Evaluating an Amazon Business During COVID-19
There is no doubt that the COVID-19 period has caused ongoing turbulence in the world of e-commerce. With the outbreak in the US, Amazon froze shipments for certain categories, giving priority to home-related products and products that are essentials under lockdown. Amazon then reopened its delivery service, and consumers under lockdown increased their online purchases to an all-time record rate. Elder populations, who were used to buying in retail stores changed their shopping habits and began shopping online, thus increasing Amazon purchases.
As a result, some Amazon businesses experienced a steep growth in sales, a quasi-“spring-time -Christmas” with a tenfold increase compared to previous years. In contrast, some sellers suffered a temporary decline, either due to delivery restrictions or to their product field (e.g., products in the travel and office supplies fields suffered a decrease in sales, and some completely evaporated).
This extraordinary boost resulted in the entry of investors into e-commerce, as well as an increasing shift of funds to this field. In recent years, there has been a consolidation process of e-commerce stores, with Amazon stores at the forefront. This process has also been taking place in recent months at an accelerated rate, with the entry of new players, working to implement a roll-up strategy in this decentralized market, and acquire Amazon businesses.
In this new and changing reality, where the market is undergoing a shake-up and the sales rate can fluctuate, how do we assess the value of an e-commerce business? How do we factor in the drastic increase, or decrease in sales as part of the valuation process?
How to Evaluate an Amazon Business – The Traditional Way
The traditional formula for valuing Amazon businesses is a profit-based comparison. Thus, these businesses are acquired at a price equal to a multiple of the profit (SDE) for the last 12 months:
However, valuing an e-commerce business is not a “reward” for past performance, but rather an attempt to assess its future performance, and the timeframe for return of buyer investment. But is the traditional formula still relevant in this period of uncertainty?
Flash in the Pan or Something More?
In a business that has experienced significant sales or profit growth during the COVID-19 period, a buyer may argue that the last 12 months are a mere anomaly – an increased and unusual rate of purchases, stemming from a temporary change in consumer behavior, rather than a reflection of future sales. In some cases, however, there are clear indications of a continued increase in growth. For these businesses, alongside the increased sales, there is a sustainable growth in positioning and reputation that will continue to serve the business in the long term.
For example, many listings received an unusual “boost” during the beginning of the COVID-19 period: Listings with a small number of reviews (sometimes even recently launched listings), have accumulated hundreds and even thousands of reviews in a short time span. The result was clear: these listings have changed, they have more reviews, a higher entry barrier for competitors, increased sales, and the business is no longer the business it was prior to COVID-19. As a result of the accelerated growth, multiples previously used in the field reflect a significant acceleration in ROI.
In a business that has experienced a decline in sales or profit during the pandemic, a seller may argue that the last 12 months do not reflect the value of the business, as a decline in demand for certain products is only temporary and does not reflect the business’ sales potential. On the other hand, in light of the fear of economic instability in the markets and a possible recession, one cannot determine the point in time of a return to the growth for these businesses, if at all.
Assessing Your Business in a COVID-19 World
As mentioned, the valuation practice deals with “predicting the future”, so we must try and understand whether these are short-term and temporary changes, or changes that will affect the business over an extended period of time. To that end, we propose to answer the following questions regarding business performance from the beginning of 2020 (the beginning of the COVID-19 effect):
1) Has there been an unusual change in the sales or profit trend (from increase to decrease or vice versa)?
2) If there is a change – is it moderate or significant (over/under 30%)?
3) How has the change unfolded since the beginning of 2020? Has the account returned to its previous state or to its pre-epidemic trends?
4) Has the change that has occurred yielded long-term realizable assets? These assets can be, for example, better rankings, listings with a larger amount of reviews and sales or other products that have been successfully launched.
5) What is the performance of the business in the pandemic period in relation to the performance of competitors in the same category?
6) If there is a change in profitability – what are the reasons for this change and is it sustainable?
Has the Pandemic Drastically Changed Your Business? You Still Have Options
If the changes are only temporary or moderate, the traditional formula can be used as a basis of the valuation. If these changes are significant, or if the parties are uncertain regarding the consequences and sustainability of these changes, they can be balanced through different transaction models. And indeed, the market in this period adopts such models such as these:
1. Earn-out model
An earn-out model is a transaction that is performance-dependent, and in which part of the payment (about 10%, for example) is not paid to the seller at the closing date of the deal, but in the period thereafter (one or two years, usually). Sometimes a threshold of profit or sales is set, above which the seller will receive a certain percentage. In some cases, a maximum amount is set for this component (ceiling) and sometimes it is unlimited. An inherent pitfall in this model is that the business and its management has changed hands, and the seller is required to trust the buyer’s performance. However, this reward component can reflect a good solution to uncertainty for both parties to the transaction – the buyer seeking to achieve higher certainty in relation to the investment he made, and the seller seeking to benefit from the continued growth of the business while realizing the value they created.
