In its usual spare style, Amazon.com (NASDAQ:AMZN) announced Friday that it and Whole Foods (NASDAQ:WFM) have agreed on an acquisition $42 per share, or about 30X this year's guesstimated EPS. Neither company held a conference call; AMZN did not indicate how it plans to pay for the acquisition. Given AMZN's P/E, equity makes sense, but only the company knows for sure.
WFM's shareholders must approve the deal for it to occur.
In addition, quite reasonably, AMZN has not said publicly what its detailed plans for WFM are, though it apparently has leaked the general plan to make it more of a downmarket (more on that below).
Nonetheless, market action and some "known knowns" allow some comments about AMZN's stock and WFM. Firstly, we know that the Street went ga-ga for AMZN (as usual) on this announcement, even though the WFM CEO is staying in place and HQ remains in Austin, Texas. The estimated market cap gain for AMZN and decline for its/WFM's competitors approaches $45 B.
This article evaluates several points and comes to a much more restrained view of this deal. Beginning with the above one:
Mr. Market goes wild for WFM, reminiscent of a Celgene (NASDAQ:CELG) deal two years ago
Granted that there is so much bullishness around on AMZN that one may think that it was already due for a rally, having declined several percent from its recent all-time high, but just on the face of it, the stock gained about $11 B in market cap; competitors are said to have lost about $32 B in value, most notably from drops in Wal-Mart (NYSE:WMT), Costco (NASDAQ:COST), Target (NYSE:TGT), and Kroger (NYSE:KR). This suggests that the market thinks that WFM is a huge bargain at roughly a 30X P/E. In the good old days, stocks of acquirers paying a premium for a large, mature company would drop on news of the deal. That's logical. Either the acquirer needs to issue shares, diluting existing shareholders, and/or issue debt, which adds costs and brings in greater financial risk to the company. Plus, over the years, extensive experience shows that most such deals diminish shareholder value rather than adding to it.
In the context of a frantic atmosphere for Internet stocks a la 1999, this market reaction, involving market cap moves of tens of billions of dollars seems overdone. It is very reminiscent of market moves made on announcements of a pending software introduction in the late '90s - though often it was just vaporware, and other times, hyped real products such as Java from Sun Microsystems had little commercial importance.
I had a correct and negative reaction to the CELG deal for development-stage Receptos almost exactly two years ago. In that deal, where CELG committed to spend about $8 B and quickly put on as much as $20 B in additional market cap, I wrote a critical article, saying (with current comments in brackets):
CELG is trading around 50X GAAP projected EPS for 2015... That's rich. It does not imply "bubble," but it's not an attractive metric... [How quaint of me that a 50X mostly forward P/E was "too high" ...]
Of course, we're in a go-go stock market environment, with "growth" the flavor of the day...
The Celgene-Receptos deal has created some challenges for value-conscious growth stock investors in the biotech field. Short-term, CELG looks OK, but I've left the stock for valuation reasons. [Substitute "Internet" for "biotech" and you have today's situation in my humble opinion.]
I also made a more general comment about the biotech sector as a whole, saying in this July 21 article that:
The biotech revolution has years and decades to run. In the short run, it would be unsurprising to see choppier trading in this sector coming into the seasonally-challenged August-October period.
Within weeks, biotech stocks (NASDAQ:IBB) crashed and have yet to regain their peak 2015 levels (Note: I bought back into CELG at $104 last October and again up to the $115 level subsequently).
Will past be prologue for the roaring Internet/tech stocks?
If 50X P/E was too high in 2015, why is about 200X (approximate) OK today for shares in a larger, much lower-margined enterprise?
The extreme market reaction to this press release is important to consider, because, as a detail...
This deal is not set in stone
The lawyers are already circling the wagons, arguing that WFM is undervalued as a takeover target. The price that the two boards have may be just a starting price. WFM traded in the $60s in 2013 and in the high $50s as late as 2015.
- AMZN may not end up with WFM at all,
- AMZN may end up paying more for WFM, and
- the nearly $45 B net market moves favoring AMZN should be adjusted for the chance that a higher bid appears.
WFM, having closed Friday at $42.68, appears interesting as a possible long purchase now: limited downside, moderate upside potential. It may jump Monday morning, though, and if so, that would take buying into it off the table for yours truly.
It's unclear that this is a good fit for AMZN
Basically, this involves one low-margin company buying another, therefore: meh. Reasons to think this include the following:
There are few Amazon shoppers left to recruit from Whole Foods' customer base, who (to generalize) are middle to upper class already, use the Internet extensively, and already do all the online shopping they want. Whole Foods stores cannot act very much as warehouses for extensive delivery efforts locally, as they need to act as "warehouses" for the stores themselves. Warehouses are warehouses, and occupy cheap space, not expensive land in affluent areas as is typical for Whole Foods stores.
