Clearly, Amazon has decided to crush brick-and-mortar grocers the same way it’s crushed brick-and-mortar everything else.
The blockbuster $13.7 billion Whole Foods acquisition was obviously the biggest story on the Street today and although it is indeed something of a bombshell, we’re not entirely sure why everyone is surprised. After all, it’s not like we didn’t know that Jeff Bezos wanted into this market.
“Amazon and Whole Foods weren’t always seen as obvious partners, but John Mackey, Whole Foods’ outspoken co-founder, has been under pressure to find an acquirer after Jana disclosed a more than 8 percent stake and began pushing for a buyout,” Bloomberg noted this morning, before reminding you that Jana’s “prodding irked Mackey, who has referred to Whole Foods as his ‘baby’ and to Jana as ‘greedy bastards.'”
So that’s fun.
“These guys just want to sell us, because they think they can make 40 or 50 percent in a short period of time,” Mackey said recently of Jana in an exclusive interview with Texas Monthly. He also accused them of intentionally fucking up the launch of his new book on vegans.
“They hijacked my book tour,” he fumed. Here’s an amusing passage (or three):
Monday, April 10, was going to be a big day for John Mackey, but he had no idea how big it would turn out to be. The co-founder, CEO, and spirit animal of Austin-based Whole Foods Market was flying to New York to launch a tour to promote the publication of his second book, The Whole Foods Diet (summary: Go vegan, or mostly vegan). He was set to lead things off at the Lower Manhattan headquarters of Goldman Sachs, in a gleaming tower overlooking the Hudson River, as part of a speaker series at the powerful investment bank. Mackey was going to follow that event with a signing at a nearby Barnes & Noble, an interview on CBS This Morning, and a handful of other appearances.
As he stepped off the American Airlines flight at JFK (Whole Foods doesn’t own a jet, and Mackey flies coach), his phone lit up with urgent text messages and voice mails. A hedge fund in New York called Jana Partners had snatched up almost 9 percent of Whole Foods’ stock and announced that it would pressure the company to either overhaul its business or sell itself—perhaps to another grocery giant, such as Kroger, or to a less traditional player, such as Amazon. Mackey and other leaders might have to be replaced. A media frenzy ensued, and the PR team who had carefully staged what should have been a traveling celebration of their boss as a thought leader shifted into immediate crisis mode.
“From that moment on, I was drowning in it,” Mackey says, “including when I got to Goldman Sachs. The CEO of Goldman [Lloyd Blankfein] wanted to meet with me because, of course”—he adopts a sardonic tone, a tic that tends to make his handlers stiffen up—“ ‘Goldman Sachs would love to represent you. If you guys are going to be sold, we’d love to make one hundred million dollars doing that. Don’t forget your buddies at Goldman Sachs!’ ”
That last bit is especially hilarious when you consider this from Amazon’s Friday 8-K filing announcing the acquisition:
The Company expects to finance the Merger with debt financing, which could include senior unsecured notes issued in capital markets transactions, term loans, bridge loans, or any combination thereof, together with cash on hand. In connection with entering into the Merger Agreement, the Company has entered into a commitment letter (the “Commitment Letter”), dated as of June 15, 2017, with Goldman Sachs Bank USA, Goldman Sachs Lending Partners LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, and Bank of America, N.A. (collectively, the “Commitment Parties”), pursuant to which, subject to the terms and conditions set forth therein, the Commitment Parties have committed to provide a 364-day senior unsecured bridge term loan facility in an aggregate principal amount of up to $13.7 billion (the “Bridge Facility”), to fund the consideration for the Merger. Bridge Facility availability is subject to reduction in equivalent amounts upon any incurrence by the Company of term loans and/or the issuance of notes in a public offering or private placement prior to the consummation of the Merger and upon other specified events, subject to certain exceptions set forth in the Commitment Letter. The funding of the Bridge Facility provided for in the Commitment Letter is contingent on the satisfaction of customary conditions, including (i) the execution and delivery of definitive documentation with respect to the Bridge Facility in accordance with the terms sets forth in the Commitment Letter, and (ii) the consummation of the Merger in accordance with the Merger Agreement.
Well anyway, now those “greedy,” pirate “bastards” at Jana are set to make something like $300 million on the sale. And that other “greedy bastard” Jeff Bezos is one step closer to taking over the entire planet.
Meanwhile, everybody from Kroger to Walmart just had a really – really – bad fucking day:
So what does this mean for grocers and discounters long-term?
Probably nothing good, but before you jump to any conclusions, maybe consider the following take from Goldman, who definitely didn’t try to shark this deal like Mackey claims (a spokesperson for the bank swore to Texas Monthly that no such meeting as the one Mackey described ever occurred).
AMZN to buy WFM: Our thoughts for grocers, discounters
To the extent that AMZN has decided to pursue a brick & mortar solution for the first time after years of testing and rolling Fresh and other solutions, we believe it confirms that the online-only model for food is in fact a difficult one. This suggests some silver lining for retailers despite the prospective addition of a new competitive force in brick & mortar.
AMZN has been far more successful in durable goods and, more recently, softlines, than in consumables based on aggregate online market share data from third parties projecting channel share. It is clearly more focused on the consumables arena, creating omnichannel prerogatives and raising the probability of new competition just as competition among legacy competitors has been intensifying (as per KR’s recent estimate cut).
