Entrepreneurial Finance

ENTREPRENEURIAL FINANCE : Strategy, Valuation, and Deal Structure EF 2 -1 Case Study Amazon.com, Inc. – Early Development and Financing At age 31, Jeffrey Bezos resigned his position as Senior Vice President of D. E. Shaw & Co., a Wall Street in vestment firm, to found an Internet venture. Bezos, who holds a B.S. degree in Electrical Engineering and Computer Science from Princeton University, had been searching systematically for a way to participate in the growth of retailing on the Internet. A fter considering a number of alternatives, he settled on the idea of establishing an online bookstore. Overview Amazon.com was founded in Seattle, Washington in July 1994 with an initial investment of $10,000 by Bezos. The entire first year of the vent ure’s existence was devoted to development of infrastructure: designing the website, establishing relations with distributors, developing software to manage book orders and deliveries, designing a search engine, and developing the software to manage the ca sh flow of the venture. For the most part, development efforts were performed by Bezos, himself. Amazon.com opened for business on the Internet in July 1995, billing itself as “Earth’s Biggest Bookstore.” The Company offers over 2.5 million titles, incl uding most of the 1.5 million of the English -language titles currently in print. By contrast, even the largest traditional bookstore does not carry more than 175,000 titles in inventory. The Company’s objective is to become “the leading online retailer o f information - based products and services, with an initial focus on books.” Amazon expects to compete against traditional bookstores by offering books that are in high demand at discount prices that are difficult for the traditional bookstores to match an d by offering convenience and information that cannot be duplicated by traditional bookstores. Amazon’s reliance on the Internet affords it a cost advantage that cannot be duplicated by traditional bookstores. The Company hopes to compete against the potential emergence of competition of other Internet book sellers by building customer loyalty, maintaining technological leadership, building a strong brandname, being strongly service -oriented, and capitalizing on incremental revenue opportunities. Since the range of services is always changing, the best way to understand the Company’s strategy is to visit its website, http://www.amazon.com/ . The retail book market is large and growing. By the year 2000, annual U.S. book sales are projected by Euromonitor to reach $30 billion and worldwide book sales are projected to reach $90 billion. The two largest U.S. retailers account for less than 25 percent of the U.S. market. Amazon.com views its market as world -wide. As of year end 1996, the Company had approximately 180,000 customers and was receiving regular book orders from more than 100 countries. 2 Financing Exhibit 1 contains a chronology of Company financing from 1994 through early 1998. Exhibit 2 contains a summary of the financial statements of Amazon.com during the Company’s early years of operation, and for the first quarters of 1997 and 1998. 1 The Company has a December 31 fiscal year end so the statements do not reflect the effect of the debt restructur ing in May of 1998. 2 Also, in April 1998, the Company announced that it acquired three Internet companies: Bookpages Limited (in the United Kingdom), Telebook, Inc. (in Germany), and Internet Movie Database Limited. The acquisitions were made in exchan ge for 540,000 shares of common stock and the Company incurred $55 million in charges associated with the acquisisions. Status As of summer 1998, Hoover’s Online ( http://www.hovers.com/ ) reports that Amazon.com has customers in more than 150 countries and all 50 states. The Company is integrating into online sales of music and video. Jeffrey Bezos and family members own 48 percent of the Company, and two Kleiner Perkins Caufield & Byers venture capital funds own 1 2 percent. In total, 42 percent of the stock is owned by institutions. With an annual salary of $79,197, Bezos is among the lower paid members of the management team. The IPO occurred in 1997 and was priced at $18 per share. In April 1998 the Company announced a 2 for 1 stock split. The closing stock price of Amazon.com on July 2, 1998 was $124 per share (after the split), resulting in a market capitalization of $6.1 billion. The stock price was 28 times annual sales revenue for the prior 12 months and 310 times book value per share. Exhibit 3 shows the price performance of Amazon.com stock from the IPO in 1997 to July 1998. 