Amazon.com's purchase of Whole Foods is a rounding error for the giant online retailer. For the struggling grocery industry, it is the biggest shift in a century.
Amazon.com already sells groceries, of course, along with nearly everything else, but skeptics have pointed out that supermarkets are one business that may be largely safe from its mushrooming retail empire. Today's deal may prove the skeptics wrong.
Whole Foods will give Amazon a much bigger footprint in the food business. In addition to over 460 stores, Amazon also will be getting the high-end grocer's distribution chain. That will allow its food delivery service, which is so far limited to only a handful of cities, to rapidly enter multiple markets.
Moreover, Whole Foods is concentrated in the richer, higher-density markets where delivery makes the most sense. A quick glance at its store locations shows this. It has 28 stores in health-conscious Colorado and Connecticut combined. Kentucky and Alabama, with an almost identical population but lower incomes, education levels and population density, have six stores combined, one each in their major urban centers.
That could give it a leg-up on other food-delivery ventures such as Royal Ahold Delhaize's Peapod and venture-backed Blue Apron Holdings. The cache of the Whole Foods name -- it was named most-admired food and drugstore by Fortune last year -- could also make it a formidable competitor in the delivery business.
Whole Foods also operates at much higher profit margins than other grocers, thanks in part to the higher markups it gets for many of its upscale items. It has a gross profit margin of 34%, which compares to 21% for Kroger Co. If Amazon's tolerance for lower profit margins in its retail business translates into its grocery venture, it could rapidly compress profitability in the sector.
Amazon's timing for the deal appears impeccable. Its $42 a share offer represents a modest 27% premium to Whole Foods's closing price on Thursday and just 18% to its closing price a day earlier. The entire grocery sector had sold off in the wake of a plunge in Kroger shares following a profit warning.
Even with the deal premium, Amazon's $13.7 billion price tag including debt compares to a debt-adjusted market value of $23 billion for Whole Foods less than four years ago when it had a fifth fewer stores.
And, while it seems somewhat surprising that Amazon is paying cash rather than some combination of shares and cash despite having one of the best-performing large-company stocks in recent years, it is more likely to make the deal accretive to earnings per share. The price represents less than 3% of Amazon's own market value. Indeed, the rebound in Amazon's stock price as it began trading shortly after the news broke added as much market value as the purchase price.
Rounding error or not, this is Amazon's biggest acquisition ever and it will be consequential for the grocery industry. Amazon's entry into a new business is awful news for anyone currently in it, and initial investor reactions show that this should be no exception.
Consider Kroger's share price. Following its swoon on Thursday, the largest this century, its stock was off by an additional 15% in early trading on Friday in response to its formidable new competitor. And Wal-Mart, the world's largest retailer by sales, America's largest seller of food and Amazon's most credible old-line competitor, saw its market value drop by $14 billion.
The Amazon-effect has finally hit the grocery business and it has been with a bang.
Write to Justin Lahart at email@example.com and Spencer Jakab at firstname.lastname@example.org
(END) Dow Jones Newswires
June 16, 2017 11:52 ET (15:52 GMT)