On Monday, a Morgan Stanley report that Amazon was contemplating "disrupting" the Healthcare Distribution sector slammed stocks in the industry, sending the sector sharply lower. Fast forward two days, when Amazon's disruption appears to have started earlier than even MS anticipated, after a CNBC report that AWS CEO Andy Jassy is planning to announce that Amazon is teaming up with Cerner, one of the world's largest health technology companies, to help health-care providers better use their data to make health predictions about patient populations.
Yet while Amazon is pursuing aggressive market share theft in the healthcare sector, in retail it is expected to have a more amicable approach, and according to a note by Citi, shortly after its acquisition of upscale grocery chain Whole Foods, the next corporate move by the world's richest man will be to buy a prominent retailer. The question is which.
As Citi's Paul Lejuez explains, when AMZN bought WFM in June 2017, it led many to believe that AMZN might have aspirations to establish more of a bricks and mortar presence in the US. Citi also argues that while "grocery is different" (and AMZN may just stop there), Amazon may next target a retailer. It also make the following explicit caveat:
To be very clear, we are not asserting that AMZN will buy any of the names we suggest in the foreseeable future. We have no insight into any AMZN M&A activity or deal flow. We are simply performing an exercise where we consider the question “If AMZN were to buy something in our universe, who could make sense?”
Below, we show who Citi believes may be the best candidates for acquisition by Amazon, and summarize some key components of each of the companies that Citi suggests AMZN may eventually buy.
Why ANF?: (1) EV of only $620MM for 2 brands (A&F/Hollister); combined sales of $3.4BN, (2) own college like campus in Columbus, OH, (3) instant infrastructure to design, source and merchandise apparel on a global basis, (4) young customer base, (5) can use flagships (in amazing locations) to sell proprietary AMZN product.
With ANF, AMZN would acquire a very impressive headquarters in Columbus, OH, which is similar to a college campus. It has a strong culture and has a young workforce that could be leveraged across the AMZN organization.
As far as AMZN’s apparel aspirations, ANF offers an instant infrastructure to design, source and merchandise apparel on a global basis. ANF is vertical, so the brands would become AMZN’s proprietary brands to sell on its own website. And don’t forget they not only have a teen and young adult customer, they also have the A&F kids brand (abercrombie), which could have appeal to the mom shopping for kids clothes on Amazon’s website.
For less than $1BN, AMZN gets three apparel brands they would own (A&F, Hollister, abercrombie kids), a seasoned design/sourcing organization, ~850 stores (including instant access to some of the most desirable locations in the world), and a campus like headquarters they can use (with space to build on further). Oh, and we estimate ANF generates in the range of $50-100M of FCF annually (and imagine how much more productive/profitable those flagship stores could be if they were selling AMZN product). At that small price tag, there wouldn’t be much to lose.
if you’re AMZN, might it be more of an asset to suddenly have control over these flagship stores that are in some amazing locations. Just look at this list:
- NYC (34,000 sq ft on 5th Ave and 56th St)
- London (24,000 sq ft on Savile Row)
- Tokyo (30,000 sq ft on 11 floors in the Ginza shopping district)
- Paris (28,000 sq ft on the Champs-Elysees)
- Milan (20,000 sq ft) – Corso Matteotti
- Shanghai (25,000 sq ft) – Nanjing West Road
- Singapore (20,000 sq ft) – Orchard Road
* * *
Why SFM?: (1) They’re already partners, (2) potential synergies with AMZN grocery delivery business, (3) compliments the WFM platform with a high/low price approach.
We outline 3 possible methods of obtaining a takeout value per share for SFM using the recent Whole Foods transaction as a guide (which may be more relevant in this case than looking at historical precedent transactions). The more likely of the scenarios is a $27-$33 takeout price, representing a 30-62% premium to the current price of $20.37 (11/16/17). Stock Price Premium Using Whole Foods As a Guide: Whole Foods was taken out at a nearly ~30% premium. This would imply a takeout price of ~$27/ share for SFM (using it current stock price of $20.37), at a ~13x TTM EV/EBITDA. Note that this would be significantly higher than the historical average of precedent transactions in supermarkets of 7.4x TTM EBITDA and Whole Foods at 10.3x TTM EBITDA.