Note that AMZN is arriving at a level of market share similar to WMT’s at the time it accelerated its focus on the Supercenter, and hence on food, as we outline in Exhibit 1.
Implications for grocers and their distributors
An increased focus on food retail at Amazon is likely to portend more disruption across food retail. This could show up in (1) incremental margin pressure across the natural and organic food category, (2) improved logistics and the credibility of one of the strongest brands in food retail that together could drive a greater share of food spend online, (3) an even greater impetus to consolidate among incumbent grocers to improve competitive standings via scale and expertise.
Margin pressure could stem from the fact that Amazon generated a 3.0% EBIT margin in North America last year, while WFM generated a 5.2% operating margin over the same period. To maintain current price gaps, conventional grocers could preemptively or reactively reduce prices across the natural and organic food retail space.
Online share gains within food retail are likely to become more pronounced. We believe some consumers may have preferred to pick their own fresh foods in-store rather than trust an online retailer without an established brand in food. We believe the combination of a strong food retail brand coupled with a strong logistical operator could break down this barrier to online adoption. In May, we found that 54% of WFM stores were in zip codes where AmazonFresh was available, up from 47% in January (Exhibit 1). Within these zip codes, we find only 3% of KR’s stores, 9% of SFM’s, and 1% of SVU’s retail stores.
Looking at WFM in total, we see 29% and 48% of KR’s stores within 5 and 10 miles, 53% and 78% of SFM’s stores within 5 and 10 miles, and 25% and 52% of SVU’s retail stores within 5 and 10 miles.
Incremental margin pressure and a greater shift of food retail online could drive a greater impulse to consolidate among incumbent grocers. This already looked likely – as called out by KR on its 1Q earnings call – due to the fact that prolonged deflation, intense price competition, and growth in brick-and-mortar capacity in food retail has already inflicted considerable pressure on weaker players, some of which have filed for bankruptcy of late (e.g., Marsh Supermarkets and Central Grocers in May). KR noted that the industry was likely at the “front end of the next phase of consolidation,” and in our view, greater scale and combinations among incumbents that bring together key competencies relevant to the changing food retail backdrop will prove more relevant going forward.
Over the long term, we believe an increased focus on food retailing at AMZN has the potential to evolve into a revamp of traditional food retail distribution models, given the company’s logistical expertise and existing infrastructure. Any impacts are likely to occur over a long period of time, but we would not dismiss the potential for inroads and market share gains at the expense of grocery distributors, including SVU and UNFI. As it relates to WFM, we note that UNFI’s contract with the company, which represented 33% of its revenue over the past 12 months, currently runs through September 28, 2025, and does not expire on a change in control.
Implications for discounters
This expression of interest by AMZN in WFM increases risk to margin and market share and the imperative to increase investment online. We see the most risk in this regard to COST, which has stuck to its highly successful, highly analog model, whose cost structure and pricing do not easily allow incremental services, and whose members have a high propensity to also be members of Amazon Prime based on our proprietary survey of 2,000 US consumers.
TGT, with a lower proportion of groceries, (22% for food, plus 22% for “household essentials”) vs. 57% for COST (food/sundries) and 56% for WMT – is less impacted by category, though its customer base over-indexes to AMZN Prime, as per our consumer survey.
WMT likely has the least customer overlap, and has been the most aggressive at preemptively investing in online, across the enterprise.
And here’s Deutsche Bank, who says the deal “changes everything”:
WFM acquisition changes everything
A brick-and-mortar acquisition We see WFM acquisition bringing instant credibility to Amazon Fresh in the US and expanding the potential scope and size of other acquisitions AMZN might consider. The deal looks slightly accretive to EPS and NA retail margins (WFM 5.5% vs AMZN at 5.1% in 2016) pre-synergies. We expect AMZN to stay mum on strategy and operational plans given its penchant for secrecy.
Best-case scenariofor WFM The $42 purchase price represents a 27% premium to WFM shares as of Thursday’s close (~$13.7B EV implies ~11.0x/10.4x FY17E/FY18 EV/EBITDA (vs WFM’s 9.8x 10-yr NTM EV/EBITDA avg)). The all-cash transaction represents a best-case scenario for WFM given the significant challenges facing WFM’s business, which will likely take time to address (a turnaround of WFM’s sales and earnings growth is even more uncertain given the increasingly competitive grocery landscape). While another bid is possible, we believe it unlikely given the premium valuation in AMZN’s all-cash bid. AMZN can justify paying more than a traditional strategic or financial sponsor given its potential leverage of WFM’s brand to sell additional products to Prime customers.
Whole Foods brings instant credibility to Amazon Fresh Considering high-quality fresh produce, we see WFM branding and product as more important than WFM’s store base to AMZN. The WFM brand should help convert Prime members to Fresh customers in our view, and doing more in the high-frequency food category may help AMZN further build out its last-mile delivery infrastructure.
AMZN-Sprouts (SFM) partnership helps explain rationale for integration AMZN has integrated the ability for Prime Now users to purchase food/produce from Sprouts in 12 SFM stores (AMZN saw Sprouts as boosting its credibility around produce). SFM has noted purchases on AMZN from zip codes outside its core markets, indicating incremental business. AMZN is seemingly pleased with the relationship and plans to expand it from 12 to 20 stores later this year. In our view, SFM/AMZN validates the notion that WFM’s product and brand can strengthen AMZN Fresh credibility on a national scale.