Whole Foods Swallows Up Wild Oats !

Whole Foods, one of my favorite long term companies, today announced after market close they were to acquire rival Wild Oats for $565M, their largest single acquisition ever so far.

For WFMI, that's a quick way to eliminate competition and expand geographical presence, all the more that there is a good regional complementarity (regional critical mass is key in retailing for obvious logistics reasons). That's also $1.2bn revenues more on the top line of WFMI whose 2010 sales objective remains at $12bn vs the today $6bn.

However, though both companies are natural and organic food specialist retailers, their store format are rather different with the average Whole Foods units usually twice as big with almost twice more sales per square footage (specifically, $5.6bn for 190 units at WFMI and $1.2bn with 110 units at Wild Oats). As a consequence, Wild Oats is significantly less profitable then Whole Foods, and they were also not growing as fast.

Expanding is always long and painful for a physical retailer - finding the right place, negotiating the lease, building the store, etc - so that acquisitions usually make sense. Howewer, integration is no easy task, as with any acquisition in fact.

In physical retail, it's long and costly to set up new stores, but when they open trafic then flows immediately (if location is right). In the e-commerce business, it's so easy to open a store, but it's then so tough to make trafic flow in. Worse, when someone drives to your store, it could be a pain to get out without buying anything as it means having to spend time going to another one, while a competitor is always just one click and one second away in the cyberspace ! Though trafic and conversion rates analysis (on a daily basis) are the basics of the retail business, physical or e-commerce, the nitty-gritty and the logic are altogether different.

Anyway, Wall Street seems to like the move as it pushed WFMI 4% higher in after hours trading despite the dissapointing earnings report (Whole Foods missed analysts' expectations).

Note that a Los Angeles based Private Equity firm was a key shareholder of Wild Oats.

Comments

[Jeremy Fain]

The price paid is still a bit high. You don't mention it, but an EBITDA of 13 looks a bit excessive: it's the highest transaction multiple of the last decade in the food retail business.

Furthermore, WFMI now has debt and consequently faces a higher risk in case of a market downturn.

Last but not least, Wild Oats stores are very small compared to Whole Foods ones. So the acquisition urges a strategic shift by WFMI: from superstores to just stores (less profitable).

Needless to say, I wasn't buyoant reading the news this morning...

[Michel de Guilhermier]

Well Jeremy, I think you are making a mistake !

First, OATS EBITDA is $51M, so that's a bit less than 11 times.

Still, this is quite pricey, but bear in mind 3 things about retail :

- What matters foremost in physical retail is location.
- A superior concept yields more revenue per square foot
- Purchasing and logistics costs come down with volume.

WFMI is basically acquiring 110 new locations which, thanks to its superior merchandising/premium products, will later yield significantly more $ per square foot than what they do today with the present OATS merchandising.

I think it's reasonnable to estimate that WFMI has the potential to raise revenues per square foot in the OATS stores (which are all going to be rebranded) by at least 50%. This should in turn probably double the EBITDA of OATS.

Furthermore, $1.2bn additional top line revenues will drive purchasing costs down and improve logistics efficiency throughout the system.

All told, I believe this $545M acquisition should create at very least twice as much value for WFMI.

The 12% stock price increase of WFMI yesterday is logical !

[Michel de Guilhermier]

However, I must add that I was more concerned with the earnings report than the price paid for OATS.

There appears to be pressure on prices and margins, and this will undoubtely impact the bottom line of the combined company.

In the same time, by getting bigger they will lower purchasing cost down and somewhat offset potential lower pricing.

[Jeremy Fain]

I'm sorry Michel, but the transaction will occur in the $565m range and Oats' EBITDA amounts to $40,86m. 586/40,86 = 13,82.

I couldn't agree more on the purchasing economies of scale; however, I can only express doubts regarding logistics. Transportation costs aren't so much likely to go down as Oats' stores are remote from WFMI ones. As for the supply chain system, true efficiency should theoretically improve. However, practically speaking, and I'm certain you have at some point experienced it growing Photoways (I'm just guessing), the entire supply chain may get more complex. So the system will have to be updated, which requires IT investments.

Last but not least, true WFMI's concept is great. But Oaks' concept is different: smaller stores and hence lower revenues/store and profit margins impacted (lower bargaining power with suppliers).

So let's watch and see what the management of Whole Foods does with Wild Oats. It should be quite interesting and pretty quick to come in the news.

[Jeremy Fain]

"586/40,86 = 13,82" sorry for the typo; should've been "565/40,86 = 13,82" but I'm sure you would've corrected yourselves.

Source for OATS' EBITDA, Dow Jones Market Watch: http://www.marketwatch.com/tools/quotes/profile.asp?symb=OATS&sid=17938&dist=TQP_Nav_profile

[Michel de Guilhermier]

Hi Jeremy,

As for OATS EBITDA, I refered to Yahoo Finance. One source should more accurate than the other, but I can't tell which one !

Anyway, more interesting are the fondamentals.

A agree for logistics, only minor gains have to be expected. They will mostly be on OATS bottom line as I'm sure WFMI has the potential to improve it. You are also reight to pinpoint the systems upgrade you also have to make. Possible that WFMI has to make them (but not sure, I don't know the exact status of their IT systems).

Though OATS store are different with lower revenues/sq ft, I for my part bet this is where will come most of the gains. OATS stores will not reach the sq ft rev of WFMI as there's a retail law : the bigger the store the bigger the rev/sq ft (for a given concept). That's why I capped at +50%.

But WFMI's superior merchandising and premium products will undoubtely make a key difference.

And you also have a better purchasing power now with 20% more revenues (which can become 40%).

[Michel de Guilhermier]

Bottom line for me is that Wild Oats locations, once they have WFMI merchandising, will either upsell ex OATS shoppers or will attract new upmarket ones.

I've just read that John Mackey, WFMI CEO, had dec in declared that it anticipated sales up by 50 to 70% in some locations, higher that what what I assumed.

OATS was a laggard and I have no doubt WFMI superior management and merchandising will make a big difference. I have already seen that in other environements.

However, again, there's these days a global price pressure on the natural and organic food retail market, so I'm just midly bullish on WFMI for the short term.

Long term, not a single concern !

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