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| Amazon won't have issues raising $13 billion to acquire Whole Foods |
Amazon may have been pondering such a move for a long time and then pounced on the opportunity when the $13 billion price tag was too enticing a value.
Industry strategists and business futurists have already begun to imagine what Amazon will do with Whole Foods and how it will revolutionize how food is marketed, sold and delivered in the U.S. and, perhaps eventually, around the world.
By tradition, Amazon takes big steps, makes acquisitions, starts new activities and ventures and examines them over long periods. It admits failure and doesn't tolerate short-term scorecards to measure what they do. It won't care how markets assess the Whole Foods acquisition in, say, October or November or even a year from now. Right now, the acquisition is about developing a business model with little regard (for now) for expenses.
If the acquisition is consummated (barring counteroffers from other suitors and prohibitions from regulators), industry watchers will unleash unending analysis on the Amazon-Whole Foods marriage.
On the finance side (balance sheets, capital, returns, shareholder value, cash flows, debt levels, etc.), how is the transaction rationalized or justified? How might have performance and financial strength at both companies led to the two parties coming together? How will Amazon structure and finance the deal?
For those who follow Amazon shares, the company is a long-term growth story. Earnings have always fluctuated. Losses occurred intermittently, although performance has improved the past two years. On the other hand, revenues surge year after year. The Bezos approach to corporate management is growth first (measured by new businesses and stunning increases in revenues) and pay attention to earnings later. Stock markets have bought the growth story. Why else would its Price-to-Earnings (P/E) ratio exceed 180x, when values are hardly influenced by promises of dividend streams and smooth income statements. (Amazon still doesn't pay dividends.)
The growth story is indeed extraordinary. Revenues will approach or exceed $140 billion this year, almost doubling those of 2013. Earnings, which until 2016, were a succession of losses and gains from quarter to quarter, will likely approach $3 billion this year. That puts it on a pace to generate balance-sheet returns of a 14% (before Whole Foods' numbers are tacked on).
Notwithstanding volatile earnings in the past, Amazon has always been adept at generating handsome amounts of operating cash flow, thanks in part to shrewd, efficient management of current operations (inventories, supply chains, etc.). But operating cash flow from recent periods ($16 billion last year, is not enough to pay for Whole Foods. Operating cash flow is already used to support and grow existing businesses.
Remember, the company, even as old as it is, doesn't pay a dividend. All operating cash flow is reinvested into its many businesses (and new ventures).
The company enjoys the advantages of debt (low costs, leveraged returns), but in moderate doses. Debt has financed growing levels of assets and new ventures. Debt isn't used (as with other companies its size) to fund stock repurchases and subsidize dividend payouts, because the company has never elected to reward its owners that way. (Rewards come in increased stock values based on, yes, assumptions and expectations of long-term growth.)
Investment bankers will have already advised Amazon on how it will fund its purchase of Whole Foods. The company has about $20 billion in cash reserves, but won't exhaust most of that to acquire Whole Foods. Also, it won't likely issue new equity (because it hasn't done so in years and because it won't risk diluting current share values).
Including capitalized leases, Amazon's debt level exceeds $15 billion, and based on sustainable operating cash flows of about $16 billion (excluding contributions from Whole Foods), Amazon may have "room" to increase debt another $10 billion or so before ratings agencies and credit markets get worried. Because of such "room," for the total amount it needs to acquire Whole Foods, it could borrow some of the $13 billion and use some balance-sheet cash for the rest and then fine-tune these proportions, depending on market conditions and reviews from of ratings agencies and shareholders. Amazon may not likely want debt to rise too far above $20-22 billion. And it may not likely want cash reserves to dip below, say, $15-18 billion.
This, of course, assumes Whole Foods will operate at least at breakeven and won't be a financial and cash-flow drain on Amazon, as the two companies integrate and try to figure out that magic model for how groceries will be sold and delivered in the 21st century.
Now what about Whole Foods?
Company management has been subject to analysis and criticism, mostly because performance has been flat the past several years for many reasons. Revenues hover about $15 billion, and earnings exemplify that flatness (simmering within a range of $507-579 million annually the past four years). Whole Foods is viable and sound, and balance-sheet (book-value) returns on equity are satisfactory (about 15%). But shareholders are displeased. There didn't appear to be a thrilling investment upside in the years to come. Whole Foods' numbers would suggest the company is operating on a treadmill--not stumbling and falling, not really going anywhere.
Shareholders might have benefitted from stock-repurchase and dividend-payout programs, as part of an effort to make them happy. In 2016, the company, which had operated with negligible debt levels, took on about $1 billion in new debt, partly to finance stock repurchases (to help boost sagging stock prices).
Whole Foods has tweaked its business model (fresh, organic, premium-priced food), but the numbers suggest it hasn't made eye-opening investments or stepped beyond its niche. It's a $15 billion (revenue) company that seemed stuck at $15 billion.
Amazon's finance team won't have an eye on cash reserves on Whole Foods' balance sheet (It keeps cash at low levels), but will like that Whole Foods doesn't bring hefty amounts of debt to Amazon. That permits Amazon to rationalize incremental debt to acquire Whole Foods.
In effect, Whole Foods won't be a financial drain on Amazon while the latter conducts its experiments on what to do with it (and how, of course, to keep the likes of Walmart at bay). Whole Foods shareholders will miss the modest dividend payments, but will certainly have gained value by selling out.
Some will ask whether Amazon could have paid less for Whole Foods. In another year, it might have. In 2017, Amazon is buying stable cash flows, an operating structure, a brand, a customer base, and some infrastructure.
But it is also paying for not having to start this new experiment from scratch.
Tracy Williams
See also:
CFN: What Does the Market See in Amazon? 2014
CFN: What Happened at J.C.Penney? 2013
CFN: Why Is Dell Going Private? 2013
CFN: Yahoo Tosses in the Towel, 2016
CFN: Alibaba's IPO, 2014
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