Grocery Aisles and E-Commerce Collide With Whole Foods-Amazon Deal

In this segment from the Motley Fool Money show, Chris Hill is joined by Motley Fool analysts Jason Moser, Matt Argersinger, and Ron Gross as they discuss the big M&A announcement from the past week. It was common knowledge that Amazon (AMZN 3.13%) was looking to make a bigger push into groceries, but its unexpected buyout of the struggling, premium Whole Foods (WFM) chain is sending shock waves through the grocery industry and markets.

How good is this deal for the two companies? What does it mean for competition? Tune in to learn more.

A full transcript follows the video.

This video was recorded on June 16, 2017.

Chris Hill: We begin with the blockbuster deal from Friday morning -- Amazon is buying Whole Foods Market for $13.7 billion. This is an all-cash deal, and that is a 27% premium for Whole Foods shares. CEO John Mackey is on our board of directors here at The Motley Fool. He will remain the CEO of Whole Foods. Ron Gross, I'll just start with you. This was a stunner.

Ron Gross: As an Amazon and Whole Food shareholder, I'm pleased on both ends here, but I'm a little bit surprised that I didn't see this coming at all, really. It seems kind of silly in hindsight. It makes sense, there were some tests that the two had done together, we know Amazon for the longest time has been really pushing into that grocery business, we know Whole Foods has been struggling for a variety of competitive reasons. So I like the deal, I think it makes sense, shame on me for not seeing it earlier.

Hill: Yeah, Jason, for anyone who was wondering how serious Amazon is about bricks and mortar, they're serious.

Jason Moser: Yeah, let's reiterate here, shame on you, Ron. We all saw this coming -- no, it's funny, we're all riding into work this morning and our phones were all lighting up, Twitter was crazy, and wow. First thing's first, I would much rather see this deal than something like the rumors we were seeing with Amazon potentially taking some interest in Slack. I just couldn't see how those two really work together, and it seems like the valuation for Slack was out of control. This, there's a lot to unpack here with this deal, but I think, like Ron said, it is a good deal for both companies. Whole Foods, for a long time, we owned it in MDP for a while and our big concern was groceries becoming a hyper-competitive market where really the primary form of competition is price. It's become abundantly clear the people don't care as much about the experience as they care about the price. And that put Whole Foods in a really tough spot. And they, I don't think, had a really easy way out from there.

Kroger's recent results reinforce that. I think this deal gives Whole Foods the opportunity to continue competing on price and growing that business without being held to the scrutiny of your public companies. For Amazon, this is right in their wheelhouse as far as, they can leverage their expertise in shipping and logistics with the physical footprint that Whole Foods has today, to really grow out what is becoming a very robust market, online grocery. It should do nothing but continue to grow here for the coming years.

Matt Argersinger: It's certainly a shocker to me. I had no doubt that Amazon was going to invest big and go big in groceries. If you think about it, outside of rent and your mortgage payment, it's pretty much the most consistent monthly expense that anyone has, and it's non-cyclical. So, it's a big market. I'm not surprised Amazon was going after it. I am surprised that they decided to do the biggest acquisition deal ever since Twitch in 2014, about $1 billion. Right, Twitch. To go after Whole Foods. To Jason's point, it's definitely a distribution deal. I thought Bloomberg had an interesting heat map of it and showing how both companies had significant correlation on the coast, but if you look at Whole Foods, they have a lot more stores in the Midwest and Southeast where Amazon really doesn't have any kind of footprint. So, there's a lot to gain if you're Amazon. I just think, if you're going to make a big move into the groceries, I think you could have done something different than going with Whole Foods. I think there's a cultural difference there between the two companies. I think Jeff Bezos in Amazon is more of a hardcore, "Let's cut expenses, let's focus on distribution," where Whole Foods is more about store friendliness and customer experience.

Hill: Well, let's get to the price tag for a second here, because this has already been referenced. This is not just the biggest acquisition Amazon has ever made, this is exponentially the biggest acquisition they've ever made. You mentioned Twitch, you look at Zappos, those are both in the neighborhood of $1 billion. This is $13.7 billion. Jason, we've talked before about Facebook and the amount of money that they paid for WhatsApp, $19 billion, and analysts asking questions over time, like, OK, how's that going? And I think that one of the things has bought themselves here, fairly or unfairly, is ongoing questions -- I think it's completely fair, and I say this as an Amazon shareholder, to start to ask Amazon on a quarterly basis, "You just wrote the biggest check you've ever written, how is that going so far?"

Moser: That's a very good point. It's something that I don't think the market is just looking at this and saying, "OK, it's Amazon, it's Jeff Bezos, great deal, let's move forward." We are all going to want to see some results on how this affects the company's bottom line. When you look at something like WhatsApp and compare it to something like Whole Foods, the glaring difference there is that Whole Foods obviously makes money and WhatsApp does not. And I think that what this does is give Amazon some credibility in probably what's the biggest hurdle to clear in the online grocery space, and that's figuring out a way to deliver quality, fresh produce, fruits, meats, things like that. I think that's probably one of the hang ups a lot of consumers have with ordering groceries online. They've done really well with Prime Pantry with the shelf-stable stuff. This is going to give them the opportunity, but it's just that, it's an opportunity. They still have to execute. And we are going to learn very quickly how they plan to execute. But again, with that Prime membership, with all of the leverage they can pull within that Prime membership, I just think the opportunities here are so vast, and Jeff Bezos is such a good long-term thinker. And it's very clear that John Mackey cares deeply about this company, and I think that's important to remember here, because it's going to give him a chance to really get back to doing what he wants to do, without everybody holding him up to the fire quarter in and quarter out.