* * *
Why BBBY?: (1) Store space already dedicated to online pick-up, (2) access to growing furniture space, (3) logistical/fulfillment know-how for large items, (4) overlap of merchandise assortments, (5) 1,100 off-mall stores across N America.
AMZN could acquire BBBY for a similar figure as RH - about $4.4B assuming the same 20% stock price premium – and would achieve still gain a physical F&HF presence and large-items fulfillment know-how while avoiding the drawbacks associated with a potential purchase of RH.... We do not think an AMZN purchase of BBBY is imminent. Only about 8% of BBBY’s sales come from furniture, while the majority of the remaining sales are items that consumers are increasingly-willing to buy online. BBBY looks significantly over-stored, even excluding non- BB&B brands. And BBBY’s product assortment is narrow compared to a retailer like KSS. Finally, from a financial standpoint, BBBY looks to be in structural decline and while we believe AMZN could certainly turn BBBY around, it’s unclear to us whether they would have interest in investing the capital and resources necessary to do so.
* * *
Why RH?: (1) Access to growing furniture space, (2) logistical/fulfillment know-how for large items, (3) overlap of high-income consumers, (4) both run a membership model, (5) equity/recognition of RH brand.
Within our furniture and home furnishings (F&HF) coverage, RH comes up most frequently in conversations as a potential AMZN target. The F&HF market is an attractive one given it is highly-fragmented, is growing at a MSD rate overall and is seeing sales rapidly shift online. Over the last five years, ecommerce F&HF sales have grown at a 15.9% CAGR and are projected to reach 17% of the domestic industry total by the end of 2017, up from 10% in 2012.
We think a F&HF acquisition makes sense for AMZN for two main reasons. First, an acquisition would aid AMZN’s build-out of large-package fulfillment, which – like grocery – is fraught with complexity. And second, an acquisition could provide AMZN with an immediate physical F&HF presence, a factor that remains important to consumers purchasing furniture and home furnishings product (again, similar to groceries).
RH’s valuation isn’t particularly compelling as the stock is trading at 25x FY2 P/E and 15x EV/EBITDA. Assuming a 20% stock price premium, an acquisition of RH would cost $4.7B which is far from prohibitively expensive for the online giant, but likely does not represent the best use of capital given the factors noted above.
* * *
Why AAP?: (1) AMZN’s growing interest in the automotive space, (2) price is important for the DIY customer, but convenience and immediacy is more important, which highlights the need for stores, (3) highly specialized inventory build out will take time; AAP provides inventory breadth and depth, (4) specialized supply chain, (5) even at a 20% premium, AAP is less than half the value of ORLY and AZO.
We think we can make the argument that Amazon could buy one of the auto part retailers. When considering the needs of the DIY customer, we argue that most DIY’ers aren’t going to drive to a store, ask a store associate a bunch of technical questions on what they need to buy and do and then purchase the parts on AMZN and make the repair themselves. Most DIY’ers likely don’t make the same repair more than once so they always need guidance. Therefore, Amazon owning an auto part retailer with brick and mortar presence would achieve the ability to cater to consumers looking for the convenience and immediacy needed.
However, we think a buyout of AAP is likely a long shot due primarily to 1) AMZN could likely finance the deal but it’s fairly soon to do an acquisition of this size, especially with the upcoming WFM integration and 2) AAP has experienced challenging demand trends (similar to WFM) but lacks large synergistic characteristics that would make AMZN uniquely capable in improving productivity. In the end, if the argument for AMZN’s acquisition of AAP is to gain market share through buying a major player in that sub-industry of retailing, the list of targets could get fairly long.
* * *
Why KSS?: (1) 1,100 off-mall stores to sell AMZN top-sellers, use for pickup/returns, (2) would own KSS proprietary and exclusive brands, (3) middle America customer, (4) $1BN+ annual FCF, (5) already an AMZN/KSS partnership.
