Amazon: Acquisitions Make Sense With Such A Pricey Stock

Given YCharts’ unkind remarks about Amazon (AMZN) stock a few weeks ago, it might seem odd that we’re writing to endorse the company’s acquisition activity, including the deal disclosed this week to buy the owner of Diapers.com, Quidsi, for $500 million plus the assumption of about $45 million in other obligations.

We’re not in any position to judge the Quidsi deal – or, for that matter, the earlier purchase of Zappos for about $850 million plus debt assumption. They’re both privately-held companies and we’ll have to take Amazon’s word that the businesses are sound. Generally, corporate acquisitions aren’t such a good idea, with acquirers more often than not overpaying and promised synergies frequently failing to materialize.

Given all that, why cheer Amazon on as it makes deals? One simple reason: its shares are overvalued, trading at nearly 70 times trailing earnings, a multiple considerably higher than the company’s growth rate.

Amazon.com Stock Chart by YCharts

And when you have a precious currency like that, you’d be nuts not to be out spending as much of it as you can.

The practice of using pricey shares – say, those trading at 20 times profit, to buy less pricey companies, say those selling for 15 times profit – helped build some big rollups like Waste Management (WM), the trash hauler, and Service Corp. International (SCI), the funeral parlor operator, each buying scores of smaller companies. Most rollups, these two included, eventually run into trouble. They get desperate to keep growing and begin overpaying for acquisitions. And few have been very good at actually integrating the purchased companies.

But as long as you’re buying dollars for 75 cents, the wind is at your back.

Amazon has two types of currency, its pricey stock and actual cash.

Amazon.com Stock Chart by YCharts

Obviously, if one sees the shares as overvalued, then making acquisitions with stock makes more sense (so long as the target is priced below Amazon’s multiple). That’s what Amazon did with Zappos, the shoe seller, paying almost entirely in stock. Bully.

Sadly, Amazon is paying cash for Quidsi. Maybe the Diapers.com founders and investors agree with YCharts, and don’t want Amazon shares at current prices. A mere 3.2 million shares (at Amazon’s current price of about $170) would have roughly equaled the $545 million price; Amazon has about 450 million shares outstanding. The deal would have been a rounding error, and one hopes Quidsi’s projected profit wouldn’t be dilutive at Amazon’s valuation.

Nevertheless, we’ll cheer this cash deal on, too, if only in hopes that it emboldens Amazon’s CEO, Jeff Bezos, to make some far larger acquisitions – how about some more mature companies, with stable earnings? – before the company’s shares tumble back to earth.

One of the greatest examples of such buying, of course, was AOL’s (AOL) acquisition of Time Warner (TWX) a decade ago. Though the deal is frequently listed among the worst ever, if you were an AOL shareholder, you traded your highly-inflated stock for more than half of the combined company, even though Time Warner brought about 80% of the revenue and 70% of the operating cash flow. On that basis, AOL’s chief Steve Case was a hero, not a goat.

Of course, few company founders are ever of the opinion that their stock is overvalued. It’s like saying your kids are homely. Here’s hoping Bezos is the exception.