1 Per share figures in Exhibit 2 reflect a 2 for 1 stock split after the end of the first quarter of 1998. Per share figure in Exhi bit 1 are adjusted for the split. 2 The IPO prospectus and the 1997 10 -K are available in the Resources file for this case. Exhibit 1 Summary of Financing Activities of Amazon.com Date Amount Terms July 1994 $10,000 From Jeffrey Bezos, in exchange for 10,200,000 shares of common stock ($.001 per share). 3 July 5, 1994 $15,000 Interest -free loan from Jeffrey Bezos. Repaid August 1995. November 1994 $29,000 Interest -free loan from Jeffrey Bezos. Repaid April 1995. November 1994 Jeffrey Bezos pe rsonal guarantee of obligations to Seafirst Bank. February 9, 1995 $100,000 From Miguel Bezos (father of Jeffrey), in exchange for 582,528 shares of common stock ($.1717 per share). April 1995 Jeffrey Bezos personal guarantee of Company credit cards. July 1995 Jeffrey Bezos personal guarantee of obligations to Wells Fargo Bank. July 24, 1995 $145,500 From Gise Family Trust, Jacklyn Gise Bezos (mother of Jeffery), Trustee, for 847,716 shares of common stock ($.1717 per share). August 7, 1995 $5,408 An employee , for 42,000 shares of common stock ($.1287 per share). November 1995 $40,000 Interest -free loan from Jeffrey Bezos. Repaid November 1995. December 6, 1995 $50,000 From Tom Alberg, preferred shares convertible to 150,000 shares of common sto ck ($.3333 per share). Alberg became a Company director in June 1996, and a senior officer of both McCaw Cellular and LIN Broadcasting until October 1995, when they were acquired by AT&T. May 1996 $117,200 To family member at price established in Decembe r 1995 ($.1717 per share). May 3, 1996 $20,000 From Mark Bezos and Christina Bezos Poore (siblings of Jeffrey), for preferred shares convertible to 60,000 shares of common stock ($.3333 per share). 3 If the Company proposes to register any of its securities for its own account or the account of other security holders, Jeffrey Be zos has the right to include shares in the registration at Company expense. The underwriter, in a public issue, may limit the number of shares in such a registration. 4 December 6, 1995 To May 16, 1996 $937,000 From 20 other investors as a private placement, for preferred shares convertibile to 2,811,000 shares of common stock ($.3333 per share). Average investment, $46,850 per investor. June 21, 1996 $8,000,014 From two venture capital funds managed by Kleiner Perkins Caufi eld & Byers, for 569,396 shares of preferred stock, each share convertible to 6 shares of common stock, (at a value per common share of $2.3417). 4 January 1997 and February 1997 $200,000 Equally from Scott D. Cook and Patricia Q Stonesifer (new member s of the Amazon board) , for 30,000 shares of convertible preferred stock, (at a value of $6.6667 per common share). 5 May 15, 1997 $49,100,000 Net proceeds of initial public offering of 3,000,000 shares at $18.00. All outstanding preferred stock was conv erted to common at the time of the IPO. 6 December 23, 1997 $75,000,000 Senior secured variable rate term loan at LIBO R plus 4% or a comparable rate, and with warrants to purchase 750,000 shares of common stock at an exercise price of $52.11 per share. Ma y 8, 1998 $326,000,000 Public issue of 10% Senior Discount Notes due 2008 (sold at discount from $530 million par value, with no interest payments to be made until 2003). Proceeds used to retire $75 million of existing debt (including cancellation of warr ants) and for other purposes. 4 In connection with the preferred stock investment, L. John Doerr, and General Partner of Kleiner Perkins Caufield & Byers joined the board of Amazon.com. If the Company proposes to register any of its securities for its own account or the account of other security holders, KPCB has the right to include shares in the registration at Company expense. In addition KPCB has demand registration rights, pursuant to which it may require the Company to file a registration statement. The underwriter, in a public issue, may limit the number of shares in such a registration. 5 Scott Cook, co -founder of Intuit, joined the board in January 1997, and Patricia Stonesifer, an independent management consultant, joined in February 1997. 