Landmark Links June 20th – Imminent Threat

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Lead Story…. I was about to start writing this blog post about something else and then this came across my iPhone on Friday: Amazon to Buy Whole Foods in $13.7 Billion Cash Deal.  The news ripped through grocery stocks like tornado and sent them plummeting as reality set in that Amazon is getting into the grocery business and they are getting in now.

Source: Fox News

Regular readers of this blog are probably aware by this point that retail disruption via technology in general and the Amazon effect in particular have long been fascinations of mine.  I’ve been an Amazon Prime subscriber for years and have been using Amazon Fresh – their fledgling grocery delivery service that is only available in a handful of states – for a bit more than a year.  If you have young children and don’t at least have Prime, you might as well be living in the dark ages.  I suspect like many others, my wife and I became slowly hooked on Amazon’s convenience and pricing until suddenly we woke up one day and realized that we couldn’t live without free two day delivery on pretty much anything that we could ever want.  As huge of a player as Amazon is now, this latest acquisition is a game changer.  Today, I’m going to explain why.

For most of my adult life, there has been a prevailing sentiment in the financial world that the legacy players in the grocery business were in trouble.  However, their main threat wasn’t Amazon but Walmart.  The behemoth from Arkansas had devoured smaller retail competitors by opening up big box locations with lower prices and more selection than mom and pop stores could ever offer.  The result was that Walmart effectively killed Main Street USA by offering better selection at a cheaper price.  Walmart got into the grocery  business in the late 1980s and was far and away the dominant force by the early 2000s. However, although Walmart is still the proverbial 800 lb gorilla, they have struggled to gain traction in upscale market segments and have been losing market share in recent years.  Amazon’s acquisition of Whole Foods sets the stage for a battle between the eCommerce giant and Walmart for supremacy in the grocery space.  The two have been encroaching on each other’s turf for a while now with Walmart moving into eCommerce and Amazon into brick and mortar.  This feels a bit like the beginning of the end for a lot of legacy players caught in between the two giants.

Amazon has a couple of advantages upfront.  First off, they have mastered both last mile distribution and branding in a way that Walmart has not.  While upscale consumers look down their noses at Walmart, the same cannot be said of Amazon.  Buying a well known upscale brand like Whole Foods as a way to get into the brick and mortar grocery business is not going to hurt this image.

There were two things about the transaction that really stood out to me:

  1. Amazon rarely buys high profile existing brands.  When they see a space that they want to be in, they typically invest heavily to build it out organically rather than buying a legacy competitor.  The only other time that they did something similar to this was purchasing online shoe retailer Zappos which was a fraction of the size of Whole Foods. In fact, this would be Amazon’s largest acquisition by over $12.7 billion.
  2. The transaction was air-tight. How did this not get leaked?  This will be a merger of two incredibly high profile brands.  Almost the entire hedge fund and investment bank set shops at Whole Foods and subscribes to Prime yet nothing leaked about the two companies even being in conversations.  This is sort of amazing in and of itself

The Amazon/Whole Foods deal dominated the financial news on Friday in a way that I haven’t seen for an acquisition announcement.  However, if you step back and think about it, grocers are far from a sexy business.  They have low margins and inventory that goes bad quickly.  The space is also very competitive and highly site specific – being on the wrong side a the road for home-bound commuters can be death for a grocer.  Also, Whole Foods was struggling.  It had been well documented that the grocer had sliding sales as other competitors entered the organic space that it used to dominate at cheaper price points.  So, why did Amazon pay up for them?  I have a few ideas:

  1. Location is everything.  Whole Foods is well known for their rigorous site selection.  Their +/- 460 stores are in some of the most coveted and upscale locations in the US.  This presents a distribution opportunity for Amazon – a company obsessed with last mile delivery.  They are not only purchasing those 460 stores, they are also purchasing the ability to transform them into distribution hubs for other products that they sell outside of groceries.  This is a great real estate play for Amazon to establish a brick and mortar beachhead in upscale neighborhoods.
  2. Amazon understands volume.  As previously stated, grocers do not typically have great margins.  They do however, drive an incredible amount of foot traffic when compared with other retailers.  Grocers are one of the few retail experiences that we take part in each an every week.  We may not go clothes shopping or go out to eat on a weekly basis but nearly every American goes to the grocery store and does so in high frequency.  This makes a highly trafficked grocery store a potential goldmine for a retailer that relies on high volume like Amazon who already does cross selling and low margin volume retailing better than anyone else.
  3. Name Brand.  Despite recent struggles, Whole Foods is still a very well regarded brand – especially among the affluent demographic that Amazon covets.  Buying an outfit like Whole Foods gives Amazon a foothold in the industry that they can build on without having to re-brand a larger legacy grocer without the name cache of Whole Foods.
  4. Marginal Moves: Despite the recent struggles, Whole Foods has substantially fatter margins than other grocers. Amazon is accustomed to thin margins.  Don’t be surprised to see post-acquisition Whole Foods drop prices in order to drive competitors out of the organic grocery space.

It wouldn’t surprise me if another grocer threw their hat into the ring to increase the price of this acquisition.  It’s highly doubtful that anyone could ultimately beat out Amazon’s bid but there are many competitors who would love to make them pay up as Amazon’s entry into the space becomes a matter of survival.  In fact, Whole Foods is trading above the level of Amazon’s bid in expectation of a bidding war.

We’ve already seen what Amazon and other online retailers have done to the malls despite still being just north of 12% (but quickly rising) of the total non-food services retail market.

The result has been struggling big box stores, soaring vacancies and plunging property values.  The grocers may not be able to avoid this fate but I doubt that they are going to go down without a fight.  By some estimates, Amazon is now going to be one of the five largest grocers within a year of the Whole Foods deal closing.  They are going to be in a position to wreak absolute havoc on the space and weak grocers or owners of poorly positioned grocery anchored centers can’t be sleeping too well tonight.  The ongoing disruption of the mall and big box models have been painful for the retail sector to say the least.  Grocers have now officially been served notice and pharmacies could be next.  The only things that I’m certain of when it comes to retail in the US is that we still have way too much of it and it will look very, very different about 10 years from now.

Economy 

Pancaked: Yes, the yield curve is still flattening but that does not necessarily mean that it’s going to invert.

Letdown: The temperature of the US economy is running quite a bit cooler than economists had expected.

Low Expectations: Investors appear to be coming to the conclusion that oil prices are going to stay low as OPEC production cuts fail to work.

Commercial

Make it Rain: China’s real estate investors are now on a $200 billion global spending spree.

Residential

Dark Cloud: The continuing hedge fund shakeout means that no one can sell their mansions in previously high-flying Greenwich.

Get Out of Here: The Bay Area’s sky high cost of living is fueling a housing boom in Sacramento.

Out in the Cold: The housing recovery has skipped over poorer regions of the US while values soar along the coasts.

Profiles

End of the Line: Amazon’s Whole Food acquisition could lead to a bunch of cashiers getting laid off.

Not Even Close: Those who say that tech companies today are in a bubble reminiscent of the late 1990s clearly didn’t live through the tech bubble of the late 90s.

Get In Line: Meet the entrepreneur who started a business by standing in long lines for hire waiting for everything from iPhones to tickets to food.

Chart of the Day

The Agony of Defeat: Cavs fans had an interesting way of dealing with their NBA Finals Loss. (side note: I had a bunch of economic charts that I wanted to use but none was nearly as entertaining as this).

Source: Busted Coverage

WTF

If at First You Don’t Succeed: A daredevil who made history in 2003 as the first person to to over Niagara Falls with no protection and survive tried it again last week.  It went poorly.

A Picture is Worth A  Thousand Words: This mugshot of a man who traded meth for a stolen Chrysler looks exactly like what you would think someone who traded meth for a stolen car would look like.

When in Rome: A woman killed an attacking rabid raccoon with her bare hands because, Maine.

Landmark Links – A candid look at the economy, real estate, and other things sometimes related.

Visit us at Landmarkcapitaladvisors.com

Landmark Links June 20th – Imminent Threat

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