Last week, Amazon.com, Inc. (NASDAQ:AMZN) fired a shot all grocers heard loud and clear. That is, the e-commerce powerhouse announced it would be acquiring grocer Whole Foods Market, Inc. (NASDAQ:WFM), taking its nascent food business to the next level by offering $42 per share of WFM, or $13.7 billion worth of cash, for the entire company.
But shares of AMZN stock also advanced following the announcement, with most owners of Amazon well aware that the online-shopping behemoth could do something with WFM that Whole Foods could never do for itself.
Those investors are right, by the way … Whole Foods Market’s weak link is a lack of marketing firepower, which is Amazon’s bread and butter.
Before those Amazon shareholders get too excited though, they may want to crunch a couple of numbers.
AMZN Stock Pointed in the Wrong Direction
Click to Enlarge Calling a spade a spade, Amazon is buying into a business that isn’t doing well. While sales are still growing for Whole Foods, the pace has slowed to a crawl, and per-share earnings have been declining since last year. Net income has been retreating since 2015.
Per-share earnings would have fallen farther, faster, were it not for a relatively aggressive stock-buyback program. As of the end, there were 338 million outstanding shares of Whole Foods stock.
Now that figure is 319 million, and projected to slide to only 300 million by late 2018. That’s the crux of the earnings turnaround analysts are calling for on a per-share basis.
Those same pros are still calling for a reversal of the net income downtrend beginning in 2018, but that outlook is less impressive than the per-share profit projection … and is also based more on hope and faith in the company’s so-far-unproven turnaround plan.
In other words, Amazon is taking on a fairly significant project if the end-goal is to turn Whole Foods into a profit center. The grocer is — or was — only expected to turn a profit of $411 million this year.
Still, that’s roughly 16% of the $2.6 billion worth of income Amazon boasts for the past twelve months.
Don’t look for per-share earnings to jump by 16% for AMZN stock though. See, while Amazon had $21.5 billion in the bank as of the end of last quarter, it’s not expected to fully fund the acquisition by just merely writing a check — Amazon is apt to take on debt to get the deal done without crimping its ability to fund other growth projects.
Debt May or May Not be the Solution
Though a precise figure for new debt hasn’t even been speculated yet, with $7.7 billion in long-term debt on the books plus the $1 billion in long-term obligations Whole Foods is already sitting on, Amazon’s margins will remain in check.
Last quarter, Amazon made $139 million in interest payments … a figure that has been gradually getting bigger.
Depending on how much new debt the company takes on to purchase Whole Foods, that figure could ramp up at a much faster rate going forward. Even if Amazon only issues new debt to finance half of the Whole Foods purchase — $7 million — its quarterly interest expense would approximately double.
Or, perhaps this will paint the picture in clearer terms: In each of the past three quarters, Whole Foods has earned less than $100 million. If Amazon chooses to issue debt to finance even just $7 million of the $14 billion price tag for the acquisition, the deal will cost the company more than it gains.
Looking Ahead for Amazon Stock
That’s not to say Amazon made a bad deal, nor is it to say to AMZN stock owners that Amazon shouldn’t take on meaningfully more debt to acquire Whole Foods.
It is to say, however, that Amazon needs to enter into this new venture with a very deliberate, believable plan to make sure the time and money are well spent.
If the end goal is to use Whole Foods as a marketing tool for the company’s other services, that’s fine. If the plan is to help the struggling grocer rebrand and reposition itself, that’s fine too. If CEO Jeff Bezos’ only plan is anything other than something rather dramatic though, the acquisition runs the risk of not even paying for itself.
That’s what shareholders need to look for from here… what’s being done that realistically makes the deal pay for itself. Just randomly casting a bigger net isn’t enough.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.