Above the Crowd

I Do Not Believe that Zappos Was “Forced” to Sell

July 27, 2009:

zappos_logoThere are quite a few stories circulating in the blogosphere and Twittersphere discussing the recent acquisition of Zappos by Amazon. Some of these articles have a quite sinister and devious tone, imagining some remarkable behind-the-scenes drama that would make Spielberg pay attention. Here are two specific example:

PE Hub’s “Zappos CEO Wanted To Stay Independent, Sequoia Wanted Liquidity—Sources” and the more strongly titled “Zappos Deal Shows VCs Hate Entrepreneur“.

I should state up front that I have no specific data on this deal.  I haven’t talked to Sequoia nor Tony Hsieh. That said, my view is these articles are little more than sensationalist journalism guaranteed to attract a ton of page views.  The specific charge that I call into question is the suggestion that Sequoia forced a sale of the company.

The first thing to point out is that it is very unlikely Sequoia had any “mechanism” to “force” a sale of the company.  I am unaware of any “you must sell now” clause in any corporate documents.  A VC might have one BOD vote out of five or more votes, and the right to vote their shares, but this is also a minority claim. Preferred investors do have have “blocking” rights, but this gives you the ability to stop something, not make something happen. 

The more important point to make is that the CEO of Zappos, the remarkably successful and talented Tony Hsieh, had several mechanisms to block a deal if he in fact was not in favor of it.  

1) Tony could have withheld his vote at the BOD level, or even dissented. Most public companies will not go through with a sale with a split BOD vote on any acquisition, and this would be doubly true if that vote were the CEO.  Acquirers typically indemnify the BOD of the acquired company, and a split vote would leave the door wide open for liability claims from Zappos other shareholders.  I don’t have any details on this specific deal, but I would be very surprised if it wasn’t a unanimous BOD vote (this detail will eventually be provided in the proxy; Update: S4 now available – tons of data).

2) For the exact same reason, Tony Hsieh “could have” withheld a positive shareholder vote from his common shares. Almost no major public company would approve a merger if there were a large voting block (from the company being acquired) dissenting the deal.  Once again, I suspect Tony voted his shares in favor of the deal.

3) Last but not least, Tony Hsieh could have informed Jeff Bezos that he does not want to sell and that he will not work for him, and that he would convey that same message to his employees. This “blocking mechanism” is perhaps more powerful that the first two.

Of course, none of these three things happened. Tony sent an amazing letter to his employees espousing the merits of the deal and the shared culture.  He also directly informed the press that these conspiracy theories were misplaced.  

Personally, I think its a great match and a great outcome for both companies.  They have a shared mission and very similar service oriented customer brand.  

Note: As I have stated in my blog posts before, I am an Amazon shareholder in my personal account.

Update: A very relevant post from TechCrunch.

14 Comments

  1. jd July 27, 2009

    It’s just that the buyout at this time and that price doesn’t make sense if the Zappos mythology is to be believed. While I don’t think Zappos was “forced” to sell, I think there was probably some pressure and Tony, et al knew that Zappos could never be radically profitable.

    Reply
  2. John Mecke July 27, 2009

    The odd thing about this deal was the valuation. Zappos basically sold at a discount to its trailing twelve months revenue of about $1 billion. At Amazon’s current stock price the deal is worth about $920 million. Zappos has posted very strong revenue growth over the past 10 years and reportedly grew from $860 million to $1 billion between 2007 and 2008. Growth like that should command a strong premium. Amazon itself trades at a 1.62x enterprise value/revenue multiple. Based on the limited data available, it looks like Zappos had a 0.92x EV/Revenue multiple. While Amazon does 20 times the revenue Zappos does, from my perspective it doesn’t justify such a relatively low valuation — even Yahoo has a better relative valuation.

    Companies don’t up and sell themselves at a discount unless there’s a reason. Once Amazon files the proxy associated with this purchase we’ll get a peak at some of the detals and see what the story is.

    Reply
    • bgurley July 27, 2009

      Some thoughts on this:
      1) Some have suggested that Zappos “reported” revs were gross (not net of returns). With a 35% return rate, this alone would go a long way to close your gap.
      2) I have heard suggestion that Zappos’ inventory turns were as low as 2X. This would imply that Zappos is a much heavier user of capital than Amzon (per revenue dollar), and this capital has a cost. This would also result in lower ROIC. For more see: http://www.amazon.com/Valuation-Measuring-Managing-Value-Companies/dp/0471361909
      3) Amazon is the worldwide leader in Cloud Computing. This obviously represents part of the premium in Amazon’s shares.

