping the gun) announced Zappos was coming to eBay in a big way at Internet retailer.  Earlier in July, Zappos told Auctionbytes: "We did a small test on eBay but are not currently planning on moving forward with it."  We monitored the test and the seller ID has been mysteriously deleted recently. Hmmmm.

Sellers were concerned that Zappos would take a big chunk of that $375m/yr returns and sell them on eBay in a liquidation kind of a model that would be tough to compete with.  eBay shoe sellers are now breathing a collective sigh of relief because It's now crystal clear that Zappos and eBay won't be working together.  That being said, it will be very interesting to see where the massive Zappos return stream ends up and that will drive any negative impact on third-party sellers.

What do you think?

We'll keep you posted on any new news or scenario implementations we see as the deal closes - please feel free to share your comments, opinions and thoughts on the merger in comments.

SeekingAlpha Disclosure - I am long Google and Amazon, eBay is an investor in ChannelAdvisor

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