Amazon and Target, can it really be done? Yes, indeed no, certainly maybe

08 Jan 2018
A few days ago the American market was in turmoil due to the hypothesis formulated by Gene Munster, managing partner of the venture capital company Loup. According to Munster, Amazon could acquire Target in 2018. Reactions were fast to come: there were those who were quick to write "I said so!", those who considered the fact unlikely if not impossible, those who were open to any possibility, rationally listing the pros and cons of the operation. Retex has written a lot in these years, both about Amazon and about Target. In a different way and importance, they are two essential entities of US and world Retail and it's certainly not only us who notice their actual complementarity. In the case of Target, we are convinced that after Walmart and with CostCo and The Home Depot, it is the confirmation of the centrality of physical distribution in the Retail sector, despite the hasty and superficial de profundis tuned in the past few years. Only a year ago, Munster's hypothesis would have been dismissed as a gamble and nothing more. Instead, after the acquisition of Whole Foods, the discussion verged on the actual merging probabilities, not on its meaning: it is clear that for Amazon the future of Retail is a combination of online and offline services. Target could be the ideal offline partner for several reasons. According to Neil Saunders, CEO of Global Data Retail, the single entity deriving from the merger could boast solid infrastructures, operational efficiency and brand strength to improve the overall value for customers and the profitability of the business. Of course, it's about understanding what of Target would be more appealing to Jeff Bezos. What is the frequency of visits to sales points, what is the average value of the cart and the sales margins. But there is a lot of reliable data, first of all the excellent performance of Target after the difficulties of the "Apocalypse" and the extension of the commercial network (1,800 stores in the area). Competitiveness with Walmart, therefore, would be guaranteed. Also the strength of the company is out of the question: Target has paid 200 quarterly dividends in a row and has increased its dividend for 46 consecutive years. But there are also reasons for skeptics. Richard Kestenbaum, analyst of Forbes, focuses on the reactions of investors to the possible merge. In the last year, Amazon made almost 14 billion dollars of EBITDA, Target just over half as much. Shares are often valued based on profit multiples, so Kestenbaum's doubt is how the market can evaluate the combined profits of the two companies. If what Munster assumes happens, many would quickly realise that the multiple of Target's revenue would not rise to Amazon's multiple, due to the different nature of the business. amazon-target

The way Amazon is seen today by investors is unique and its cost of capital is very low, almost zero. If Amazon incorporates Target, the profits of traditional low-growth stores will be more than one-third of the combined company's profits. Therefore, there would be the high risk for investors to see Amazon differently, because the e-commerce giant needs a 20-25% growth per year to confirm the low cost of capital. As long as Amazon offers substantial revenue growth with the possibility of future profits, the market will continue to guarantee it. But if a very large part of its profits were given by a lower activity growth than that consolidated up to now, this could have disastrous effects.

Kestenbaum's perplexities are confirmed by several analysts who claim that the acquisition of Target would allow Amazon to enormously increase direct relations with consumers, but with a normal incremental growth perspective and not by orders of magnitude.

After all, after the Whole Foods operation, the media is every day full of bets on Bezos' next move. Before Munster took a clear stand with his exacting statement, it was assumed Amazon was thinking of Lowe's (the second largest retailer in the home improvement supplies sector), of the "eyewear" start-up Warby Parker and of Nordstrom, one of the most important apparel distribution brands. The acquisition of Kohl's, the Illinois department store chain (1,200 sales outlets with about 18 billion dollars in revenues), had been considered even more likely in the recent past, since it had already linked a partnership with Amazon since last spring. In ten Kohl's stores in the areas of Chicago and Los Angeles there is a space devoted to Amazon where it is possible to make purchases or deliver returns.

But nothing of this has yet occurred.

2018 will be more than ever a year of retail sales in the spirit of the combination of old and new. It is a step in the natural evolution of the sector, and there will be surprises and confirmations, illusions and disappointments, risks and missed opportunities for more or less compulsory prudence. What Gene Munster predicted could be a mistake or an intuition, but it does not change the substance of things: competition within the sector will be with no holds barred, and merge & acquisition strategies will play a decisive role in this.