After AMZN bought Whole Foods, if we had to come up with a list of ten companies AMZN could target next, KSS would have been on that list. After seeing the partnership between the two companies with KSS accepting AMZN product returns in 82 of its 1,100+ stores (with 10 of the stores home to a 1K sq ft AMZN shop in shop), we would argue KSS moved higher up that list. One of the reasons we believe AMZN might have chosen KSS as a partner to test its product returns to stores is that they have off-mall locations, which offer an easyin, easy-out shopping experience. Their store base is also relatively young, as 30% of their stores have been opened over the past 10 years (vs ~10% at JCP and ~7% at M – and M and JCP are largely mall-based).
The 1,100 KSS stores would offer AMZN many points of distribution that could help them in several ways. And let’s keep in mind, if AMZN bought KSS, we shouldn’t necessarily think of them as simply running the KSS chain. These stores could be rebranded as Amazon stores or “Amazon Kohl’s”.
At a $12BN acquisition price (assuming a 20% stock premium), a KSS deal would be about 10% less than what Whole Foods cost ($13.7BN). It would cost AMZN $9BN plus the assumption of $3BN in net debt. And let’s be honest, department stores are in a tough spot in the current retail environment, which might make KSS a more willing seller. Since department stores are facing serious challenges, we believe if there is one that can link up with AMZN, the others will be in that much more difficult of a spot. And let’s not forget, over the past 4 years KSS has generated an average of $1.2BN in FCF, including $1.4BN last year. We estimate they will generate around $1BN this year and for the next several years.
* * *
Why KR?: (1) Sizeable grocery presence with assets that may be of interest, (2) provides another point of attack against WMT, (3) obtain valuable consumer data via KR 84.51 division, (4) significant click and collect presence to help with last mile grocery challenges.
KR is the 2nd largest grocery store in the U.S. and would allow AMZN a way to take a sizeable 14% share of the US grocery market (vs. the paltry 2% share they attained through WFM). KR has 2,796 store locations- of which 1,445 fuel centers and 2, 255 pharmacies reside (pharmacy and fuel centers could be additional segments of long-term interest to AMZN). KR is also one of the best run grocery chains, in our opinion, which has led to continual market share gains. Competitive advantages for KR include: real estate locations, data analytics, purchasing power, vertical integration (they own several processing/production facilities, have self-distribution capabilities which can be enhanced by AMZN, and also have a large private label sales mix which may be of interest to AMZN), and a large loyal customer base.
KR has a treasure trove of data that could be useful to AMZN to better personalize promotions and improve space optimization (could improve both AMZN and KR grocery operations). Their 84.51 data analytics division tracks 2,700 consumer attributes to determine geo density from a competitive perspective (including restaurants), hobbies (spend index across entertainment, travel), and social connectedness data, which are used to create a rich picture of their customers. This data allows them to more truly personalize their offerings and the shopping experience.
We outline 3 possible methods of obtaining a takeout value per share for KR using the recent Whole Foods transaction and past supermarket transactions as guides. The scenarios indicate a $29-$34 takeout price, representing a 30-53% premium to the current price of $22.28. Stock Price Premium Using Whole Foods As a Guide: Whole Foods was taken out at a nearly ~30% premium. This would imply a takeout price of ~$29/ share for KR (using it current stock price of $22.28), at a ~6.8x TTM EV/EBITDA. Relative P/E Multiple Turns Using Whole Foods As a Guide: Whole Foods was taken out at nearly 30x ’18 P/E at the time of announcement which was ~6x turns higher than its ~24x ’18 P/E before the announcement. Adding 6x turns to KR’s current ’18 P/E of 11.3x results in a 17.3x P/E multiple. Applying a 17.3x multiple to KR 2018 EPS estimate of $1.98 results in a ~$34 / share takeout price. EV/EBITDA Multiple Using Precedent Supermarket Transactions As a Guide: Using the supermarket precedent transaction (see Figure 3 below) average EV/EBITDA takeout multiple of 7.4x TTM EBITDA derives a $33 takeout value.