Argersinger: I think, today, we're closer than ever to that future where I'm at home, I'm getting ready to go to work or leave the house, and I speak my grocery list into Alexa, and by the time I get home, I have groceries delivered to me. I think that's a future a lot of people are probably excited about. To Jason's point, the hang up there has always been fresh food on a daily basis. Now, Amazon has that capability.

Gross: To your point, Chris, I don't think Bezos really sweats those quarterly conference calls as much as some CEOs do when they feel the need to explain away every quarter what's going on with same-store sales or price points, I think he's just fine offering the information he's going to offer, and let investors do what they will. I think the only disconnect I see with this, Matty mentioned the culture, I think price point, typically Whole Foods is a premium-priced product, "Whole Paycheck" is the big joke there, whereas Amazon you think more of discount, lower priced items. So, it'll be interesting to see now that Whole Foods has less scrutiny on the quarterly basis, are they going to keep prices where they were, are they going to lower prices and try to take a chunk out of the competition? As we know, groceries are thin margin business, Whole Foods is probably a 3% profit margin business, there's not that much leeway there. But if Bezos, wants to, he can take this down to a 1.5% to 2% business, and just try to take huge margin share.

Moser: Yeah, like he says, your margin is my opportunity, I think that comes into play here. But let's also remember, a lot of times we see these kinds of deals, shares of the acquirer will go down while the company being acquired might go up in this case, the market is bidding both stocks up, so it seems on the surface at least that the market might be alright with this deal, as well.

Hill: You mentioned the margins, Ron. Yes, this is traditionally a low-margin business, but let's go back in time 6 to 12 months, whenever Amazon unveiled that video of the store concept that they were testing out in Seattle, which had very few employees.

Gross: Amazon Go.

Hill: Yeah. So, yes, it's a low-margin business, unless you significantly reduce the number of people who work there, and then all of the sudden the margins start to get better.

Gross: They said for now that they won't be laying off Whole Foods employees, specifically cashiers, because people are wondering, does technology all the sudden start replacing the cashier. And let's face it, eventually I think that happens more and more. For the time being, no. But if that Amazon Go worked in that one test market, and I think it did, it would be awfully exciting to push that out to other stores.

Argersinger: I think we should talk about what this means for competition.

Hill: I was just going to say, Jason mentioned Kroger before, I think it's worth pointing out that earlier this week, Kroger came out and lowered their revenue guidance for the full fiscal year, and the stock fell almost 20%, and then this happened and Kroger shares fell on Friday another 10% to 12% on top of that.

Argersinger: Right. I saw Friday, Costco was down, Wal-Mart was down. This is the business that these companies have gone after tremendously for the last few decades, at least. And now Amazon is making the big play. Earlier, when I was saying the deal surprises me, I actually thought from a cultural standpoint that Amazon buying Costco actually made a lot more sense. Of course, that's a bigger deal, you would probably have to pay $80 to $90 billion for Costco, still not a humongous deal, if you compare it to Amazon's $460 billion market cap. I just don't think they would have gotten that deal past regulators. That, to me, would have made more sense, if Amazon was going to really, as Jason said, go in and grab market share in a big way, and do it in a business that has a lot more of the distribution and fulfillment capabilities, membership business, it made a lot more sense.

Hill: What about this notion that's going around that Amazon got a really good price, even though they're writing the biggest check they've ever written. There was one firm, I don't remember which one it was, the buyout price was $42 a share and one firm came out and put a price target on a Whole Foods of $45 a share, saying, "We think there are going to be other bidders coming in for this." Who else? I was trying to wrap my head around who this makes sense for.

Moser: There are two concepts that could come into play here. Kroger is one --

Hill: Kroger is having a bad week. [laughs] 

Moser: They are having a bad week, but let's not forget, it's not just Kroger. They own Harris Teeter, so they do have some familiarity with that upper-end space. And don't neglect private player Publix, Mac's favorite grocer, right Mac? We all love a little Publix now and then. We don't get enough exposure to Publix up here. Wonderful store down south. They are private, as we said. That would be an opportunity, of course, for Whole Foods to be able to get out of the limelight as well, there. I like your thinking there with Costco, two companies with very loyal fan bases, subscribers, they have great renewal rates. But at the end of the day, I think this is going to be something that ends up making a lot of sense. And honestly, I don't want to call Whole Foods a desperate seller. But I will say, this was a business that was clearly facing monumental challenges in the coming years, and I don't know if there was really any easy way out for them. I think this is ultimately the best-case scenario for them, and shareholders ought to feel pretty good about this deal.

Gross: Yeah, speaking to the competition, even without the online piece here, there's just too much competition in this business for such a thin-margin business, and there's too much price competition, and you see it hitting all these folks. Now we have the Europeans coming in with Aldi and Lidl -- I probably pronounced both of those wrong, I apologize -- so now we even see more competition. Then, you layer in the fact that online grocery is only 2% of all online sales. A major competitive force about to come in, I think we could start to see more and more consolidation in this industry, and a few years from now there will be bigger players but less.

Moser: Yeah, I think a lot of people may not realize how robust the online grocery space is. In 2016, it was about $42 billion in sales, which grew more than 150% from the year before, and that is projected to take up more and more share of the overall grocery market as time goes on. So clearly, Amazon placing a bet on the direction this market is headed, and I think they're on to something.