Whole Foods: A Bidding War

About: Amazon.com, Inc. (AMZN), Includes: COST, KR, SVU, TGT, WMT
by: Activist Stocks

Whole Foods has the $42/share offer from Amazon.

But there might be something better to come - even as soon as this week.

The idea being that legacy grocers will have to get involved in the bidding war just to block Amazon from getting its hands on this strategic asset.

In a letter to customers, Whole Foods (NASDAQ:WFM) reached out to let shoppers know that even after the Amazon (NASDAQ:AMZN) buyout it will still be providing the same high quality organic products Whole Foods is known for. However, not all shoppers are convinced.

Will Whole Foods join Amazon in the race to the bottom? Ultimately prices will come down at Whole Foods, but does that mean quality will also be sacrificed? That remains to be seen, but from an investment perspective, there are still implications for current shareholders and competitors.

In terms of still having an advantage, Whole Foods does enjoy higher margins and returns on capital because of its superior product mix. Which includes wine/beer bars and restaurant-like meals.

But there's also the fact that most of its revenues are less susceptible to e-commerce, being either fresh or prepare foods. It also has the advantage of being in urban, wealthy areas. This should appeal to other grocers, including those that currently only target the middle market.

Because of all this, and the fact that Whole Foods is such a strategic asset in the retail space, could a bidding war be on the horizon?

The bidding war?

Neuberger Berman, which is the mutual fund that helped push for a buyout along JANA Partners, says the buyout of Whole Foods will become a bidding war. Amazon wants to pay $42 a share, or roughly $13.7 billion.

But the stock, trading at nearly $43, is betting on a bidding war, and in the least, that Amazon will be able to pull this deal off without any hiccups or flack from regulators.

Still, the $42 buyout price is 35% below the 2013 high of $65 a share, and off more than 25% from its more recent high in 2015. Part of Neuberger's thesis is that buying Whole Foods isn't a "big check." Granted, that's relatively true when you look at the market cap of a Wal-Mart (NYSE:WMT), but even at that price, the Whole Foods buyout is still pretty expensive. Amazon's offer is for nearly 11 times 2018 expected EBITDA - earnings before interest taxes depreciation and amortization. Kroger trades at 5.6x forward EBITDA and SuperValu (NYSE:SVU) is at 4x.

The hope is that bigger players, such as Wal-Mart, Target (NYSE:TGT), Kroger (NYSE:KR) and Costco (NASDAQ:COST) - all of which saw their stock prices slammed after the Amazon-Whole Foods announcement will have to come in and overpay for Whole Foods just to block Amazon from getting its hands on this "strategic asset." In part, this would give Amazon over 400 distributions centers with Whole Foods stores (also doubling as storefronts for various Amazon products). And that means a leg-up for Amazon when it comes to the winner-take-all grocery delivery business.

But, there again, Amazon is a darling in the capital markets and will be able to win any battle, so why even compete, right? With Whole Foods already trading at a rich multiple and being up 30% in the last few days, I'm not sure any retailer wants to pony up the cash. I've made the case why Kroger won't/shouldn't get involved in buying Whole Foods, but it does make sense for Wal-Mart, which has the cash to wage a bidding war, to take a look at Whole Foods. However, I feel that no buyer makes a serious run at Whole Foods, where, as much as they're worried about what Amazon plus Whole Foods means, they're more worried about the possibility that Whole Foods' margins continue to get squeezed and "figuring" out grocery delivery never really pans out.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.