  3. Alain Raynaud July 27, 2009

    Bill,

    You are playing with words here. Imagine this slightly different scenario: Sequoia “strongly” asked Zappos to look into an acquisition. When Amazon showed up on their radar, Tony was pleasantly surprised and agreed to the deal. If my scenario is correct, then:

    1) the headlines are correct, Zappos was forced to sell

    2) you are correct and Tony agreed to the deal and didn’t block it

    So maybe the truth lies somewhere in between your view and those other stories.

    Reply
    • bgurley July 27, 2009

      i understand the point you are making but find the use of the word “forced” there rather misleading. Tony was a very large shareholder and as a result receives hundred of millions of dollars in this deal. Tony would be required to “understand” his opportunity set as a result of complying with Delaware law (i.e. fiduciary duty). None of which constitutes forcing.

  4. james July 27, 2009

    Bill – you are spot-on with this analysis. My understanding, off the record, is that Amazon made a run at Zappos back in 2006 which the company rebuffed. Amazon then built Endless at great expense. The problem is that Amazon can’t get access to premium brands (like Nike) who would sell to Zappos.

    Now, for Zappos to compete successfully, they need to invest significant capital in IT and infrastructure, capital and dollars it didn’t have at the time. Zappos could have raised more money though debt but that would most likely occur at less than desirable terms in the current environment. It could tap public markets, but again, probably not good timing. It could go into harvest mode and invest modest amounts until the economy stabilizes and then tap the public markets. But doing so would put it years away from exploiting the fruits of the technology investment. So, selling out to proven industry leader like Amazon gives them much needed access to technology expertise at precisely the right time to exploit it; and it offers Amazon much needed access to brands and assortment as well as a foothold (pardon the pun) in the apparel space where it has struggled. If both sides are smart, they will continue to operate independently.

    Regarding valuation, Tony was always resolute in stating gross sales. Net sales of 620m implies a 38% return rate, an extraordinary number. To get that number reduced, the company needs to improve its technology to better match buyers to products or improve average order value / units per transactions. Both are areas where Amazon’s technology can make a major difference. Zappos generated a $40m operating income last year, implying a 20x valuation at 860m. The acquisition seems very fairly valued.

    Reply
  5. bijan sabet July 27, 2009

    agreed.

    I had the same feeling as you about this one. shared my thoughts a couple of days ago.

    http://bijansabet.com/post/147548060/did-sequoia-force-zappos-to-sell

    Reply
  6. Dave July 27, 2009

    WSJ’s Venture Capital Dispatch blog has a nice summary of all the details:
    http://blogs.wsj.com/venturecapital/2009/07/27/amazon-discloses-more-details-around-zappos-acquisition/

    Reply
  7. Pingback: Evening Reading: MicroHoo and the Problem of Integration - Deal Journal - WSJ

  8. Michelle Leder July 30, 2009

    But how do you explain away this statement in the S-4 that Amazon filed on Monday?

    “On February 23, 2009, Mr. Moritz called Mr. Blackburn and Mr. Krawiec to discuss a potential business combination of Amazon and Zappos and Mr. Moritz’s history of working with the Zappos management team.”

    As I wrote on my site here, it’s not exactly a smoking gun. But it’s not nothing either.

    Also to @James, the S-4 makes it pretty clear that Amazon reached out to Zappos back in 2005.

    Reply
    • bgurley July 30, 2009

      So a BOD member talks to head of corp dev at a major company and you call that “forced” a deal. You guys are seeing ghosts.

  9. Charlie K July 30, 2009

    You’re probably right on the main subject of this post, however this doesn’t sound right — “I am unaware of any “you must sell now” clause in any corporate documents.” Many preferred term sheets carry a “redemption right” which when exercise can force the Board to seek liquidity.

    Reply
    • bgurley July 30, 2009

      No redemption right was in play in this scenario.

  10. Bob Schwartz September 9, 2009

    Bill
    Love your analysis and my gut says you are spot on, that everyone was on board for this deal. Yet aside from this deal, Speaking of Shoes, I have heard of (know of and experienced one) Venture deals structured with a Put at a multiple of invested dollar if there is not a liquidity event in X period of time. This essentially is forcing liquidity or a buyout of VC holdings at a large multiple.. but those were bubble days gone by…

    Reply

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