EC Winner & Losers From Amazon’s Proposed Purchase Of Whole Foods

Amazon (AMZN: $1000/share) saw its stock jump by 3% Friday morning after it announced its intention to acquire Whole Foods Market (WFM) for $42/share. The acquisition represents a 27% premium to WFM’s closing price the day before and big win for activist hedge fund Jana Partners, which had been pushing for the high-end grocery chain to sell itself.

Based on AMZN’s share price gain, investors clearly think this deal is a winner for the e-commerce giant. While this deal certainly could be good for AMZN, we believe the market may be ignoring some of Whole Foods Market’s off-balance sheet liabilities that make this acquisition more expensive than it appears.

What is undoubtedly true is that this deal is terrible news for any company in the grocery business, as evidenced by the large drop in the stock prices of Kroger (KR), Target (TGT), Wal-Mart (WMT), and Sprouts (SFM).

Winner: Whole Foods Needed This Deal

We have been bearish on Whole Foods for several years. In the past, the company had strong revenue growth but weak margins. As Figure 1 shows, that issue has become even worse in recent years, as revenue growth has slowed and operating profit (NOPAT) margins have worsened.

Figure 1: WFM Margins And Revenue Over The Past Decade

 Sources: New Constructs, LLC and company filings.

Before this merger was announced, WFM’s valuation had shrunk significantly. Its price-to-economic book value (PEBV) of just 1.1 suggested that the market expected the company to grow NOPAT by no more than 10% over the remainder of its corporate life.

Still, the trends in Figure 1 suggest that even those modest expectations would have been too much for Whole Foods to achieve. The company’s NOPAT declined by 8% in 2016 and has fallen 18% over the past twelve months. This buyout looks like a best-case scenario for WFM shareholders.

Loser: AMZN Investors: This Deal Is More Expensive Than It Appears

Most outlets covering this acquisition have slapped a $13.7 billion price tag on it, reflecting the $42/share offer plus roughly $1.2 billion in long-term debt and capital lease obligations. However, that number misses roughly $6 billion from the present value of future operating lease obligations.

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Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, style, or theme.

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Comments

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Barry Hochhauser 1 year ago Member's comment

#Amazon's acquisition of #WholeFoods could revolutionize the industry. I don't think it will be the end of #Walmart though unless Amazon starts selling actual products in the the physical stores like Walmart does. And I don't think the Whole Foods locations are physically large enough. $AMZN $WMT $WFM

Danny Straus 1 year ago Member's comment

Personally, I hope this acquisition is the end of #Walmart. Shopping there is a dreadful experience and they don't deserve to stay in business. Yes, prices are cheap but there is zero customer service, horrible wait times, etc. #Amazon could radically change all that doing what they do best. $WMT $AMZN

Alexis Renault 1 year ago Member's comment

I agree but I wouldn't be surprised if we started seeing #Amazon Kiosks in the corner of every #WholeFoods location. A great way to sell their actual devices, similar to mini #Apple Stores. $AMZN $WFM $AAPL

Gary Anderson 1 year ago Contributor's comment

Amazon is planning on cutting staff at Whole Foods, which will likely make shopping there a miserable experience. When people see the real Amazon at work, in the real economy, they will be able to form their opinions about how things might be in the other sections of the company. A filthy Whole Foods will tarnish Amazon.

Harry Goldstein 1 year ago Member's comment

That's a good point. I also saw a similar thread about this here:

www.talkmarkets.com/.../amazons-acquisitions-create-adverse-reactions

Craig Newman 1 year ago Member's comment

Shopping at #Walmart is a miserable experience. #Amazon excels at customer service. If they increase efficency at #WholeFoods, they can likely do less with more, while still keeping customer service a priority. $WMT, $AMZN $WFM

Gary Anderson 1 year ago Contributor's comment

Craig, Amazon will not excel at customer service because this is a produce business. I wrote about the Whole Foods problem here: www.talkmarkets.com/.../amazons-jeff-bezos-doesnt-understand-female-shoppers

Rudy Patel 1 year ago Member's comment

It's going to be interesting to see how #Amazon is going to react to this speculated rival bidder. This has already caused a bidding war and #WholeFoods' price has risen above what amazon has agreed to pay. $AMZN $WFM

Carol Klein 1 year ago Member's comment

Yes, this is the first I'm hearing of this.

Dean Gilmore 1 year ago Member's comment

Where did you see that there are rival bidders?