In addition, few Whole Foods stores have the physical space available that Wal-Mart stores usually have to add on curbside delivery (from online ordering) or futuristic automated kiosks located in parking lots.
Thus it's not clear that there are any or many synergies to AMZN from this deal, or even non-synergistic but additive benefits worth the cost.
Buying brick-and-mortar may show AMZN agrees with my bearish perspective
I was bullish on AMZN from about $750 early last December until about $850 not all that long ago. I switched when Amazon Go was widely reported not to work, making it (for now) vaporware; Amazon had a web page and video on this cashier-free retail shopping technology, promising that the Seattle store would open to the public early in 2017. The web page remains, but that promise has been expunged.
My thesis has been that e-commerce had limited profit potential, and that Amazon Go represented a creative way for AMZN to enter the retail space with some pizzazz, even if just in the small format convenience store space. Now, AMZN is doing plain vanilla bookstores, competing with Barnes & Noble (NYSE:BKS). Brilliant? If this is all AMZN can do, is this copycat behavior really worth a 200X P/E?
With the failure of Amazon Go (again, for now), investors may wish to question whether this deal for WFM is defensive rather than offensive. Yet articles are being written this past weekend about how Amazon Go will come to WFM in the future. Note that Amazon Go is RFID-based, which adds cost to each item of, according to my research, more than 5 cents per item. For convenience stores, that's fine, but for large format stores, what I've read is that it's viewed as a material negative. Plus, the human interaction at the checkout counter leaves customers with a positive vibe if it is pleasant, and KR already is deploying a system that brings lines down to extremely short levels. So who needs Amazon Go?
The failure of Amazon Go, yet the continued hype over it, is but one of many examples of the overawed commentary about the company one sees all over. As even a skeptical MarketWatch article Friday titled The mighty Amazon may soon go the way of the Roman Empire says:
There are parallels between Amazon and the Roman Empire. The Roman Empire won new territories, and so is Amazon. The Roman Empire ruthlessly crushed its enemies, and so is Amazon. There was no match for the Roman army, and so is the case for Amazon's technology.
Competitors are apparently leagues behind AMZN technologically. Really?
And, to beat the sleeping horse one more time, what about the Amazon Go vaporware? Where's the proficiency there?
So why is even the author of that article, a scientist, so sure that AMZN's "technology" (of which it has more than one) as powerful as the Roman army at its peak? Did AMZN invent the Internet? Does it have a monopoly on any key Internet-related technology that gives it a meaningful, sustainable advantage over its growing number of competitors in the online space? When I go to Amazon.com, I see... a website. Same as at Jet.com, Macys.com (NYSE:M), etc.
Is it possible that Wall Street is taking a very good company, AMZN, and pumping it up to be greater than it really is?
The WFM deal introduces more conflicts
There is already tension within the AMZN empire. On the one hand, Amazon wants to promote its house brands; this is a conflict with established and young brands alike. Then there is the conflict between AMZN having more incentive to move the merchandise that it actually purchases in preference to that which it merely acts as a storefront for (Fulfillment by Amazon or FBA).
Adding Whole Foods now adds the further conflict with WFM's 365 brands and those of other brands.
Plus, it adds the potentially large conflict between selling merchandise online versus from a store. Some competitors have, for now in this evolving omni-channel brave new world of retailing, established the point that they are store-based retailers first and online sites second. Thus, Wal-Mart will give buyers a discount if they order online but save the cost of delivery to the home and instead pick the item up in the store - but only if the item is not carried in the WMT store. Home Depot (NYSE:HD) and Nordstrom (NYSE:JWN), two very well-run profit-oriented retailers, have their own solutions that also focus on stores first, online as an adjunct. COST is even clearer that it wants shoppers in the stores first and foremost, but it is indeed moving to offer what it calls low-hanging fruit - i.e. commonly-ordered items - online.
It is not easy to manage conflicts between different power centers and different interests even in small companies. Will AMZN turn out to be like so many conglomerates, where one hand fights the other and/or doesn't know what its partner is doing?
In addition, grocery retailing looks like the wrong space to be buying into now.
Grocery price deflation moves along while competition ramps
It is amazing for those of us who are older, and for whom inflation was simply a given, to see this price-cutting, but it is indeed happening. KR is the latest to show this; per its prepared remarks attendant to the conference call:
Basket size and price per unit were down, but those were offset by household growth.
