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Drone-Delivered Granola? Dissecting the Amazon-Whole Foods Deal

By John Persinos on June 21, 2017

Since Amazon (NSDQ: AMZN) announced on June 16 that it intends to buy Whole Foods Market (NSDQ: WFM) in a deal valued at $13.7 billion, the jokes among analysts have been fast and furious. Typical example: “Thirteen billion dollars? At Whole Foods prices, that’s worth about two bags of granola.”

It’s true, Whole Foods is renowned for high prices (hence the snarky nickname “Whole Paycheck”) and the health food chain has endured public embarrassments over price gouging. Perhaps the most notorious scandal was a bottle of water containing three stalks of raw asparagus that sold as “asparagus water” for $6.00, which the store recently pulled from shelves after widespread ridicule.

But the Whole Foods deal itself is a bargain for Bezos and represents less than 3% of Amazon’s $475 billion market cap. Whole Foods boasts an affluent, upscale clientele that any retailer would covet. In the wake of the news, Wall Street has applauded the proposed merger and shares of both Amazon and Whole Foods have been rising.

It’s unclear whether you’ll soon see Amazon’s drones delivering kale, almond milk and gluten-free quinoa to your doorstep, but one fact already is quite clear: this move is a game-changer not only for the two companies involved, but also the entire retail sector. Below, I examine what it all really means for investors. I also highlight a technology play on the trend that probably will surprise you.

Bezos has a history of trumpeting splashy deals, but the purchase of Whole Foods would be the biggest acquisition Amazon has ever made. The announcement already is sending ripple effects throughout retail in general and grocery chains in particular.

For Amazon, gobbling up Whole Foods’ stores would give the digital retailer hundreds of physical locations and a substantial presence in the vast market for everyday consumer staples that are repeat purchases. Accordingly, just as AMZN and WFM shares have risen in recent days, the stocks of legacy supermarket chains have plummeted.

That’s not to say the Amazon/Whole Foods deal is a foregone conclusion. Despite the tenacity and deep pockets of Bezos, other grocery chains could jump into the fray and make offers of their own. Those threatened by the merger include Wal-Mart (NYSE: WMT), Costco (NSDQ: COST), Kroger (NYSE: KR), and Personal Finance Growth Portfolio holding Target (NYSE: TGT). The merger poses potentially ruinous competition to Amazon’s Big Box rivals, so don’t expect them to take it lying down. Any rival bids for Whole Foods could in turn raise the buying price.

That said, investors could be prematurely punishing grocery purveyors. Jim Pearce, chief investment strategist of Personal Finance, asserts:

“I think this deal makes a lot of sense strategically for Amazon from a long-term perspective, but I also feel that the market overreacted to its implications for other retailers in the near-term, especially Target.

Unlike Costco, which was conceived entirely on the premise of selling commoditized products in bulk to price-conscious consumers trudging through cavernous warehouses stocked with a revolving inventory of off-brand products, Target’s value proposition is geared more towards value-conscious buyers with an equal emphasis on price, quality, and service.”

A wholesome marriage…

Born of the counter-cultural 1960s and 1970s, Whole Foods was founded in 1980 by former hippies whose vision made them rich entrepreneurs. Whole Foods was the first grocery chain exclusively featuring foods without artificial preservatives, additives, chemicals, sweeteners, and hydrogenated fats.

Headquartered in the progressive environs of Austin, Texas, Whole Foods also was the first grocer certified as organic according to National Organic Program standards. During the 1990s, Whole Foods expanded by purchasing several organic food chain competitors, including Wellspring and Freshfield’s, rapidly becoming the highest-volume seller of organic food in the U.S. WFM currently has a market cap of $13.6 billion, 87,000 full-time employees, and 460 stores in the U.S., Canada, and the United Kingdom.

Now, Amazon plans to bring its huge cash war chest to a grocery industry bedeviled by high labor costs and thin margins. The big retailers could find themselves under greater pressure to improve their problematic profitability; food manufacturers could feel the heat, too. Also under the gun would be online companies that directly deliver groceries, such as Blue Apron, Sun Basket and Peapod.

That said, Linda McDonough, chief investment strategist of Profit Catalyst Alert, offers this caveat about the home delivery of groceries: “The problem is that after a period of time, the novelty of meal delivery wears thin and the convenience factor is not strong enough to support the expense.”

Will conventional grocery stores go the way of bookseller Borders, which once ruled the roost but eventually went bankrupt? The verdict is still out. Grocery retail has proven resistant to online inroads, because shoppers have an ingrained preference for buying food in person at physical locations. But Amazon has changed seemingly permanent consumer behavior before. Just ask the executives who formerly ran Borders.

The Amazon/Whole Foods deal probably will spark a wave of merger and acquisition activity, as the already beleaguered retail industry pursues greater cost efficiencies through economies of scale. However, Bezos’ bet on Whole Foods reflects his acknowledgement that Amazon needs both an online and bricks-and-mortar presence.

Crunching data on earthy-crunchies…

An investment opportunity likely to emerge from these interrelated developments is greater demand for companies that make sense of consumer data, to help grocers draw fickle food shoppers, especially millennials, into their online and physical stores.

Among the up-and-coming “data crunchers” worth considering is Alteryx (NYSE: AYX), a cloud service software company that strives to create products that can be used by non-specialists. The company’s products help end users predict consumer behavior and drive brand loyalty.

Alteryx hit the public stock market March 24, closing up 10.7% from its Initial Public Offering pricing on its first trading day. Since then, the stock has risen another 25%.

With a market cap of $1.1 billion, the Irvine, California-based company’s competitors include Silicon Valley’s titans, such as Microsoft (NSDQ: MSFT), IBM (NYSE: IBM), and Oracle (NYSE: ORCL). Alteryx differentiates itself by providing boutique technology solutions that dovetail with smaller-scale consumer operations, such as a grocery store.

Founded in 2010, Alteryx has been licensing its platform since only 2013 and its operating history is limited. The company has never earned a profit but revenue in 2016 reached about $86 million, up from $38 million in 2014. The company is expected by Wall Street to post year-over-year earnings growth in 2018 of 7.70%.

IDC estimates that the worldwide market for analytics technology and services will surpass $203 billion by 2020, representing a compound annual growth rate of 11.7% from 2015. Amazon already is adept at mining data, a capability that will become increasingly important in the grocery business. The food stores that don’t adopt the latest consumer data analysis tools will fall behind, a trend that’s a tailwind for Alteryx.

Even food manufacturers aren’t immune from these sweeping changes in the grocery retail business. Amazon already makes its own brand of everyday items, such as batteries. If this digital behemoth starts to make its own food brands for greater vertical integration in the grocery space… watch out.

Impatient younger consumers with short attention spans and busy schedules seem especially susceptible to the ease, convenience and time savings of buying food online. Supermarkets aren’t just labor intensive — for consumers, they’re time intensive as well. According to the Bureau of Labor Statistics, about 16% of Americans spend nearly an hour shopping for food every weekend.

Will food shoppers respond to Amazon’s efforts to push them online? A few naysayers have emerged to warn that the pursuit of Whole Foods is overly ambitious and could prove a Waterloo for Jeff Bezos. And yet, many analysts scoffed when Bezos announced that he was getting into the drone delivery business. Once seemingly far-fetched, drone delivery is quickly becoming a reality.

So don’t be surprised if one day, you see unmanned aircraft in the skies over your neighborhood, delivering boxes emblazoned with the Whole Foods logo.

Comments or questions? Send me an email: mailbag@investingdaily.com — John Persinos

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