By Chirag Gupta (New York University), Chan Seomun (University of Warwick), Callum Magee (University of Glasgow), Seerat Sandhu (Claremont Colleges)
Overview of the deal
Amazon, the world’s largest online retailer with a market cap of $1.513 trillion as of July 2020, raised a total of $10 billion in debt on June 1, 2020, by issuing multiple bonds with varying maturities. The American tech behemoth is offering $1 billion of 0.4% notes due 2023, $1.25 billion of 0.8% notes due 2025, $1.25 billion of 1.2% notes due 2027, $2 billion of 1.5% notes due 2030, $2.5 billion of 2.5% notes due 2050 and $2 billion of 2.7% notes due 2060.
With interest rates tied to Amazon’s credit rating and investor demands, the interest rate of 0.4% set by Amazon is the lowest for any bond in American corporate history, according to the Financial Times. With a record-low yield, Amazon has managed to not only emerge as one of the few firms that succeeded to stay afloat during this pandemic, but the company also saw its $10 billion worth debt offering being oversubscribed by more than 3 times. This overwhelming response indicates the confidence bestowed by the public in Amazon’s ability to perform despite turbulent market conditions.
Macroeconomic Trends
The coronavirus pandemic has imposed lockdown measures and travel bans globally. With lockdown periods ranging from two weeks to many months, there has been a rapid switch in consumer behaviour from conventional shopping methods to e-commerce. A change in consumer sentiments, lengthening lockdown periods and the possibility of a second COVID-19 wave has prompted bulk-buys of essentials through online sources. Businesses such as Amazon with an active e-commerce presence are amongst the few who have achieved substantial growth through the pandemic, as reflected by a 33% increase in Amazon’s web services in Q1 2020 YOY and a rise in subscription services by 28% to $5.56 billion.
The coronavirus pandemic has upended the global economy and numerous businesses. As a result, cash-strapped firms have been seeking opportunities to raise capital in the debt capital markets. Raising capital is especially crucial for firms during the pandemic era, not only to offset lockdown-measures and declining cash flows but also to refinance old debt. With the Federal Reserve pledging to support corporate debt and massive oversubscriptions of debt instruments of big companies across industries, firms not only have the confidence to approach debt markets but also seem to be enjoying an upper hand in terms of price negotiations.
Amazon has come out as one of the biggest winners during the COVID-19 induced aggravated business climate. Normally, when companies borrow money from their lenders, they offer a premium to the existing debts to lure investors. Albeit the conventions, recently, the trend altered. Big firms such as Ralph Lauren and Comcast, who were planning to issue bonds, received orders well in excess of the amount they had initially planned. Larger than expected demand gave them the upper hand in negotiating prices. On the other hand, underpinning both the supply and demand for corporate debts is the Federal Reserve. In March 2020, when COVID-19 cases surged and prompted the crash of the stock market, the Fed pledged to support the market by purchasing large amounts of corporate bonds, even going as far as buying junk-rated debt through ETFs. The Fed’s support has given firms the confidence to tap the debt capital markets but also introduced the biggest buyer to the liquidity-deficit market. Amazon’s concentration on e-commerce business, a sector where its U.S. market share hit 49% in 2018, works to their advantage amid the lingering economic contractions and changing consumer trends.
Company Details
Founded in: July 5, 1994
Headquartered in: Seattle, United States of America Founder and Chairman: Jeff Bezos Number of employees: 935,000
Market Cap: $1.578 trillion
EV: $1.54 trillion
LTM Revenue: $321.78 billion
EV/Revenue: 4.78x
LTM EV/EBITDA: 37.67x
Table 1: Amazon’s Current Capital Structure (Capital IQ)
Bond Details
Table 2: Bond Structure of Amazon (Cbonds)
Table 3: Credit Ratings for Amazon (Capital IQ)
The credit ratings take into account Amazon’s flexibility and ability to work across numerous verticals. Their record of strategic vision and utilization of new growth opportunities results in a positive outlook. Additionally, Amazon’s strengthening operating and financial profile, including better than expected revenue, continuous EBITDA and cash flows growth adds to its current standing. Given the current market scene around ongoing regulatory activity and the company’s long-term growth plans, Amazon has been able to maintain a relatively strong credit profile.