As for online competition to AMZN, KR also announced that it is growing rapidly online:
In the first quarter, we saw more than 30% growth in new digital customers and a more than 30% increase in digital visits... compared to last year.
Also, regarding competition for AMZN's house brands and WFM's 365, apparently KR has some secret sauce. Also per its prepared remarks:
Our Brands are one of the primary means we have to differentiate ourselves from our competitors.
Last year, we commissioned an independent third party to conduct research that would give us an objective view of how our customers view Our Brands.
This included blind taste tests with national brands and other private label foods. The research showed that the most-loved brands sold in our stores are Our Brands - above even the national brands! And in the blind taste tests, Our Brands outperformed competitive national brand and other private label products ...almost 100% of the time.
One may be a little skeptical about company-sponsored research, but this is nonetheless interesting.
It appears that for AMZN, competition is everywhere - and intensifying.
And beyond WMT and TGT, Aldi is here as a deep discounter, and is planning to invest substantial amounts to upgrade its stores and offerings. And, an even deeper discounter, Lidl, also from Germany, is on its way to the US.
So the question is what AMZN sees in groceries. It looks like a tough business that's in the midst of getting tougher.
Apparently AMZN agrees, making the deal look even more bearish for its shares going forward:
"Whole Paycheck" no more?
Based on the history of acquisitions, the strategy laid in the following Bloomberg News article from Friday is one that calls for an independent, non-herding point of view (emphasis added):
When Amazon.com Inc. completes its acquisition of Whole Foods Market Inc., Chief Executive Officer Jeff Bezos will try to keep the grocer's reputation for premium fresh foods while cutting prices to shed its "Whole Paycheck" image.
Amazon expects to reduce headcount and change inventory to lower prices and make Whole Foods competitive with Wal-Mart Stores Inc. and other big-box retailers, according to a person with knowledge of the company's grocery plans. That includes potentially using technology to eliminate cashiers [Amazon Go again].Amazon, known for its competitive prices, is trying to attract more low- and middle-income shoppers with its grocery push.
Translation: According to Bloomberg, AMZN is going to purchase a premium name in groceries and turn it into something more like Publix (OTC:PUSH) or its small slightly more upscale experiment, Greenwise.
Are investors sure this will enhance profits for AMZN?
This from a 200X P/E stock?
What would explain this behavior, which may be defensive rather than a stroke of genius?
WMT gains on AMZN online
This fits with my alternative idea that AMZN may actually be running scared due to the failure of Amazon Go, its late start in brick-and-mortar, its undifferentiated bookstore concepts, and, one day, the maturity of AWS. This Bloomberg News article interestingly ran Friday morning; it was clearly written before the WFM deal was announced. Here is the title:
That in itself is interesting. It's sort of like the old Yogi Berra quip about no one going anymore to a restaurant because it was too crowded. From the article, evidence that AMZN may be peaking in online market share:
The notion of Amazon merchants selling through Wal-Mart Stores Inc. would have been risible just a few years ago. But much has changed. Wal-Mart's struggling e-commerce operations have shown signs of life since the company acquired startup Jet.com last year and put its co-founder, Marc Lore, in charge. Meanwhile, among merchants, Amazon has earned a reputation as a demanding and cranky landlord, kicking sellers off its marketplace when customers complain and reaching deeper into their pockets with steeper fees and new advertising products that merchants say are now required to get a sale.
For merchants, Wal-Mart today is what Amazon was a decade ago: a vast frontier with room to grow.
The following statistic referenced in the article may be telling:
Amazon... attracts 180 million unique web visitors each month, about double Wal-Mart's traffic...
WMT already has half AMZN's online visitor count? With its vast store network globally, and with its tie-in of online ordering to store-based pick-up just beginning to ramp, how difficult will it be for WMT to catch up to AMZN? Maybe it's happening.
One final additional point is that WMT made an additive move by acquiring the Jet.com website. This allows sellers with up-market brands to differentiate their offerings from Walmart.com sellers, as the article explains:
Some high-end manufacturers refuse to list their products on the site because Wal-Mart is still perceived as low-end... vendors leery of selling on Walmart.com have no qualms about Jet.
All the above issues with AMZN tie into its spotty earnings history, frequent "misses" or "beats" only due to previously-lower guidance and, of course, its valuation. Before summing up, here are some numbers obtained by reviewing old Value Line (NASDAQ:VALU) data on AMZN.
