Amazon.com’s (AMZN US) recently announced US$13.7 billion acquisition of Whole Foods Market (WFM US) is sending shockwaves through the retail and grocery market as well as financial markets. We wrote back in April 2017 that one of the key reasons for investing in the organic food industry was the potential for consolidation as industry players chase better growth prospects in organic foods, making brand names such as Whole Foods and Sprouts Farmers Market (SFM US) primary targets.
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Amazon.com will pay Whole Foods’ shareholders US$42.00 per share in cash, a 27% premium to the closing share price prior to the announcement and will assume all of Whole Foods’ debt. Whole Foods is one the portfolio companies in our Healthy Lifestyle Fund, a company whose brand and ethos of healthy eating resonated with health-conscious consumers. Amazon.com’s founder and CEO stated –
“Millions of people love Whole Foods Market because they offer the best natural and organic foods, and they make it fun to eat healthy … Whole Foods Market has been satisfying, delighting and nourishing customers for nearly four decades …”
Despite dealing with rising competition and increasingly price-sensitive consumers, we believed Whole Foods presented significant value, even before activist investor, Jana Partners took an 8.3% stake in Whole Foods in April and began pressuring the company to pursue various strategic options.
So, why is this corporate transaction sending shockwaves around the industry?
1. The 1,000-pound gorilla is coming after groceries
The acquisition of Whole Foods will accelerate Amazon.com’s push into grocery and fresh food offerings after numerous reports that it was considering building its own grocery stores to complement its online fresh food offering. Amazon.com wants a larger slice of the US$617 billion grocery market, per the U.S. Census as online grocery remains a small part of the overall market (about 2% to 3% of sales) despite its faster growth.
To date, Amazon.com has experimented with a range of online offerings including Amazon Fresh in the U.S.; Amazon Pantry for online non-perishable goods; Prime Now, which delivers groceries from local stores in some U.S. cities; Dash buttons allowing semi-automated ordering of household items; and Subscribe & Save, which is a discounted offering for customers who commit to regular deliveries of household products.
Arguably, the variety of options confused consumers but most importantly, Amazon.com has found selling fresh groceries a challenge as many consumers still prefer selecting their own produce. Costs relating to wasted inventory can also be high compared to the other non-perishable categories that the company sells.
The acquisition of Whole Foods is perhaps an acknowledgement by Amazon.com that selling fresh groceries requires a physical presence to complement its online presence. Whole Foods is a leader in fresh food and premium, organic food with almost 70% of its sales coming from perishable foods such as fruits, vegetables and meat.
Whole Foods’ experience and knowledge of fresh groceries coupled with Amazon.com’s business acumen is a potentially frightening combination for its competitors in supermarkets, general merchandise, specialty grocers, warehouse or discount stores and convenience stores. Not surprisingly, all these stocks sold off on the announcement of the Whole Foods deal. Even payments companies sold off on concerns that Amazon.com is working on alternative payment methods at physical stores like it is trialing with its Amazon Go concept.
In Australia, retailers such as Woolworths (WOW AU), Myer (MYR AU), Harvey Norman (HVN AU) and JB Hi-Fi (JBH AU) also continued their slide this year as they fell between 2.2% to 3.5% after the announcement. This follows an average fall of 18.4% since the start of 2017 for these stocks as investors digest the pending reported launch of Amazon.com in Australia in 2018.
Lastly, the fact that Amazon.com reportedly considered this transaction for three years and that it is also the largest deal ever for Amazon.com (significantly larger than its acquisitions of Twitch for US$970 million in 2014 and Zappos for US$850 million in 2009), indicates how serious its ambitions are in grocery and fresh food offerings.
2. This is not just about groceries for Amazon.com
With Amazon.com, the picture is always bigger than it initially seems – its expertise in areas such as software engineering, big data analytics, digital marketing, inventory management and logistics are likely to bring significant efficiencies to Whole Foods over time, thereby benefitting the consumer. By acquiring a specialty organic retailer with higher margins, Amazon.com has shown a willingness to spend and invest in areas such as automation, alternative payment and delivery systems.
In addition, a new footprint of more than 460 physical stores in prime locations gives Amazon.com more flexibility on how it can potentially distribute its general merchandise products even more efficiently. It would allow for a true omni-channel offering (in-store pick up or delivery) and in larger, population centres, reduce delivery times even further.
Amazon.com wants to be a ubiquitous part of a consumer’s life and its Prime membership encourages multiple and frequent shopping moments. Imagine your groceries being delivered within an hour of being ordered? Or feel like a snack as you watch the latest TV series on Amazon Video? Why not use your Amazon Echo home device to order some popcorn and ice cream from Whole Foods?
3. What’s next?
The deal has been agreed to by both companies but is there potential for another bid from a competitor?
The shares in Whole Foods closed at US$42.68 per share indicating that some investors are hoping for a higher bid but we believe the chances are slim. Not only will Whole Foods have to pay a US$400 million termination fee to Amazon.com if it accepted a better offer but we believe that there are unlikely to be many competitors with the financial firepower to make a counter-bid. Only Wal-Mart (WMT) and perhaps Costco (COST US) have such financial firepower and it would also represent a significant change in strategy for either to pursue such an acquisition.
Wal-mart itself has been focused on acquisitions to add to its online presence having spent US$3 billion on Jet.com in 2016 and making smaller, niche acquisitions of online sites such as ModCloth, MooseJaw, shoeBuy.com and the recently announced Bonobos deal.
We believe corporate activity will remain focused on specialty retailers in the organic food industry, with its higher margins and faster growth rates. With Whole Foods being acquired as well as The Fresh Market being acquired by Apollo Global Management in 2016, the next potential sizeable target could very well be Sprouts Farmers Market.
At the time of writing, the AtlasTrend Big Data Big Fund and the AtlasTrend Online Shopping Spree Fund owned shares in Amazon.com and the AtlasTrend Healthy Lifestyle Fund owned shares in Whole Foods Market and Sprouts Farmers Market.
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