Watch out, grocers. Amazon.com (ticker: AMZN) is coming for you! On Friday, the e-tailer announced an agreement to acquire Whole Foods Market ( WFM) in a $13.7 billion all-cash deal.
“What you’ve got is two polar [opposites] coming together. You’ve got Amazon, the online business that’s moving towards brick and mortar, and you’ve got Whole Foods, the brick and mortar that’s moving to online,” says Roger Beahm, the WestRock executive director of the Wake Forest School of Business Center for Retail Innovation.
[See: 7 of the Best Stocks to Buy for 2017.]
What does this mean for AMZN and WFM shareholders? And shareholders of other grocery store chains?
The scenario for Whole Foods shareholders is pretty straightforward: The deal, at $42 per share, is great for anyone who held WFM stock. It represents a 27 percent premium to the previous day’s closing price, and it comes at a time of decelerating sales growth and declining profits.
In other words, an acquisition is pretty much the best thing that could’ve happened to WFM stock.
Exactly what Amazon needs. In Whole Foods, AMZN gets a great brand and a massive brick-and-mortar footprint overnight. The company has more than 460 stores in the U.S., Canada and U.K. — precisely the type of scope Amazon needs if its plans for an online grocery delivery empire at scale are to be accomplished.
And it’s no secret that Amazon is looking to build just such an empire.
In fact, this deal comes literally one day after a new Amazon commercial debuted for the Amazon Dash Wand with Alexa. The Dash Wand is a small handheld device that sticks to the fridge and uses barcode scanners and voice instructions to order and reorder groceries through Amazon Fresh, Amazon’s grocery delivery service. In the commercial, a couple uses the device to order ingredients for dinner, which arrive at the door in no time.
So yes, this is a great deal for AMZN stock owners, as evidenced by the stock’s 3 percent gain on Friday, which is atypical for an acquiring company.
When you look at the size and growth potential of the market, this $13.7 billion deal makes a lot of sense. A report from Nielsen and Food Marketing Institute sees online grocery shopping growing to the $100 billion level by 2025.
“Although this is by far the largest acquisition Amazon has made, they have a competitive advantage which will create synergy over other grocers — they can utilize the brick and mortar presence as a distribution center to supplement their online sales,” says Kristina Minnick, associate professor of finance at Bentley University and an expert in corporate mergers and acquisitions.
In other words, Amazon drone delivery — at scale, no less — just became a lot less farfetched. That’s a lot easier when you own over 460 grocery stores near large population centers.
The Prime factor. Another reason this is such a great deal for AMZN is that this is will likely dramatically beef up and help to expand its Prime membership base, which pays $99 per year for the privilege of free two-day delivery, Prime Video and other benefits.
Recent estimates have pegged the number of Prime members in the U.S. at 80 million. Not only does that provide a healthy chunk of recurring revenue in the neighborhood of $8 billion a year, but Prime members typically spend dramatically more money on Amazon than non-Prime members.
[Read: Grocery Store Stocks Fall on Kroger Guidance Cut.]
According to the same report, done by Consumer Intelligence Research Partners, Prime members spend $1,300 annually on Amazon versus $700 for Amazon shoppers that aren’t Prime members.
What does all that have to do with Whole Foods?
It would be shocking if Amazon didn’t do some sort of cross-promotion — Prime members get discounts at Whole Foods, Whole Foods shoppers get discounts on a Prime membership, that sort of thing — once this deal goes through in the second half of 2017.
Needless to say, those promotions would be very good for Prime membership numbers, and some sort of Whole Foods deals would certainly increase the value in having a Prime membership, and perhaps even justify an increase in its annual cost.
Two more positives for AMZN. Finally, in looking at the $42 per share Amazon is paying for Whole Foods, while it is indeed a premium, it comes while shares have been in a years-long bear market. As recently as February 2015, WFM stock was trading for $56.70. Factoring in a 27 percent premium, Amazon would’ve had to pay $72 per share to acquire the company back then.
Moreover, the acquisition is an all-cash deal, which shows AMZN management has extreme confidence in the long-term prospects for AMZN stock, which could have itself been used to finance the acquisition. When a stock is overvalued, as some argue Amazon is at 88 times forward earnings, it makes sense to pay for merger and acquisition deals with stock, as Tesla ( TSLA) did with its SolarCity merger.
Competition not faring well. While the deal looks by all accounts to be a win-win for Amazon and Whole Foods, grocery stocks got slammed on Friday on the news. Historically, it just hasn’t turned out very well to compete head-to-head with Amazon.
Some of the day’s biggest losses were incurred by Supervalu Inc. ( SVU), down 13 percent, Kroger Co. ( KR) off 11 percent, and Target Corp. ( TGT), which shed 8 percent. Even Wal-Mart Stores ( WMT), the largest of Amazon’s retail competitors, fell 5 percent.
“If Amazon replicates their customer-centric, skinny margin model at Whole Foods and now that Whole Foods is relieved of the street pressure to boost margins, you could anticipate falling consumer prices for the goods offered within the store,” says Stefan Weitz, executive vice president of technology at Radial, a commerce technology company.
Lower prices means lower margins, which means fewer profits. If Weitz is right about that strategy, the rest of the chain grocery stores will be forced to lower prices to match Amazon’s — and immediately thereafter they’ll have to lower their full-year EPS estimates, too.
That prospect so scares some of these grocers that they might even consider Bogarting Amazon’s acquisition deal. Wall Street certainly thought that was possible, as WFM shares closed at $42.68, 68 cents above the proposed takeout price.
[Read: What Industry Will Amazon Enter Next?]
Some analysts believe a bidding war could emerge, with a rival food retailer offering a higher price for WFM stock just to keep the company out of the hands of Amazon.
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Why Amazon.com (AMZN) – Whole Foods Market (WFM) Is a Natural Marriage originally appeared on usnews.com
