Amazon Buys Whole Foods – Maybe the Only Bargain at Whole Foods is the Company Itself

In a bold move, Amazon acquired Whole Foods for $13.7 billion.  Yes, that Whole Foods, where groceries are pretty expensive.  For example, here’s what I had to go through to earn enough money to shop at Whole Foods.  Aside from the fascinating strategic implications, the news spawned all kinds of one-liners.  I can’t come up with anything better than what’s already been tweeted out, so I’ll just link to the best of them here.  At first blush, Amazon seems to have gotten a pretty good deal.  The premium paid over the closing share price on June 15th was only 21%.  In the last few years, we have observed the median control premium for take-private transactions on U.S. exchanges to be over 30%, per data from Mergerstat.  Come to think of it, it would be kind of cute if the only bargain ever associated with Whole Foods was buying the company itself… (OK, I got a joke in, so sue me.)

Given how important a company Amazon is in our economy, and how important grocery stores our in our day-to-day life, this deal has unsurprisingly garnered quite a bit of attention.  The question that interests me is, “Why did Amazon choose Whole Foods as their entry point into the physical retail market for groceries?”.  Amazon could easily buy any of the major grocery chains if it so chose (except for Wal-Mart, which was off the table after the acquisition).  Why did they choose Whole Foods?  Sure, there’s the argument that Whole Foods and Amazon share a common consumer base (I’m not sure I completely agree with that – do most Amazon shoppers buy into the magic of $11/lb chicken salad?) . But, I think the argument lies in something more fundamental – indeed, in something having to do with value.  

Let’s think about why Amazon buys a company like Whole Foods in the first place.  Amazon has been tinkering with physical retail a bit, even launching, ironically, some physical bookstores.  Amazon has also become slowly but increasingly involved in the grocery business.  There’s Amazon Prime Pantry.  There’s the ability to easily re-order products from Amazon via their wand, through the Alexa system, or their panic button.  Amazon could have created their own infrastructure, of course, but that takes time – and can be very challenging in a time when most major metropolitan real estate markets are tight.

Like The Bachelor, Amazon had many potential candidates from which to choose.  Kroger, Publix, and other companies had many more locations with broader market bases.  Even Target, now a major player in the grocery space, may have been within reach.  The membership club stores like Costco, et al. seem anathema to the Amazon way.  Amazon wants a wide variety of products, available in the quantities preferred by customers.  In other words, Amazon isn’t interested in making you buy 2 gallons of dill chips to save $3, so Costco likely wasn’t a match.  As you can see from the charts below, Amazon could have made a much larger splash with an acquisition (Source:  Each company’s 2016 SEC 10-K filing).


In the case of the number of locations, Whole Foods’ footprint is relatively small.  With respect to employees, the scale is somewhat larger, but neither feature is quantitatively superlative.  While a minimum footprint was likely a qualifying criteria (they weren’t about to buy a 12-location chain), Amazon was not necessarily looking at sheer volume.

I think the answer lies in two primary elements:  The nature (as opposed to the number) of Whole Foods’ locations (retail businesses are always dependent on location), and the features of the Whole Foods labor force.   The kinds of people Amazon hires and the culture of customer service are integral to Amazon’s DNA.  If you aren’t smart and/or don’t care about customer service, you can’t work for Amazon. Thus, for Amazon to make an acquisition, they need both the right locations and the right people to be part of the deal. Both would require billions of dollars of investment and years of time to build.  Jeff Bezos is patient, but even that would likely go beyond the limits of his patience, so an acquisition is the way to go.  But, how do we know, or at least guess in an educated way, that Whole Foods’ locations and employees are superlative?  The answer starts to become clearer when we look at the companies’ respective market capitalizations:

The next chart helps bring the discussion into focus, and is, in fact, the key to the analysis (Source: Pitchbook.  Adjusted market capitalization means that market capitalization is computed as price per share times shares floated.)