Projections and Assumptions
Why was this deal done?
Amazon is considered to be a major benefactor from the COVID-19 pandemic with a Q1 2020 revenue of $75.5 billion compared to $59.7 billion in the same period last year. However, a surge in demand has been accompanied by a rise in pandemic-induced expenses. Notably, these expenses shaved 30% off the firm’s profits for the first quarter of 2020. Furthermore, since the Fed’s intervention in the markets, interest rates have been maintained at record-low levels. These two factors drove Amazon’s decision to borrow $10 billion from the markets.
Amazon stated how business disruptions due to the pandemic have impacted not only its own business but also that of its suppliers, customers and third-party sellers. Hence, the company has been making adjustments to not only meet increased demand but also to ensure the safety of frontline workers through enhanced cleaning, social distancing, personal protective gear, disinfectant spraying and temperature checks. Some of their initiatives include pledging to pay $500 million in bonuses to front-line workers and delivery partners and installing thermal cameras to monitor warehouse employees fevers. The company has also hired 175,000 seasonal workers and incurred additional costs to ensure contamination-free products to its customers. In order to meet these operating costs, Amazon earmarked $4 billion out of the debt issuance.
Short-term Analysis
Amazon adapted numerous aspects of their logistics, transportation, supply chain, purchasing, and third-party seller processes to better serve its stakeholders in the first half of 2020. Among other actions, beginning in Q1 2020, Amazon extended delivery promises on some products, prioritizing stocking and delivery of essential items. The firm also took measures to moderate other orders, as well as reducing marketing expenses.
“Instead, we expect to spend the entirety of that $4 billion, and perhaps a bit more, on COVID-related expenses getting products to customers and keeping employees safe”
Jeff Bezos, Chairman of Amazon
Separately, AWS could capitalize on a variety of societal trends, including a corporate desire for operating flexibility, possibly through the use of the cloud or other AWS features, and increased working-from-home arrangements. Amazon’s expansive and flexible business model, including its suite of assets in technology, media and logistics, could enable them to strengthen their existing business lines while exploring new avenues for future growth. Amazon’s AWS revenue commitments rose 65% from a year ago and 21% from the last quarter, showing strong demand for its cloud infrastructure service during the pandemic. Debt issued by Amazon is likely to be used to further expand AWS more aggressively than before. After losing contracts to work with the Pentagon (JEDI) to Microsoft, and Deutsche Bank to Google, aggressive marketing tactics are needed if AWS wants to maintain their power in the cloud computing space.
Long-term Analysis
In the long term, Amazon aims to utilize the generated funds for “general corporate purposes.” These could potentially include payments of other debts, buying back stock, acquisitions and other capital expenditures among many others.
The coronavirus pandemic could prove a watershed moment for Amazon's long-term business prospects. The e-commerce channel is expected to become further embedded in consumer shopping patterns, particularly in historically underpenetrated categories like grocery, where Amazon could be a significant player over time. Amazon is expanding its online grocery service, even after their $13.7 billion acquisition of upmarket grocer Whole Foods in 2017, through massive investments aimed at winning more customers in the fiercely competitive U.K. market. Capital raised can be used to cover the costs generated from this expansion, while also aiming to increase capacity into more homes and offer free delivery to Prime members from August, in a bid to accelerate growth. Prime members had been required to pay an additional monthly fee for it’s Amazon Fresh service.
Amazon's expansion has been prominent, whether that be food delivery (Deliveroo), autonomous vehicles (Zoox) and even Low Earth Orbit Satellites. Amazon’s project, known as Kuiper, would see the company launch 3,236 satellites into low Earth orbit in five phases. The $10 billion investment is to enable countries such as India, Brazil and Turkey to have access to broadband where it's unreliable or doesn’t exist at all. However, Amazon stated that broadband services would only begin once it has 578 satellites in orbit. Excess cash from Amazon's issuance is likely to be spent further developing the project to keep up with competitors such as SpaceX's Starlink, and the UK Government and Bharti Global's OneWeb.
