7/29/09

Anatomy of a deal: What Amazon really sees in Zappos.com

Rather than develop any more organic brands, which Amazon tried with Endless.com in 2007, Amazon wanted another way to build critical mass in the $5.5 billion online footwear market. Acquiring Zappos.com was a good alternative.

Mark Brohan , Research Director

The beginning of Amazon.com Inc.’s tentative deal to acquire Zappos.com Inc. in a stock deal valued at $847 million didn’t start in the executive suite at Amazon’s Seattle headquarters.

Initial discussions began in 2005 when Amazon CEO Jeff Bezos met with Zappos.com CEO Tony Hsieh and Venture Frogs LLC and Sequoia Capital, a pair of venture capital firms with a stake in Zappos, to discuss a tighter strategic fit. After three years of occasional dialogue, acquisition talks heated up in March 2008 when Amazon vice president of corporate development Peter Krawiec met with Zappos chief financial and chief operating officer Alfred Lin over dinner in Scottsdale, AZ.

Through late 2008 and early this year, more talks ensued and Zappos retained Morgan Stanley as a financial advisor in April. The details of the acquisition, which are spelled out in an S4 document Amazon, No. 1 in the Internet Retailer Top 500 Guide, filed with the U.S. Securities and Exchange Commission yesterday, also note that Amazon wanted to purchase Zappos in order to make a bigger push into the online shoes and apparel space.

Rather than develop more organic brands, which Amazon tried by launching shoe store Endless.com in 2007, Amazon wanted another way to build critical mass in the online footwear market, which Forrester Research estimates could generate annual sales of up to $5.5 billion as soon as next year. Amazon settled on acquiring Zappos.com because the company had an established brand, good customer service and an experienced management team. “The merger enables Amazon to expand and strengthen its presence in soft line retail categories, such as shoes and apparel, that are strategically important to Amazon’s future business growth,” Amazon says in its S4 filing.

In return, the Zappos.com board of directors agreed to an acquisition because Amazon promised to run Zappos.com as an independent entity. With a well-financed new parent, Zappos could also take advantage of Amazon’s bigger fulfillment infrastructure, advanced technology and diverse customer base. “The merger enables Zappos to leverage Amazon’s resources to further expand Zappos’ presence in clothing, shoes, handbags and accessories,” the filing says.

Amazon offered to acquire Zappos.com for an undisclosed amount of cash in May, but Zappos held out for an all-stock transaction. In late June through mid-July, Amazon and Zappos finished their negotiations and agreed to a final deal, which was announced on July 22. Under the terms of the deal, Amazon will acquire all of the outstanding shares of Zappos for approximately 10 million shares of Amazon common stock valued at $807 million and pay $40 million in cash and restricted stock to Zappos employees. Under the tentative agreement to acquire Zappos, which Amazon expects to complete in the fall, Amazon also will assume Zappos’ debts of $52 million.

The details of the acquisition are of interest to other web retailers because the strategies and initiatives used by Amazon, the world’s biggest online retailer, to acquire Zappos.com can be studied and applied to other transactions, says Scot Wingo, president and CEO of ChannelAdvisor Corp., which helps retailers sell through online marketplaces like eBay and Amazon.com. “Most Internet retailers I talk to about the deal are really interested in the details because this will be a very large transaction that everyone looks at going forward for mergers, acquisitions, initial public offerings and private financings,” says Wingo.

Once the deal is complete Amazon also will have a much larger stake in the online apprarel business. With gross sales of $1.014 billion in 2008, Zappos was the fourth largest retailer ranked in Internet Retailer’s Top 500 apparel and accessories category, which generated total combined sales of $13.989 billion last year. “They become a market leader in apparel because of this acquisition and they eliminate a big competitor,” says Wingo.

Zappos reported gross merchandise sales of $1.014 billion in 2008, according to the Internet Retailer Top 500 Guide, and its net sales of $635 million suggest more than a third of that merchandise was returned. Zappos is among the few online retailers to pay for return shipping, and it appears many of its customers take advantage of that offer.

Topics:

Amazon.com, Online music stores, Online shopping, Tony Hsieh, Zappos.com

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