Ahhhh the 1990s. “Read my lips.” “I did not have sexual relations with that woman“, the end of the Cold War. The Spice Girls. Dial-up Internet. Friends. Star Trek: Voyager. It all brings back a certain nostalgia. And, of course, the great dot-com bubble leading to valuations of e-commerce companies that left people like me wondering if we should have gone into real estate, rather than business valuation (I lost a bunch of money investing in a company called eToys.com, so I did my part). A recent high profile merger seems to bring us back to those days.
On August 8, Wal-Mart agreed to acquire Jet.com, an online retailer that competes directly with Amazon.com by aiming to offer the lowest price on the Internet. The phrase sounds odd – I think many of use think of Amazon is the low price retailer, putting countless brick-and-mortar shops out of business. In fact, thanks to observing my wife’s business, I have learned that, quietly, Amazon is no longer the low price retailer in many items. There is a large and growing community of people who engage in retail arbitrage – buying something cheap in one place (often, Wal-Mart) and reselling it on Amazon for a profit (after Amazon takes its 25% fee, of course.) This practice is known as retail arbitrage. Amazon now sells one-stop shopping, fast shipping, and painless returns more than it does price.
Incidentally, the price of the deal was $3 billion in cash (some deferred) and $300 million in Wal-Mart stock, and is Wal-Mart’s largest acquisition ever. As of November 2015, just 9 months ago, Jet raised venture capital at a $1 billion valuation. You don’t have to go to Trump University to know that’s a fantastic return. Even Ponzi schemes don’t do that well.
Jet’s story is impressive. Launched in 2015, they reached $1 billion in merchandise sold in one year with 10 million SKU’s listed. They have had 1 million unique customers. And, like any good Internet company, they are presumed to be losing a ton of money. A sample order had Jet pricing the bundle at $275.55 but costing Jet $518.46, a loss of $242.91. I’m not at all a retail expert, but it doesn’t look like you can make up for that loss on volume. Jet also started out by trying to charge a $50 membership – think of a Costco/Amazon hybrid. However, customer resistance forced Jet to capitulate on that. Still, $1 billion in merchandise sales, and a million customers in one year of operations is impressive by any standards.
Wal-Mart and Jet have indicated that they will remain separate brands and web sites for the time being. The problem that Wal-Mart is trying to fix is clear. Wal-Mart’s online sales were $14 billion last year, compared to Amazon’s $107 billion. Wal-Mart’s online sales grew 7% last year, compared to Amazon’s 30% and 15% for the e-commerce industry overall. They are flat-out getting steamrolled by Amazon. Adding insult to injury, Wal-Mart is a prime source for retail arbitragers – they buy products on Wal-Mart (usually on sale) and re-sell them on Amazon. Amazon gets a 25% of the marked-up price whereas Wal-Mart makes the same gross margin. In other words, Amazon makes as much money on Wal-Mart’s products as Wal-Mart does (25% gross profit), and Amazon doesn’t need to tie up their own cash in inventory. In my book, that’s the e-commerce version of getting your lunch money stolen on the playground.
The symptoms of Wal-Mart’s online ineptitude are easy to grasp. Poor fulfillment (incorrect orders, overstuffed boxes, oversized boxes, delivery delays) are all-too-frequent occurrences. Wal-Mart has pledged to invest $2 billion through 2017 to bring their operations up to snuff, but the problems persist and, even when or if fixed, the reputation will surely linger longer. The causes run deep, and it’s not clear how the Jet acquisition alleviates them. Amazon’s core competency is online commerce, and the logistical expertise required to pull it off. Everything they do is about making the online shopping experience flawless. Amazon is a notoriously tough company to work for, but also pays top dollar for its people. They have a zero-tolerance-for-screwups culture. On the other hand, e-commerce is still a side gig for Wal-Mart, the equivalent of a CPA having a real estate license, and it will be after the $2 billion is spent and even after acquiring Jet. Wal-Mart’s core competency is squeezing suppliers and providing just enough of a satisfactory shopping experience so that the lure of rock-bottom prices works. It’s hard to see how Wal-Mart can catch up, and they must feel like they are about to race Usain Bolt. Even the geography is wrong. Amazon is in Seattle – every bit as tech heavy as Silicon Valley. Wal-Mart is in Bentonville, Arkansas, with the Walton family dominating its ownership to this day. I’ve never been to Bentonville and I’m sure it’s a nice town, but just try getting e-commerce heavy hitters to move there and then answer to the Walton gang… You’ll have better luck getting volunteers to jump out of an airplane without a parachute. The fact of the matter is that Wal-Mart is just late to the party. Amazon has a Simone Biles-like lead in market presence, technology, culture, infrastructure, and strategy, and Wal-Mart has a good deal of catching up to do.
It has been noted that the Jet acquisition may be been motivated by the Jet brand. I don’t buy it. You can’t build a brand in a year – surely not to an extent that justifies close to a $3 billion valuation. Other comments suggest that the customer base motivates the transaction. That doesn’t make sense to me, either. Wal-Mart has ample resources to drive traffic to their web site, and unless they improve their e-commerce experience, any customers they happen to acquire will soon be lost. Even inventory is likely inconsequential to the acquisition; Jet sources much of its products from other retailers – Jet is, in effect, the world’s largest retail arbitrager.
If you agree with the foregoing, then the conclusion is clear – the driver for the acquisition is technology and infrastructure, and perhaps personnel. The data isn’t available to value the acquired technology and infrastructure directly. We will know more when the purchase price allocation is reported in Wal-Mart’s next 10-K filing. However, we can make an educated guess.
We can estimate the value of the underlying assets by analyzing certain benchmarks. BVR publishes a book, Benchmarking Identifiable Intangibles, and Their Useful Lives in Business Combinations, and it contains benchmark data on purchase price allocations for acquisitions. The BVR book indicates that the average value allocated to acquisitions in the retailing industry is 28.6% to software, and 9.4% to technology, or 38% of the purchase price. If these benchmarks are applicable, then the value of the software and technology equals $1.254 billion (.38 x $3.3 billion), which, interestingly, is not far from the $1.35 billion valuation associated with its most recent venture capital financing in November 2015. While I admit this analysis is a bit of a blunt instrument, the logic is sound.
This $1.3-ish billion valuation seems potentially sustainable based on market indications and some business common sense, and if so, Wal-mart overpaid by $2 billion – capital it could have spent continuing to develop its own e-commerce infrastructure, or paying workers more, or just about anything might have been more productive. I’m also skeptical that there would have been many bidders for Jet with the capacity to pay. The competing “bid” was likely the price that Jet may have hoped to attract in an IPO at some point. Wal-Mart bid against itself. Ironically, the king of “rollback prices” may have indeed paid a rollback price for Jet – if you think the rollback was to 1999.
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