How Twitch Fits In Amazon’s Strategy

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Amazon (NASDAQ:AMZN) recently announced its decision to acquire video-game service company Twitch for a total of $970 million. [1] Twitch essentially allows gamers to stream their gameplay live to a large audience. The company has over 50 million monthly unique visitors and could help Amazon expand its marketing reach. Amazon outbid Google (NASDAQ:GOOG) to acquire Twitch, which means that a healthy competition between Twitch and Youtube could result in a better service for gamers and game lovers. As far as Amazon is concerned, the company can make incremental profits by monetizing Twitch’s video streams through pre-roll ads, which tend to be effective. It will most certainly leverage the platform to promote its own merchandise sales by gauging viewer preferences. The company has seen a slight slowdown in the growth of its media segment and the acquisition presents an opportunity to rejuvenate that growth. If we do a back-of-the-envelope calculation, we find that the levels of monetization required to justify the buying price are certainly within Amazon’s reach.

Our price estimate for Amazon stands for $348, implying a slight premium to the market price.

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Can Amazon Monetize Twitch Effectively?

Amazon is paying nearly $1 billion for Twitch which implies that the company will expect the acquisition to generate incremental cash flows of roughly $50 million in 2015, growing annually at a CAGR (compounded annual growth rate) of 15% in foreseeable future. This is based on our assumption of weighted average cost of capital (WACC) of 12% and terminal growth rate of 2.5%. WACC is slightly on higher side as Twitch is a technology company and operates in a industry that evolves fast. These incremental cash flows can come either directly from monetizing Twitch’s video streaming, or indirectly through advertisements and promoting the sales of Amazon’s merchandise through Twitch’s platform.

Twitch’s unique visitor count for July 2014 stood at 55 million. These users viewed a total of 155 billion minutes of content generated by over 1 million gamers, video game publishers, developers and others. [2] This implies that annual viewing could stand at somewhere around 1.9 trillion minutes. If we assume that an average gaming video lasts 30 minutes, this could translate into roughly 60 billion videos viewed annually. Let’s further assume that Amazon manages to put pre-roll video ads in 50% of these videos, at an average rate of $5 per 1000 views which is still lower than that for Youtube, it will imply incremental revenues of roughly $150 million. At an assumed EBITDA margin of 35% for Twitch, these revenues will imply EBITDA of roughly $50 million. However, this is just one way to monetize. Amazon could easily promote sales of its own merchandise and target Twitch’s user base, thus opening more revenue opportunities. Therefore, the monetization required to justify the acquisition is achievable.

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Notes:
  1. Amazon Bets on Gamer Website Twitch in $970 Million Deal, Bloomberg, August 26 2014 []
  2. Twitch: Amazon to buy live-streaming gaming network for $1bn, The Guardian, August 26 2014 []