Numbers & Narratives: Amazon buys Whole Foods and gets options

It often seems like technology company deals are so ugly that only the bankers could love them. That is why it was refreshing to see a deal that makes sense on a lot of levels. Reading a lot of the news reports I feel that there is a deeper narrative at play that has largely been glossed over. So here is a quick summary of the great options that this deal provides Amazon.

In the short-term this deal gives Amazon a power position over their competitors in food delivery. Instacart for example uses Whole Foods stores to get groceries and deliver them to customers. Assuming this deal continues, Amazon will benefit by getting a cut of the Instacart transactions. You can think of this as the Amazon tax. If Instacart starts making more money, Amazon can just raise prices via Whole Foods to get a larger cut of Instacart’s business. Instacart could also decide to move on to another grocer but Whole Foods has unique food selection. Plus, Amazon has a history of letting others user their infrastructure (e.g. AWS, fulfillment centers) and might prefer continually getting money from Instacart transactions rather than kicking them out. This deal also has short-term implications for Amazon’s current partnerships. Here in the greater Seattle area Amazon works with PCC which is another grocery store. Amazon can continue to work with PCC and use their ownership of Whole Foods as leverage in future negotiations. However, PCC will most likely be relegated to support burstable demand when the Whole Foods stores don’t have enough supply or are too busy. From a retail perspective, I wonder if Prime will enable Whole Foods to lose their “Whole Paycheck” reputation by using Prime as a driver of revenue in physical retail while lowering prices in the actual store. This is similar to Costco’s model.

Another interesting option is the stores being the fulfillment centers for groceries and perishable goods. Amazon has 99.4 million square feet of fulfillment centers (this also includes data centers which Amazon bundles in this number) in North America (source) and with Whole Foods they will now have an additional 17.8 million square feet spread across 456 stores in the USA, Canada and Europe (source). Whole Foods stores are known for being in prime locations in urban areas providing ideal locations for Amazon to reach customers in densely populated areas. These areas have higher costs and are not the type of places where a frugal retailer would open a fulfillment center. Closer locations to densely populated areas give Amazon the opportunity to provide other goods more easily to customers in 2 hours or less. Proximity is critical and the grocery store makes having a mini urban fulfillment center a profitable endeavor and not just a cost center. The more stuff you can get in this timeframe, the less likely you will be to go to the store, which leads to buying more stuff from Amazon and the flywheel will pick up speed. Amazon arrives at my door so often now I am starting recognize some of the drivers.

In the long run this is where we can see some of the more futuristic scenarios like Amazon Go. Amazon Go uses artificial intelligence so customers can grab what they need and go. As sexy as these scenarios are unless the technology is ready for prime time it is unlikely this was a strong driver for the deal. According to Amazon’s 8-K, they will be paying $13.7 billion which will be paid for in debt so any efficiency from AI won’t make this deal payoff right away.

Speaking of money, when you look at Amazon’s financials it makes sense that they would borrow the money. With $15.4 billion in cash at the end of the last quarter it highlights that Amazon is a technology company that has the financials of a retailer. Whole Foods free cash flow of $400 million last year is also not a spigot of cash that will make this deal a quick payoff either. Some argue that Amazon got Whole Foods for free because Amazon’s market capitalization increased by $11.2 billion today. This is a cash deal so the currency comparison in this case is apple and oranges unless they are going to have some secondary offerings. More importantly, Amazon has never been overly concerned about profits and this time should not be any different.

The reason why this deal makes sense in my opinion is really about the short, medium and long term optionality that sets them up for success regardless of how the food delivery industry turns out. It is for those reasons that I feel that Amazon truly made a strategic purchase in acquiring Whole Foods (pending regulatory approval of course).


Talk to you soon,

Orville | Twitter: @orville_m




Creating and Sustaining Profitable Growth

Clayton Christensen always has interesting strategy papers.  I came across this presentation that has some useful information for those who are focused on bringing disruptive technologies to market.  Some items might be considered contrarian.  For example, when searching for the right business model “good money is impatient for profit, but patient for growth.” (Slide 26)

Talk to you soon,

Orville | Twitter: @orville_m