If you take a moment to compare the gaps between numbers of employees, market capitalization and locations, the market capitalization gap looks like it’s a bit less.  Is Whole Foods generating more value per location or per employee than its competition?  Let’s look at Whole Foods’ market capitalization/employee first (as of June 15, the day before the acquisition).

Whole Foods generates a staggering $157,000 of value per employee, second only to Sprouts Farmers Market, which is about half of Whole Foods’ size.  It’s interesting to compare with Kroger and even Publix.  If you wonder why shopping at Kroger can seem like a cattle call, here’s your answer.  Amazon wants high value employees and they seem to be getting them in Whole Foods.  Let’s look at location next – the story is even more pronounced.

Whole Foods may have relatively few locations compared to the Krogers and Publix’s of the world, but those locations generate a ton of value. In the Monopoly board of locations, Whole Foods seems to own every Boardwalk and Park Place.  If you’re going to make a play into physical retail, this is a great place to start.  Whole Foods generates twice the value per location of every other pure play grocery chain, and blows Target away as well, and they sell TV’s (By the way, this gives you a hint at Amazon’s strategy – Target sells many goods other than groceries, and their value/location is well into second place – that isn’t an accident, and Amazon knows it).

This relatively simple analysis makes sense when you think about how Amazon operates.  Yes, they are a big company, and they make big bets, but they think a few moves ahead as well as or better than anyone around.  In acquiring Whole Foods, Amazon selected a partner with whom to disrupt the grocery industry that wasn’t the biggest, but was the most effective at generating value from its assets.

So, is that it?  This is a purely strategic bet due to a good fit?  I don’t think that’s entirely right.  One other element comes to light when you look at number of employees per store (Source: Each company’s 2016 10-K filing) – Amazon likely sees a financial opportunity also.

Whole Foods has the highest number of employees per store in this group.  In other words, of all these companies studied, Whole Foods has scaled the least.  That’s a big reason why Whole Foods can deliver a highly artisanal shopping experience – there is an army of folks ready to take care of you when you walk in the door, which in turn, is a big reason that your chicken salad costs $12/lb.  I think it’s a lead-pipe cinch that Amazon has looked at this metric and concluded that, if they can just get the number of employees per store down to something approaching the median, they are going to make insane amounts of money – and they are basically going to get it for free (remember, they only paid a 21% premium over the stock price, which accounts for control privileges – nothing to do with post-acquisition restructuring).  Amazon is pretty good with product delivery and supply chain technology.  They will figure out how to replace labor with technology.  (Imagine an Amazon Echo on every aisle that will do price checks and tell you where every item in the store is located.)  Even with long odds, I wouldn’t bet against them being able to realize massive labor savings.  Amazon is trading at roughly 30 times EBITDA.  If Amazon can save $100 million in labor expenses, that’s $3 billion in value that is created, which pays for just under a quarter of the purchase price. (Amazon has said they don’t plan to cut the labor force, but I don’t buy it – the value of doing so is too high.  If you work at Whole Foods today and you aren’t planning your next career move, you’re being irresponsible.)

This looks like a great deal for Amazon, to the point where I think the biggest risk is that you may see some Whole Foods’ shareholder activist objections trying to hold up the deal or find a competing buyer.  The second biggest risk is that, on the surface, this acquisition looks like it would qualify as a “bargain purchase” under GAAP, which clients and auditors hate, not least of which because it could generate an instant tax liability.  Nevertheless, when you take into account the location story, the employee story, and the potential cost savings story, Whole Foods is as good a fit for Amazon as there is in the industry, and I predict this acquisition will leave Amazon shareholders pleased with the return, and will be transformative to Whole Foods, and potentially the grocery industry.  Ironically enough, it seems the only way to get a real deal at Whole Foods is not to go shopping there, but to buy the whole company.

What do you think? Did Amazon get it right.  How do you think Amazon will disrupt the retail grocery space.  Leave a comment here and also please follow the Arpeggio Facebook page for other market insights and M&A news.






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