AMZN - Not even a light blue chip based on performance
To be even close to blue chip status, which in today's market tends to merit P/Es that I would say average 25X or so (with a wide range), companies are supposed to have demonstrated stable earnings growth and some degree of secure niche or niches in their areas of leadership. Yet, with AMZN, as demonstrated in this article, everything is in flux, with the possible exception of AWS.
As far as earnings and margins, the stock reached or exceeded $100 per share (no splits) three different times in 1999. Unexpectedly, the company lost $1.19 per share in 2001 and $0.44 in 2002. EPS then rebounded steadily to $2.53 in 2010. That put the stock at its peak in 1999 at about 45X EPS 11 years hence - clearly a bubble valuation as things turned out.
It turned out, again surprisingly, that 2010 was a major interim top for earnings. Here are the subsequent EPS:
- 2011 = $1.37
- 2012 = $0.29
- 2013 = $0.59.
So, given 2013 was the year of QE 3 and an ongoing stock market boom, it should have been onward and upward for EPS from there, but no, EPS in 2014 was a loss of 52 cents.
Lest you think this choppiness was one-time, post-Great Recession thing, this pattern simply repeated that seen in the Tech Wreck. EPS was:
- 2003 = $0.40
- 2004 = $0.82
- 2005 = $0.79
- 2006 = $0.45
Margins tended to follow the above numbers.
Putting it together, the 11/11/16 Value Line review of AMZN showed a CAGR of EPS for the past 10 years of... negative 4.0%.
But that was relatively good. The CAGR for EPS over a five-year period was computed as negative 26.0%.
Additionally, I have previously shown that almost all of AMZN's financial net worth - which does not include the value of its famous name and so on - comes from sale of stock to the public and from options exercises from insiders.
So why is this stock "worth" what Mr. Market says it's worth?
A note on WFM
In contrast, depending how trading goes, WFM is interesting. With sales this year expected to be around $16 B, and noting that WFM often has traded above 1X sales per share, I think that $50 could be an upside price target if WMT or other large players jump in. If it is correct that AMZN is looking to position WFM downmarket, then perhaps a chain that is already downmarket, such as WMT, TGT, COST or KR, could be interested in acquiring WFM and keeping it as the upscale member of an enlarged company.
That strategy makes more sense to this analyst than a commodity reseller, AMZN, turning WFM into more of a commodity, less premium brand.
Will WFM get a bid from a large retailer?
Amazon, the company, is a highly innovative first mover in online retailing with a global presence, a strong balance sheet, and a famous name with high consumer favorability ratings. Its AWS subsidiary is a technological leader in what for now is a growth field, though capital spending requirements are high and its competition includes the highly profitable Google and Microsoft. So, it's a good, or great, company in my opinion. Yet it has very low margins and has been around long enough to have advanced farther in that regard.
However, this is an article that presents my analysis of a stock price; and as stated elsewhere on this web page, I'm not a financial adviser.
My opinion, based on my research on AMZN and its competition, is that Amazon is a bubble stock. The stock's earnings yield (reciprocal of the P/E) is well below 1%; competition is A) intense and B) in several cases growing faster online than AMZN.
Thus there is no investment merit to AMZN's stock, which is higher pre-market Monday as this article is being submitted, above $996 at this point.
Also, and material to trading AMZN, the market's reaction to the WFM deal appears overexcited. This sort of reaction to press releases in general, and expensive acquisitions in specific, worked out badly in 1999 in tech stocks and for CELG buy-and-hold investors two years ago.
Perhaps past will be prologue here.
Lastly, there are two bullish aspects to the deal. Short term, WFM may be an interesting long if it continues to trade around the deal price of $42. Longer term, for patient investors, both the 1999 experience and the 2015 interim top in biotech stocks suggest that when investors lose their valuation mooring in glamour growth stocks, good investments may be available in different sectors. Two stocks that I've written about before that, while not cheap (almost nothing is in the US markets), have reasonable valuations, strong fundamentals and promising bullish charts are Deere (NYSE:DE) and WEC Energy (NYSE:WEC). It may be worth the while of investors oriented to value, with a multi-year holding approach, to think of non-Internet, non-information technology stocks as a focus going forward.
A final point is to ask if retailers that have been growing all through the years of the AMZN ascendancy, and have seen their P/Es shrink, could be attractive new money investments to scale into. These might include off-price leaders mostly in the clothing field such as TJX (NYSE:TJX) and Ross (NASDAQ:ROST). Other names such as JWN in clothing and WMT, TGT and COST may also be, or may be getting to be, undervalued.
Thanks for reading and sharing any comments you wish to provide.
Disclosure: I am/we are long WMT, HD, WEC, DE, TJX, ROST, CELG.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Not investment advice. I am not an investment adviser.