The Real Story Behind Amazon and Whole Foods

After Amazon’s (AMZN) announcement that it was buying Whole Foods Market Inc. (WFM) for $13.7 billion in cash, shares of both companies went up. (Enough in Amazon’s case to essentially make the purchase free.)

The valuation part of this story is important. Amazon spent almost $14 billion on a 460-store, retail food business with razor-thin margins. And its stock rallied.

That’s not because of synergies. It’s not because Amazon will increase margins. It’s far more simple.

Whole Foods makes Amazon’s best product way more attractive. That product is Amazon Prime.

Let me explain.

Amazon has never played by traditional big company rules. It refuses to grow up. It does not really worry about reported profits. It reinvests cash flow like a start-up. Its focus from day one through today has been securing loyal, repeat customers.

These are Prime members. They love shopping at the online retailer so much that they are willing to pay $99 per year for the privilege. It’s already a $6.4 billion subscription business.

In 2016, John Blackledge, an analyst at Cowen and Co., calculated Prime members spend a staggering $193 per month. And 91% renew after the first year. In February, he estimated the number of Prime memberships had swollen to 80 million worldwide.

Amazon built a business where its best customers pay to join, spend a lot, and don’t leave. Sweet.

Amazon’s constellation of warehouses, logistics facilities and robots are the envy of the package-moving world.

It does lavish Prime members with perks. They get free music and video-streaming services. Free two-day shipping on parcels is standard. Among other things, they can store photos, borrow digital reading material, and, in some zip codes, have takeout delivered for free, too.

The win for Amazon is not that it will boost margins at Whole Foods. In fact, Bloomberg
reports it will reduce prices. The win is it makes Prime stickier, that it ramps up customer spending.

When you examine Amazon through the lens of Prime, everything becomes clearer.

To enhance early e-commerce capabilities, it built Amazon Web Services, a massive public-cloud network of data centers. It continues to invest in artificial intelligence and bespoke customer relationship management (CRM) software tools to push the envelope in customer service.

The company’s constellation of warehouses, logistics facilities and robots are the envy of the package-moving world. It has invested in a movie studio, consumer electronics, several white label businesses, like apparel, baby wipes, and now food retailing, to offer its customers on-demand access to quality goods at reasonable prices.

It was able to make these large investments because Amazon holds two important advantages over its competitors: Its online store is a great first client, offering immediate scale. And the company continues to have unfettered access to cheap capital.

It’s easy to invest in infrastructure when you have a really big customer to smooth out the edges and when the market does not force you to reward shareholders with profits, dividends and share repurchases.

To be honest, I don’t see these factors changing anytime soon.

The fact that Amazon shares continue to rally despite the Whole Foods gambit is evidence as to why you may want to consider adding shares into weakness. Plus, other retailers may be in store for a pop as well. Check out my article here on what to look for in the space.

Best wishes,

Jon Markman

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Comments 5

  1. Carl June 28, 2017

    Buy a company with “razor-thin margins”, then “reduce prices”. Make money on volume!

    I know that wasn’t the point, but it’s funny. Instead, make money by locking customers into Amazon. Charge those customers more for other items in order to make a profit.

    Color me skeptical. I can easily imagine a website that pops up vendors with lower prices when a customer is ready to buy.

    Reply

  2. Al Kowsky June 29, 2017

    Excellent article!

    Reply

  3. H. Craig Bradley June 29, 2017

    DANGERS ON THE STREET

    I believe the flourishing of new concept tech. companies and some others since 2008 is primarily due to the ready availability of cheap capital (funding) from a number of sources. Ultimately, the Federal Reserve Bank has made this all possible with their ongoing monetary policies ( “Financial Repression”). It irrigated the field for specific crops or companies to grow that much faster with plentiful “liquidity”.

    In the process, savers were pretty much thrown under the bus in favor of a new era of much more aggressive financial engineering based on more and more ( unlimited ?) debt and credit. However, we all (should) know this is not an eternal financial set-up and eventually, someday, reversion to the mean will be very painful for companies and nations that have not achieved sustainability. Its when we have our worst national financial and social crisis and its out there in the great beyond for now.

    Naysayers keep reminding us this is not going to last, but most disregard the warnings and go with the crowd ( more consumer debt). Lots of misallocated capital. When the tide eventually shifts, the crowd will be washed-out. I only hope those with more wisdom and a longer term horizon can escape with relatively few losses, but it may not be possible. Only a minority of investors or public officials see the potential threats and risks ( e.g. emerging Public Pension Crisis). Hedging known risks will never go out of style.

    Everything is globally interrelated these days and only one falling domino anywhere can have “knock-on” effects on markets and whole economies ( So-Called “Black Swans”) everywhere. There is much risk in our new Financial Paradigm. The world still remains U.S. Dollar centric. Thus, the U.S. Dollar reserve currency and our military ( the global enforcers) are the key linchpins. So, if you want to predict the likely epicenter of the next global financial or monetary crisis (currencies) then those are two key possibilities or suspects, at least. Let’s just hope we don’t get rudely introduced to Mr. Mayhem anytime soon.

    Large Corporations can borrow, if they choose, for any number of purposes or for building-out their business. Each company and sector has their own traditions and priorities, all made more achievable with plenty of low cost credit ( Essentially 0% interest for the best companies or borrowers). Amazon is surely among them.

    Reply

  4. Ralph June 29, 2017

    Will Rite Aid be next???

    Reply

  5. richard September 25, 2017

    Consumers are short sighted boxing themselves into a corner where one day they may find the only store standing is Walmart and the only store online is amazon. For idealogical reasons I won’t have anything to do with either. But few put the long term picture or ideologies before savings. Amazon prime is an example having deep enough pockets to outdo everybody else to get full market share. Few encounter its shortcomings. Like posting a negative review of a product based on personal real experience will last only until the products maker out maneuvers the complainer and has the post removed. Try bucking Amazon and see how long it takes them to side with the one who does them the most good rather than the one who’s telling the truth. It’s a good investment in terms of money to be made but not if you’re investing in your future quality of life.

    Reply