“There have been companies that have benefited from this pandemic and Amazon is one of them... You can shop while still abiding by social distancing. They have a lot of goodwill right now”
Monica Erickson, Head of Investment-Grade Corporates at DoubleLine Capital
Financial Ratio Analysis
Table 4: Financial Ratios for Amazon (Capital IQ)
Amazon's EBITDA margins have improved in the past four years. EBITDA Margins increased from 7.4% in 2015 to 12.9% in 2019 largely due to increased margins and significant growth with AWS
Amazon ended 2019 with $52 billion in debt compared with $16 billion in debt at the end of 2016, after the company issued $17 billion in debt in 2017 related to the Whole Foods transaction. Amazon’s short term liquidity profile is consistent and speaks about the company’s ability to manage its operations even during the economic disruptions of the pandemic
The company’s incremental expenses related to the coronavirus pandemic, including wages, cleaning, thermal cameras and reduced operational productivity resulting from social distancing measures at distribution facilities has been well tackled by the company as is evident by the overall financial profile
Risks and Uncertainties
Amazon posted an increase in fulfilment costs in Q2 of 2020 and for the six months ended June 30, 2020, compared to the same periods last year. The increase is primarily driven by increased variable costs corresponding with increased sales volume and inventory levels, costs from expansion of fulfilment network, increased employee hiring, pay and benefits. Also, Amazon posted $4 billion worth of additional costs to implement COVID-19 related measures. The firm expects the ratio of fulfilment costs to net sales to continuously rise through at least Q3 of 2020. This period may be lengthened, depending on factors like a potential second wave of the virus and the development of a potential vaccine. Still, analysts expect the repayment of debts for Amazon will be relatively smooth, citing satisfactory recent financials and the fact that the majority of the firm’s businesses are merely impacted by COVID-19 related issues like lockdown measures.
Worldwide shipping costs were $10.9 billion in the first quarter, a 49% increase from the same period last year. As the pandemic continues, the company will have to figure out how to get much-needed items to customers more profitably. The deluge of orders at a time when Amazon has tried to get enough products to fulfil demand has constrained its Prime one-day delivery promise. Prime orders, which are typically delivered in as little as a day, have sometimes shown month-long delivery windows during the crisis.
Amazon still faces other challenges beyond stabilizing warehouse and logistics operations. Particularly, the Trump administration added several of the company’s overseas websites to a list of “notorious markets” believed to facilitate intellectual-property violations. These factors may have led to Amazon’s international operating loss for the latest quarter. The physical store's segment, which includes Whole Foods, had $4.6 billion in sales for the period, up 7.7% from a year ago. Profit declined 42.6% in its North American unit, which includes the bulk of its e-commerce operations.
The company has been quick to draw criticism on its many questionable business practices involving its monopolistic behaviour, treatment of workers and data breaches. With the five Big Tech companies facing antitrust enquiries, Amazon has been pushed into the spotlight by Congress with reference to its practice of using third-party product data to come up with its own alternative products. This negative publicity poses the risk of unleashing strong customer backlash which could have effects on the company’s value and performance. Outcomes of such an environment could range from no impact to forced operational changes, which in Amazon's case could include a breakup of the company. Fines or other penalties could be levied if the company was found to commit any wrongdoing relative to competitive practices. Amazon has also been facing further scrutiny across the pond, with the CMA backtracking on their approval of Amazons £440 million investment in Deliveroo due to anti-competition concerns.
Will they be able to repay?
Even before the issuance, Amazon already had a fairly strong balance sheet, both in cash and securities. Still, in part driven by the uncertainty generated by COVID-19, the economy is confronting. Securing cash from the capital markets is an ideal method for businesses to prepare for any potential risks they may face in the near future. Amazon’s Altman Z score places it in a safe zone as well. Lower yields on Amazon's debt indicates rising investment into the company, with excess cash supporting strong cash flows, coupled with expansive diversification across industries and resilient perforce in turbulent economic times, portrays a powerful company that's never likely to struggle with paying off its outstanding debt.