2. Valuation per product
A valuation model in which different products will obtain different multiples. The buyer will examine each product/listing in the account, and evaluate it separately, depending on its performance and its relative part in the business. A product in decline will not receive the same multiplier as a “rising” product, or a product with flat sales. This model allocates specific attention and treatment to products affected by the pandemic.
3. Stabilization payment
A model in which part of the payment is conditional on a minimum of income or profit. If there is a decrease in the performance of the business, the seller will not benefit from this payment (or will partially benefit from it). This is to protect the buyer from a drastic reduction of the account value after the purchase, and it constitutes a partial transfer of the risk to the seller.
We will illustrate the considerations and models using a number of examples.
Earn-Out Model Example
In a transaction that began in February 2020, the parties reached an agreement on the sale price of the business (pre-COVID-19), and signed a Letter of Intent. Then, with the outbreak of the pandemic, sales and profit suddenly increased considerably and reflected a ten-time increase compared to last year. Two months later the sales decreased a little, to reflect a five-time increase, and a month later they went down to twice, compared the previous year. It became clear that the business would not return to its norm: listings that included only several reviews developed into strong listings with hundreds of reviews. Profitability increased significantly due to a reduced need for advertising, as characterized by the market as a whole during this period.
The entire business seemed to be better positioned for a sales growth, yet there was no certainty regarding the ability to sustain the profit capability achieved during the pandemic period. The product in question was adapted to the COVID-19 period, so apparently its growth would come to a halt, but on the other hand, the exposure to its benefits had increased and with it the expectation for its continued growth. In this case, after an in-depth analysis of the account, the parties agreed to add another “earn-out” component. Beyond the basic payment paid to the sellers at the closing of the transaction, it was agreed that any profit beyond the profit of the last 12 months (up to the date of the LOI, before the start of the pandemic), will be divided equally between the parties over two years. Thus, if the business is indeed strengthened in a stable manner (and hence the investment will be repaid to the buyer faster) – both parties will benefit from this increase. If the increase turns out to be temporary and the profit doesn’t exceed the profit of the last 12 months – the terms of the original deal would not change.
Valuation Per Product Example
In another case, about two months ago, we were engaged in the sale of an Amazon business in which one product, relatively significant in the seller’s account (represented about 30% of sales), experienced a significant decrease in sales, due to the pandemic lockdowns. The product was not suitable for periods of closure and social distancing, and its sales plummeted. In contrast, sales of other products in the account increased significantly.
In light of this decrease, buyers have offered to purchase the business at an overall low multiple, which factors-in sales trends of all the products in the account. Instead of such overall multiple, we suggested conducting a separate and individual analysis of the performance of each product, including sales and profit trends. And indeed, in relation to all the products of the account, with the exception of the product in decline, the parties have agreed on a fair and suitable multiple, reflecting the account’s excellent overall performance.
In relation to the affected product only, the terms were different: the seller will receive an upfront lower multiple, yet the parties have defined certain KPIs that can potentially “cure” the affected product, and can earn the seller an additional payment to match the multiple of all the other products. This adjustment allowed for a fair deal, which depends on the development of the sales trend.
Stabilization Payment Example
Alongside these cases, we have dealt in recent months with cases in which we felt that the traditional formula was adapted to the business: although these businesses have grown nicely (about 30-40%), it seems that the upward trend continues and is not exceptionally sharp. For businesses that have recently fallen flat and have not yet recovered, we have suggested to postpone the sale until the business recovers, and until it has proven to be stable.
So… What is my Business Really Worth?
In conclusion, valuation strives to weigh-in the risks and rewards of the business in the foreseeable future. Therefore, we cannot point to a single correct and just approach for each case, especially when it comes to uncertain conditions. It seems that today more than ever a hybrid approach is required, which combines the traditional valuation formula and different models that fit each case according to its circumstances.
Either way, there is no doubt that the market is the best source of information for the value of a business at any given time. Be the valuations as they may – the business is worth what the market is willing to pay for it. Therefore, if the sellers have presented their business to all the relevant buyers (or at least the vast majority) during the sale process – they should receive the right value at the time of the sale.
The Authors, Yael Cabilly and Michal Oron are the Founders of Fortunet, an investment banking firm that specializes in the sale of mid-large Amazon businesses.