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Amazon Payments & Lunatic Valuations

Aug 13, 2014

Amazon announced today a new payments service that appears aimed at Square and other, similar, services. Point of sale (POS) payments are something we know a little bit about over here. It's not a surprising move and given that Amazon already is a major portal for companies selling their wares online - why not aide in selling wares offline? The question I have is about the rationality of the market's response.

Amazon's stock (AMZN) surged up today finishing up 2.18% at $326.60 (USD). That puts Amazon's market cap at a bit over $150 billion ($150.75 billion to be precise but hey, what's $750 million or so, when we're dealing with twelve figures?). That means the company added about $3.22 billion in value today and it's reasonable to attribute that to the announcement which was made just before the market opened and the surge was entirely at the open (see chart below).

amzn

Investors are valuing payments at $3.22B give or take. By reference, Square was valued at around $5B in its last financing in January and it doesn't seem crazy to give Amazon a value of 3/5ths of Square's; but let's really size this thing:

Amazon's offering costs $10 for the swipe device  (which they'll reimburse you for via an offset against your first $10 in processing fees) and the payments are very aggressively priced at 1.75% until January 2016 and then they rise to 2.5%. That's very favorable against Square (2.75%) and PayPal Here (2.7%) and potentially competitive against Breadcrumb (1.99% + 15¢ excluding Amex) depending on your average transaction size and card mix.

Now let's assume this is a freestanding business valued at $3.25 billion (we'll round that $3.22B to a quarter billion why don't we?) and that the valuation is calculated as 1x revenue - a common valuation method. That would mean Amazon would have to process $130 billion per year in transactions to justify that valuation. That's a lot of transactions. Especially when you consider that Amazon only did $74.5B in transactions last year.

Ok, so revenue valuation would need a lot of irrationality optimism; maybe there's a lot of profit to be had?

The world of credit card processing fees can be a bit labyrinthian (here's a good primer and here's another) but the short version is that the the amount going to the bank that issued the card (which is non-negotiable) is going to start around 1.5% + 10¢ and could be higher, then another .11% or more goes to the credit card company (Visa/Mastercard) - the rates are all even higher for Amex (why some businesses don't like taking Amex) - and the rest of the fees go to the "acquirer" and any other participants (eg: Amazon). Now let's assume Amazon builds it's own processing network and doesn't use TSYS or First Data or someone else (hey, they're Amazon, why not), and there are no other participants in the interchange, Amazon then keeps the remainder in those transactions. That means that Amazon would keep 2.5% minus the issuer fee (1.5% + 10¢) and the card network fee (.11%) or roughly 0.89% - 10¢.

On a perfect use case charge of $100 Amazon would make $0.79.

If we take a slightly aggressive - but not insane for a tech company -EBITDA multiple of 10x (that would be a high multiple for a financial services company but we're giving the investors the benefit of the doubt here) then Amazon would need to be making a profit of $325 million to justify a $3.25B valuation (that's roughly 411 million $100 transactions assuming Amazon has no expenses - a bad assumption).

But these bundled payment solutions aren't geared towards larger transactions; they're aimed at small merchants with much smaller average transaction size (think: coffee shops). That's a problem.

On a perfect use case charge of $10 Amazon would lose 1.1¢.

And that's best case. A huge number of variables could make that loss much wider.

So given all that, why are investors valuing this business at $3.25 billion?

I haven't a clue but it's safe to say that I didn't buy any AMZN today. <baa baa>

noah@two-bulls.com
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