Amazon buys Whole Foods for $13.7 billion
Amazon announced on June 16, 2017, a $13.7 billion deal to buy Whole Foods, agreeing to pay $42 per share in cash — roughly a 27% premium to the stock’s close the previous Thursday. Whole Foods CEO John Mackey, under pressure from the board to find an acquirer, kept his job while the stock price got a matching bump, rising 27% to near the deal price. Amazon’s strategy was clear: it wanted a distinct brick-and-mortar presence, and it found one in Whole Foods. Some investors felt the deal came together quickly on Whole Foods’ side, with Mackey describing the partnership as “love at first sight.”
E-commerce has been slow to catch on in fresh produce and grocery, and our read is that Amazon is looking to establish itself physically in larger local markets to enable same-day — or even 30, 10, or 5-minute — delivery based on location and Amazon’s operational strength. That’s bad news for competitors like Target, Kroger, and Walmart: people still enjoy walking into grocery stores, but Amazon’s distribution scale allows for a kind of fresh delivery most competitors can’t yet answer. Because this is a full acquisition, the risk sits almost entirely with Amazon — Whole Foods’ business had been struggling in recent months, and bringing it back will be Amazon’s challenge.
The strategy keeps the current Whole Foods CEO in place to minimize disruption during integration, while Amazon works to understand where a consolidated supply chain and other synergies exist between two very different business models — online retail versus brick-and-mortar food retail. Bringing Amazon’s technology to Whole Foods’ operations could unlock efficiencies in inventory and supply chain management that translate into better margins, and may be the key to sustainable margins for a brick-and-mortar retailer going forward.
Stage I: Deal creation
In the “deal creation” stage, each firm works to maximize the economic value at stake in the agreement. The grocery industry is known for extremely low margins, as seen with Whole Foods’ competitors Kroger, Target, and Walmart — brick-and-mortar grocers have been slow to pursue the technological advances that could help their margins. Amazon, a worldwide leader in operational efficiency, was a natural partner for Whole Foods to distance itself from the competition, leveraging Amazon’s experience in web services and online retail.
According to Brittain Ladd, a retail consultant and former Amazon executive, acquiring Whole Foods gives Amazon expertise it lacks in running both a grocery business and physical stores. That expertise comes bundled with CEO John Mackey staying on, which keeps grocery-market knowledge inside the company and limits knowledge-transfer delay, while also isolating the business from Amazon’s other lines in case things go wrong.
One risk to the deal’s economic value: Whole Foods’ reputation had taken a hit from a recent drop in share price and negative press over high prices, even as its loyal customer base stayed loyal. The efficiencies Amazon brings could help raise margins and lower prices enough to appease those customers.
Stage II: Financials
In stage two, the parties evaluate the financial landscape and implications of the deal. As the buyer, Amazon has to make sure the price per share it offers makes sense from a future-value perspective — looking at Whole Foods’ past, present, and future.
The past — Whole Foods stock at $65/share. As recently as 2013, Whole Foods Market (WFM) stock hit an all-time high of $65.24 per share, valuing the company near $20 billion, on the back of strong operations and revenue growth since its IPO. Amazon’s $42/share offer values the company at roughly $13.4 billion (with 319 million shares outstanding) — in September 2016, Whole Foods posted $15.7 billion in revenue and $857 million in operating income, meaning Amazon was buying at 0.85x price-to-sales and 15.6x price-to-operating-income. In hindsight, that could look like a steal.
The present — revenue and growth. Activist investors like Jana Partners and Neuberger Berman had been pushing Whole Foods to sell or merge, pointing to slow revenue growth driven by poor operational performance — an issue hitting brick-and-mortar retailers broadly. This is where Amazon’s strength in supply-chain retail management comes in, along with its expertise in customer experience, which could unlock a deeper understanding of Whole Foods’ customers than the company has managed on its own.
The future — synergies. Future synergies are hard to size precisely, but cost reductions in supply chain and other efficiencies are likely in the millions of dollars, helping offset the thin margins of brick-and-mortar retail. One aspect drawing particular attention: data. Amazon may look to combine its own customer data, Whole Foods’ customer data, and Alexa/Echo data to build shopping lists tailored to what a customer needs and when — a meaningful step in reinventing food retail. Changing customer shopping habits takes time, but the shift is happening, and Amazon is positioned to capture the value of it.
The biggest financial synergy in this deal is that each company holds expertise the other lacks. Amazon has been testing what the future of brick-and-mortar could look like, but it is fundamentally a technology company, not a retailer. Whole Foods has the brick-and-mortar experience but lacked technical expertise — it wasn’t until mid-2016 that it began retiring legacy systems for a new cloud-based core focused on data. Amazon takes on more risk in this purchase, but it’s buying expertise Whole Foods already has, which is what makes the financial value of this deal run in both directions.
Stage III: Design
Stage three asks what form the deal should take, what risks are involved, and who absorbs them. This deal helps Amazon expand into grocery and brick-and-mortar retail while giving Whole Foods room to be more competitive and further its mission as a leading organic-goods provider. As a full acquisition, Amazon absorbs nearly all the risk. Grocery-industry incumbents historically take few risks around technology and operational change of this scale, and this deal is shaped more by a proactive read on the future of the business than by reactive economic or competitive pressure.
Stage IV: Developing the contract
Whole Foods brings Amazon its local food-customer network — an established customer base and physical stores in prime locations that let Amazon start earning immediately. It also brings relationships with local and nationwide suppliers, nationwide distribution, and fulfillment centers optimized for its products, plus its existing online shopping option, which hands Amazon customer shopping-habit data it can use to attract more customers to its own platform. Brand equity matters here too: the deal gives Amazon access to Whole Foods’ upper-middle and upper-class customer base. Because Whole Foods competes on service and product quality rather than price — much like Amazon — the two companies’ cultures should merge without friction. Combined with Amazon Prime and instant-checkout technology, the merger positions both companies to reach customers nationwide with faster deliveries, stronger buying power, and lower prices on core products.
Stage V: Performance
Going forward, Amazon plans to integrate technology and online accessibility into Whole Foods stores without radically changing the brand’s culture — evident in the decision to retain the existing CEO, much like Disney’s approach after acquiring Pixar. Amazon recognizes Whole Foods can be profitable on its own, but there are undeniable synergies to capture, including using Whole Foods’ large, loyal customer base to drive Amazon Prime subscriptions as a one-stop shop. Management will also look to apply years of Whole Foods data toward possible synergies with AmazonFresh and Amazon Go, its checkout-free grocery concept. It’s a significant bet in a market Amazon doesn’t have much experience in, but if the integration goes as smoothly as Amazon’s track record suggests, the outlook for grocery and retail competitors alike gets considerably more uncertain.
Sources
- Amazon to Acquire Whole Foods in $13.7 Billion Bet on Groceries — Bloomberg
- Why Is Amazon Buying Whole Foods? — Forbes
- Amazon Is Buying Whole Foods in a Deal Valued at $13.7 Billion — CNBC
- Amazon’s Bid for Whole Foods Will Spur Wheeling and Dealing — San Francisco Chronicle
- The Math Behind Amazon’s $1T Valuation & Whole Foods Deal Analysis — Seeking Alpha