Everyone knew it was coming, but the long-anticipated Federal Trade Commission (FTC) lawsuit against Amazon (AMZN 2.19%) was finally announced. Amazon stock dropped by 4% on the news. While this may spook some investors, is this something to panic about? Or should investors embrace what's coming?
As an Amazon shareholder, I have some thoughts on what investors should be doing, and they may surprise you.
The lawsuit won't be resolved quickly
The FTC and 17 state attorneys contest that Amazon uses unfair practices to maintain a monopoly, including suppressing sellers offering lower-priced items in its search results, conditioning sellers to become Prime eligible, biasing search results to show preference for Amazon brands, and levying excessive fees on sellers.
However, the question is whether these practices (if found to be true) add up to anti-competitive practices. After all, earned monopolies aren't technically illegal, as the FTC defines monopolies like this:
Obtaining a monopoly by superior products, innovation, or business acumen is legal; however, the same result achieved by exclusionary or predatory acts may raise antitrust concerns.
Even though other e-commerce companies exist, Amazon certainly stands on top. But the question is, how did it get there? As alleged by the lawsuit, Amazon achieved its monopoly through antitrust practices.
Leading this lawsuit is Lina Khan, who has long been a critic of Amazon. Before becoming FTC chair, she wrote a paper on Amazon's alleged anti-competitive practice, so it shouldn't surprise anyone that this suit was coming. However, proving anti-competitive cases isn't easy, and the most likely outcome of this lawsuit is a change in business practices plus a fine.
But what happens if Amazon is actually broken up? Let's take a look.
Amazon may be worth more broken up
Valuing a company by its parts is useful when looking at a giant like Amazon. With multiple allegations against Amazon, it would make sense to separate the businesses that may have conflicts of interest with each other. To me, it would make sense to break Amazon up into four parts.
- Online and physical stores plus subscription services
- Third-party seller services
- Advertising
- Amazon Web Services (AWS)
This would separate the businesses the FTC alleges are harming consumers, but they would still be monstrous.
| Business | Trailing-12 Month Revenue |
|---|---|
| Online and physical stores plus subscription services | $279.4 billion |
| Third-party seller services | $127.4 billion |
| Advertising | $41.3 billion |
| Amazon Web Services (AWS) | $85.4 billion |
Data source: Amazon.
Valuing these segments is tricky, as there aren't great direct comparisons for any of these. But I'll apply the valuations from these businesses to Amazon's to value them. Walmart is probably the best comparison for online and physical stores, which trades for 0.7 times sales. Third-party seller services is similar to Shopify, which trades at 11 times sales, but Amazon's product is less software-based, so this valuation needs to be reduced significantly to reflect the margin profile. As a result, I'll reduce the valuation by about two-thirds to 4 times sales. Advertising is similar to Alphabet (5.9 times sales), as most of its business involves placing ads directly in front of consumers. AWS is best compared to another cloud infrastructure provider like Cloudflare, which trades for 18 times sales.
However, the problem with assigning these valuations is that revenue growth is heavily factored into comparison companies. For advertising, Amazon's ad segment is growing at 22% versus Alphabet's 7%. Conversely, AWS only grew by 12% versus Cloudflare's 32%. As a result, I'll increase the advertising valuation to 8 times sales and decrease AWS's valuation to 10 times.
After this, we can see what Amazon's businesses might be valued at.
| Business | Trailing-12 Month Revenue | Valuation (Price-to-Sales) | Market Cap |
|---|---|---|---|
| Online and physical stores plus subscription services | $279.4 billion | 0.7 | $196 billion |
| Third-party seller services | $127.4 billion | 4 | $510 billion |
| Advertising | $41.3 billion | 8 | $454 billion |
| Amazon Web Services (AWS) | $85.4 billion | 10 | $854 billion |
Data source: Amazon and YCharts.
Once again, this is just my analysis, and I had to make multiple assumptions to come to these conclusions. But one item that isn't an assumption that most investors already know is that the e-commerce part of Amazon isn't what's the most valuable. Should the FTC break Amazon up, I could buy the best parts of Amazon's business while tossing out the e-commerce wing.
While I doubt a breakup will occur, the stock still looks attractive as is. If you add up the hypothetical valuation of Amazon's business segments, you'd get $2 trillion, far above Amazon's $1.3 trillion market cap.
As a result, I think investors should use the weakness caused by the uncertainty of the lawsuit to buy Amazon stock. As my analysis shows, I think the stock would be undervalued if it was broken up, so the combined entity should be worth even more due to operational synergies. So investors shouldn't fear this suit. Instead, they should use it as a buying opportunity.