6 In addition to the listed transactions before the IPO, the company issued 2,136.444 shares at various times to licensees or through exercise of stock options, bringing the total outstanding after the IPO to 23,858,702 common shares. Exhibit 2 7 Summary of Amazon.com Inc. Financial Statements Annual Information (Thousands) 1997 1996 1995 1994 1998 -Q1 1997 -Q1 Statement of Operations Net Sales $147,758 $15,746 $511 $0 $87,357 $16,005 Cost of Sales $118,945 $12,287 $409 $0 $68,054 $12,484 Gross Profit $28,813 $3,459 $102 $0 $19,303 $3,521 Operating Expenses Marketing and Sales $38,964 $6,090 $200 $0 $19,503 $3,906 Product Development $12,485 $2,313 $171 $38 $6,729 $1,575 General and Administrative $6,573 $1,035 $35 $14 $1,963 $1,142 Total Operating Expenses $58,022 $9,438 $406 $52 $28,195 $6,623 Gain (Loss) from Operations ($29,209) ($5,979) ($304) ($52) ($8,892) ($3,102) Interest Income $1,898 $202 $1 $0 $1,640 $64 Interest Expense ($279) $0 $0 $0 ($2,025) $0 Net Loss ($27,590) ($5,777) ($303) ($52) ($9,277) ($3,038) Shares (fully diluted and adjusted for 2 for 1 spl it) 43,302 37,088 28,786 26,382 46,622 38,804 Gain (Loss) per Share ($0.64) ($0.16) ($0.01) ($0.00) ($0.20) ($0.08) 7 An Excel file of this figure is available. 6 Annual Information (Thousands) 1997 1996 1995 1994 1998 -Q1 1997 -Q1 Balance Sheet Data Cash and Equivalents $109,810 $6,248 $996 $52 $98,600 $109,810 Working Capital $93,517 $2,270 $920 ($16) $84,415 $93,517 Total Assets $149,006 $8,271 $1,084 $76 $145,007 $149,006 Long -term Debt $76,702 $0 $0 $0 $76, 702 $76,702 Stockholders' Equity $28,486 $3,401 $977 $8 $19,827 $28,486 Assets per Share $3.44 $0.22 $0.04 $0.00 $3.11 $3.84 Equity per Share $0.66 $0.09 $0.03 $0.00 $0.43 $0.73 7 Annual Information (Thou sands) 1997 1996 1995 1994 1998 -Q1 1997 -Q1 Statement of Cash Flows OPERATING ACTIVITIES Net Loss ($27,590) ($5,777) ($303) ($9,259) ($3,038) Depreciation and Amortization $4,742 $286 $19 $1,975 $683 Changes in Oper. Assets and Liab. Inventories ($8,400) ($554) ($17) ($2,703) ($368) Prepaid Expenses ($2,977) ($307) ($14) ($1,101) ($616) Deposits ($20) ($146) ($127) ($47) Accounts Payable $29,845 $2,753 $99 $1,677 $2,798 Acc rued Advertising $2,856 $598 $0 $1,895 $656 Other Accrued Expenses $5,066 $1,412 ($16) $1,088 $1,135 Net Cash Used in Operations $3,522 ($1,735) ($232) ($6,555) $1,203 INVESTING ACTIVITIES Net Purchases of Short -term Inve stments ($15,256) $0 $0 ($2,999) $0 Purchases of Fixed Assets ($7,221) ($1,214) ($52) ($2,071) ($926) Net Cash Used in Investing Activities ($22,477) ($1,214) ($52) ($5,070) ($926) FINANCING ACTIVITIES Proceeds of Initial Public Of fering $49,103 $0 $0 $0 $0 Proceeds from Sale of Common Stock or Options $518 $231 $1,272 $415 $437 Proceeds from Sale of Preferred Stock $200 $7,970 $0 $0 $200 Proceeds from Borrowing (Repayment) $75,000 $0 ($44) $0 $0 Finan cing Costs ($2,304) $0 $0 $0 $0 Net Cash from Financing Activities $122,517 $8,201 $1,228 $415 $637 Increase in Cash and Equivalents $103,562 $5,252 $944 ($11,210) $914 8 Exhibit 3 8 Stock Price Performance of Amazon.com 8 An Excel file of this figure is available. 0 20 40 60 80 100 120 140 160 5/16/1997 6/6/1997 6/27/1997 7/18/1997 8/8/1997 8/29/1997 9/19/1997 10/10/1997 10/31/1997 11/21/1997 12/12/1997 1/2/1998 1/23/1998 2/13/1998 3/6/1998 3/27/1998 4/17/1998 5/8/1998 5/29/1998 6/19/1998 7/10/1998 7/31/1998 Stock Price Adjusted for 1998 2 for 1 Split 9 Refer ences Amazon.com Form S -1 filed with SEC March 24, 1997. Amazon.com Prospectus dated May 15, 1997. Amazon.com Form 10 -K for the year ended December 31, 1997. Amazon.com Form 10 -Q for the quarter ended March 31, 1998. Yahoo Finance for Amazon listing. 10 Dis cussion Questions 1. What milestones do you think would have been appropriate for Amazon.com to establish for itself to help evaluate the merits of the venture and to attract outside funding? 2. How would you characterize the various stages of development that the Company has gone through up to this point? How do you distinguish among the various stages? 3. What stages of financing has the Company gone through? How do the financing stages correspond to the milestones you identified in question 1, and the develop ment stages in question 2? 4. How has the valuation of the Company changed over time? What roles do the special terms play in the venture capital financing and in the private debt issue? 5. Consider the IPO in the summer of 1997. Why do you think Amazon.com decided to do a public offering at that time? Why do you think investors were receptive to the offering? 6. In general terms, what do you think of the price of Amazon.com stock as of July 1998? What sorts of product market performance will the Company need to achieve to justify the price? Can you think of any reasons for the rapid increase in price beginning in June of 1998?