Amazon.com Inc. conducts several online businesses such as advertising services, e-readers and kindles, gift cards and co-branded credit cards, among others. The company also deals in a significant number of assorted products that are sold online. Amazon has posted a significant growth in the market and also opened a number of international markets (Amazon, 2016). Therefore, Amazon seems to have quite a favorable base to draw its income. However, to determine its vulnerability to financial distress, it is important to focus on factors that would readily cause it. Financial distress refers to the situation where a company cannot pay, or is experiencing difficulties meeting its financial obligations to its creditors especially because of illiquid assets, high fixed costs, or revenues that arte sensitive to economic downturns.
Amazon financial analysis
One of the factors to consider to determine the vulnerability of Amazon is it revenue flow. Significantly vulnerable companies experience problems increasing their revenues over extended periods, even during good times (Ko, et al., 2009). Over the past three years, Amazon’s total revenue increasing at an estimated rate of 29.01% year on year. Its major competitors such as BestBuy reported a -9.29% decline in total revenue over the past three quarters. Another factor to consider is margin. Mainly, declining companies are characterized by shrinking margins, generally because they are losing pricing power and also because they are forced to drop prices to keep revenues from declining further. Amazon’s net margin is 0.77% against the total cost of 99.23% in terms of profitability. The major competitor’s net margin was reported at 14.76% against a total cost of 85.29%. However, Amazon registered a net income growth of 218.99%, which is significantly higher than that of its competitor of 0.18%. Therefore, this indicates that although the margin is relatively low, it is assumed that the company reported its finances as a going-concern or both Amazon and its competitors are striving to bring the margins down to the general industry averages.
Another important factor that can reflect on a company’s vulnerability to financial distress is the earnings compared to the cost of capital. Mostly, vulnerable companies’ existing assets earn less than the cost of capital (Gepp & Kumar, 2015). Amazon’s weighted cost of capital is estimated at 13.57% while its return on investment (ROI) is 39.03%. Based on the two elements, it is clear that Amazon is making supernormal profits. A weighted cost of capital of 13.57% means that the company would pay its security holders a rate of 13.57%. The company’s market capitalization is estimated at $35309.230 Million, and is sourced from both equity and debts. The weight of the equity is estimated at 0.9717 while that of debt is 0.0283. Therefore, it means that most of its capitalization is generated from equity. If debt is a double-edged sword, mostly declining or significantly vulnerable firms find themselves on the wrong edge. Declining or stagnant earnings from the assets, exposes most declining firms to debt burdens (Outecheva, 2007). However, Amazon is not on this side of the sword because its debt weight is significantly low in its capitalization strategy.
Additionally, the expected cash flows as well as the cost of capital are important factors to determine the vulnerability of a company. Generally, vulnerable companies experience a growth rate that is below the economy’s growth rate and inflation. Sometimes the growth rate can be negative (Ko, et al., 2009). Additionally, companies that are currently earning below their cost of capital with no optimism about the future are considered as vulnerable to financial distress. This is because earning below the cost of capital in perpetuity poses challenges to reinvestment and terminal value (Gepp & Kumar, 2015). The estimated free cash flow for Amazon is $134,498,497,670. The company’s earnings, sales, and free cash flow to equity had a growth of 1% until 2016. The same assumption is held that Amazon will continue to experience the same growth rate. However, this is expected to be influenced by the rate of economy sales as well as inflation rate. Moreover, the company’s return on assets (ROA) is estimated to be equal with its return on equity (ROE). Its ROA is the same as the weighted average cost of capital, which means that the ROE is the same as the weighted average cost of capital. Therefore, since Amazon’s ROE is equal to the cost of capital, it means that the company is not vulnerable to a financial distress.
Analysis of Amazon
The estimated free cash flow terminal value of Amazon is estimated at $134, 498,497,670. This estimation is based on a five year projection of the free cash flows. According to Forbes.com, the current actual market capitalization of Amazon is $292.6 Billion (Amazon, 2016). Based on this comparison, it is clear that that the company’s cash flows for the next five years are almost half of its current value.
Based on the above analysis, Amazon.com Inc. is not vulnerable to a financial distress. The revenues of the company have been increased and are estimated to continue with the same trend. Additionally, its earnings are significantly above the weighted cost of capital. Additionally, although its margin is relatively low, all its competitors are also striving to decline the margin close to the industry’s margin level. Therefore, Amazon does not present any feature of a company that is about to face a financial distress.
Established on its stable financial merits, Amazon.com is a corporation that could be a potential buyer. Since 2004, Amazon’s acquisition strategy is to make small and strategic acquirements. This was set after the massive Amazon and M&A merger turned unsuccessful. Therefore, focusing on Amazon’s current financial stand, it needs to acquire a small but a strategic firm. Amazon should merge with a company with strong leadership, wisdom, and experience to pool diverse cultures while managing the processes of a freshly merged company. The favorable potential acquisition for Amazon is Chegg Inc. Chegg is a company that focusses on online textbook rentals, online tutoring, homework help, internship and scholarship matching. The company specializes in university, college, and high school students. It is headquartered in Santa Clara, California, and was founded in 2005 by two Iowa State University students, Osman Rashid Aayush and Phumbhra Josh Carlson (Morningstar.com, 2016).
This merge between Amazon and Chegg would be a strategic one because both companies would combine their cultures and expertise in the field for a favorable mutual benefit. Chegg has a significantly large customer base, and it is also specialized to students, which further means that it has favorable relationship with its customers. Additionally, it operates on a similar platform with that of Amazon, which means that integrating operations would be simple. In 2012, Chegg reported a revenue stream of 13% from digital streams. By 2015, the company had increased this figure up to 46% (Morningstar.com, 2016). This means that the company has a potential for growth if presented with unlimited resources. This can be done by Amazon because of its positive financial position. Additionally, Amazon is a recognized brand name, which means that merging with Chegg would mean increased sales for Chegg products. Moreover, acquiring Chegg would be consistent with Amazon’s acquisition strategy of merging with small but strategic companies.