Amazon-Whole Foods: Price Likely to Climb

 | Jun 18, 2017 | 10:00 AM EDT
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Stock quotes in this article:

wfm

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amzn

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wmt

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tgt

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cost

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kr

(This commentary originally appeared on Friday on Real Money Pro. Click here to learn about this dynamic market information service for active traders.)

There are a couple of things to be aware of with the Whole Foods (WFM) - Amazon (AMZN) deal, the most of important of which is that it is not a done deal.

When carrying cost is accounted for, WFM is trading for over $1 a share above the deal price. Why? Because there is no way this goes down this easy for AMZN. They are essentially scooping WFM on the bottom. WFM was a near-$30 billion company in 2013 and near $20 billion as recently as 2015. AMZN knows they are buying the bottom, and so does Walmart (WMT) , Target (TGT) and Costco (COST) . I think there is a strong chance one of those companies puts in a rival bid, likely Walmart.

The two might even be more symbiotic than AMZN-WFM. WMT is strong in suburban markets and even stronger in quasi-cities and surrounding rural areas (think Appleton, Wis.). WMT has its finger on the lower-class all the way to the upper-middle-class market.

Meanwhile, Whole Foods (Whole Paycheck, as we used to call it) is essentially an urban market with a strong presence in major cities and wealthy suburbs ... the 1%. For AMZN, in many ways this is just piling on more of its own customer base, and I am not sure how this helps WFM, which has been flailing, other than some ability to get cheaper pricing with more buying power. The technology of going in, grabbing what you want and leaving is cool, but I am not sure that draws anyone new to a Whole Foods; it's really only the 1%, who probably don't want to have a conversation with the checkout lady anyway.

My point is that AMZN may end up getting this prize but they are not going to pay $13.7 billion. It will be north of $15 billion or greater. I think the stock ends up getting bought for near $50 a share, about a 20% premium on the Amazon price. Here are a few ideas I have on how one could play this deal:

I can buy the November $43-$49 call spread for less than $1. That is too cheap for that spread. If the deal does go through at a higher price, that will pay out huge. An alternative to an approach directly in WFM would be to buy COST and WMT, neither of which deserves to be taking it on the chin like this today. I think July calls in WMT or COST could pay out quickly when these names get the bounce after today's overreaction. On the other hand, places where maybe there isn't an overreaction is in Kroger (KR) and some of the other names in grocery. They have a bigger problem from this deal than WMT and Costco.

A trade that might be interesting is buying the WFM call spread and financing it with a put spread or puts in either COST or WMT. There is a lot of opportunity to play this deal, and I will be heavily involved in merger arbitrage on this one.

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