(This commentary originally appeared on Real Money Pro at 8:57 a.m. ET, June 19. Click here to learn about this dynamic market information service for active traders.)
* Amazon is a change agent. The retail landscape continues to undergo change, and with it will come lower retail industry sales, profits and margins.
* Does Amazon create value through its distribution channel or does it destroy jobs? Concerns likely will prompt regulatory and tax responses that could hurt Amazon.
Amazon's (AMZN) proposed transaction of Whole Foods (WFM) puts together the best-in-class e-commerce entity with a dominant, bricks-and-mortar purveyor of high-quality foods.
This morning Jim "El Capitan" Cramer vividly relates his experience with the transformation of the retail vertical over the last few decades. Like Jim, I also view Amazon as a company that never, ever again should be dismissed, though many money managers and analysts once again may be duped!
As Jim writes (and with which I heartily agree):
"Nevertheless, anyone who thinks that Amazon won't do to Walmart what Walmart did to my father's customers just haven't lived it. You have to live it to know it. Otherwise, it's too theoretical for your taste.
Believe me, there's nothing theoretical. It's a reality for everyone from Costco (COST) to CVS (CVS) to Walmart and Target (TGT) . And it's an unpalatable but inexorable reality that they never saw coming or, if they were prescient, hoped would never come."
--Jim Cramer, "I've Lived Through What Amazon Does to Retail; Back Then, It Was Walmart"
With the stroke of this planned acquisition, the traditional delivery of food items will be upended, forcing a change in the grocery vertical and in the need for other food retailers to respond with urgency through a reduction in prices and an investment in technology in order to maintain their competitive positions against rapidly expanding Amazon's footprint.
The stunning merger announcement on what looked to be a slow summer Friday has significant implications for the retail industry in general and for Amazon that only will be obvious after some time has passed.
Opinions undoubtedly will change, but here are my principal reactions:
With the Whole Foods transaction, Amazon's vast power will be under the microscope. Is Amazon a productive change agent and force for the good of the consumer by virtue of a reduction in product prices? Or is Amazon's disruption of the general retail business a destroyer of jobs, moving previously productively employed workers into the unemployment line?
* Unlike Jim, it is my view that Amazon's shares should be sold on strength as the company could face regulatory restrictions in reaction to its expansion plans and customers who use the service could face a rising tax burden over the intermediate term. It is not clear to me, given the extended valuation, that investors will be so patient with this possible threat.
* Given the disruptions in jobs, malls and elsewhere, I wouldn't be surprised if the proposed acquisition and future acquisitions will be opposed by many, possibly including politicians and regulatory authorities. (Note: Retail stores are closing with rapidity -- an estimated 8,000 stores in 2017 alone compared to about 4,000 in recession-savaged 2008 -- as the business landscape radically has changed due to Amazon's strategic alliances and business objectives and strategies.)
* The acquisition of Whole Foods is an existential threat to grocery store chains and to food manufacturers. The transaction reduces sales, profit and margin expectations for those industries and puts a lower cap on private market values.
* The acquisition is another example how disruptive technological change is an important deflationary influence. (There will likely be no more Fed rate cuts this year!)
* Finally, there are a number of tech companies that will benefit from the need of retailers to adopt new technology to thwart Amazon. The technology beneficiaries are a host of companies that enhance and speed up the experiences of the Internet, mobile and bricks-and-mortar channels. Some possible examples of companies benefiting from the adoption of enabling technology are Twitter (TWTR) (my "Trade of the Week" below), NCR (NCR) , ON Semiconductor (ON) , Shopify (SHOP) , Square (SQ) , VeriFone Systems (PAY) , Verint Systems (VRNT) , Yext (YEXT) , Nvidia (NVDA) and Cognex (CGNX) .
Amazon Disrupts
Although few focus on this important metric, Amazon's marginal productivity of capital was falling before the WFM deal. It will decline more rapidly now.
Amazon is using a 40x Ebitd multiple stock as a credit card to buy into an 8 times (or less) multiple business. The deal will be financially accretive since AMZN's cash pile earns essentially nothing. That is irrelevant in my opinion. I am surprised that AMZN was trading up so appreciably on Friday and again this morning. By buying WFM and going full tilt into groceries, AMZN is entering a competitive arena that does not justify a 40 times multiple.
Some investors may decide it is time for Jeff Bezos to lose his blank check. This past week's "Variety" actually wrote an article critical of some of Netflix's (NFLX) content investment strategies.
This deal finally could encourage regulators to close the Internet tax loop.
Channels of Food Distribution Will Change Rapidly
Walmart (WMT) is the largest U.S. grocer. Having met Sam Walton for the first time in 1973, I understand the culture of WMT. They cannot be beaten on price. It will not happen. Costco (COST) also sells food at a very low gross margin, relying on float and its membership fees. AMZN does not disclose much of anything, but it is hard for me to believe it makes any money distributing groceries nor has Wall Street required that it do so. One implication here is fairly obvious.
If you are a food retailer in the middle of this battle of titans, the best analogy is that you are Belgium and it is the spring of 1940. The industry has become uninvestable, in my opinion. Food retailers are going lower. Rational standards of value may not apply. Not all will fail. Some may even be unaffected. But when Aldi and Lidl are thrown into this stewpot, it becomes a mess of biblical proportions. Rational investors will stay away, at least for now.
This may hasten the needed demise of Sears Holdings (SHLD) . The Kmart division has a significant grocery exposure. Lights may go out here sooner rather than later. There are 140,000 jobs and $20 billion or so of sales.
The traditional bricks-and-mortar grocery chains face an existential threat.The values of the companies will now diminish over time coincident with a changing business landscape characterized by lower sales volumes and margin contraction.
Food manufacturers are also expected to face margin pressures -- perhaps not immediately, but certainly down the road. Besides the profit reductions, the values of those previously moated businesses are now uncertain.
Anticipated losers not only may be other retailers and suppliers but also in the ad industry. Amazon is NOT good for advertisers and WMT advertises with great reluctance. COST spends little on ads. Suppliers will be under great pressure, some of which WMT was subtly applying after its acquisition of Jet.com. This will surely get worse. Use of private label is growing and this may accelerate the trend.
The Political and Regulatory Backlash May Hurt Amazon
I am not at all sure antitrust forces will stand idly by, nor am I certain that politicians will stand by. Predatory price cutting may be a term that might become more familiar. I think this deal may take longer to close than anyone's wildest imagination. It threatens a lot of jobs. These employees have representatives and senators.
Chairman Jeff Bezos may find he is spending a lot of time in D.C. (and not on Washington Post business!) and AMZN may need to open its books to regulatory scrutiny.
That will be refreshing to some, but could be increasingly worrisome to Amazon shareholders.
