Amazon's Whole Foods aftershock throws up some beneficiaries (perhaps)

In the aftershock from Amazon’s $13.7 billion bid for Whole Foods late last week, supermarket stock prices took a massive hit, both in the US and across Europe.

There was a notable exception to that trend - UK online grocery firm Ocado, whose share price jumped up on the Amazon news.

Now, that’s not necessarily good news as it’s indicative that Ocado is seen as a highly likely takeover candidate for the e-commerce behemoth.

As a thesis, it’s far from beyond the realms of possibility. Whole Foods provides a valuable logistics and supply chain boost for Amazon Fresh in the US, but not outside of that market.

In Europe, Whole Foods has only nine physical stores, all of them in the UK, seven of those in London. So if Amazon Fresh is to bump up its non-US presence through acquisition, it’s going to have to look beyond Whole Foods.

If that basic premise is accepted, then Ocado becomes a very obvious target in the sights. The Ocado story has been a remarkable combination of innovation on the technology front, but not such great success on the commercial side of things.

There’s been heavy investment in technology futures, such as bots and AI, as well as the creation of one of the most efficient DevOps operations in any business sector.

Mystery buyer

But the firm’s growth strategy is aimed at finding third retailers willing to pay to use its platform and technology to help run online grocery delivery businesses - and that’s been markedly less successful to date. There are existing deals with Waitrose and Morrisons, but overseas customers hadn’t materialised until last week when Ocado announced a partnership with a “regional European retailer”.

This was another exampler perhaps of mixed fortunes for Ocado. Senior management had promised investors that it would deliver overseas deals by the end of 2015, so finally making good on that promised 18 months late is a positive of sorts.

But the curious level of secrecy around the idenity of the retailer in question has alarmed some investors. The cautious description of the firm makes it clear that we’re not talking about a European retail giant like Carrefour here. Or as Andrew Gwynne of analyst house Exane BNP Paribas put it:

Because we don’t know who the partner is, we don’t know how credible the partner is.

According to Ocado’s announcement, this secrecy is at the request of the customer, which wants to keep its power dry until its online service is ready for launch, so that it can “retain competitive advantage”.

Hmm, OK. But there’s a still a whiff of this being a somewhat half-hearted commitment at present. Ocado will provide software to help the customer run its website and app, forecast stock levels, and route its delivery vans. But the mystery retailer won’t be installing all of Ocado's wizz-bang robotic and AI technology in its own warehouses for now, although it does have an option in the form of:

the right to request in the future the installation of automated mechanical handling equipment in centralised warehouses, powered by OSP technology, on terms to be separately agreed but within given parameters.

A key figure to watch in whatever happens next is Richard Bernstein of activist investor Crystal Amber, which has taken a 0.5% stake in Ocado. Bernstein wants a major shake-up of the firm, not only in its strategy, but in how it presents itself to investors.

Currently Ocado pitches itself at grocery and retail analysts. Bernstein reckons that’s an error and the firm should be positioning itself a technology company that sells products to grocery firms, asking:

Why is it positioned as a food retailer? Because the expenditure is going into becoming a provider of technology solutions for food retailers.

He’s told clients:

From an investor perspective, this is a story of disappointed expectations. The objective is to under-promise and over-deliver. With Ocado, this hasn’t been the case…Either its smart platform technology will prove to be scalable and the business will gravitate towards a seller of technology to global food retailers or it will have to recognise that its strategic value is far greater than its operational value.

From Ocado’s perspective, its technology focus is clearly going to remain a strategic priority. Last week it announced that it’s raised £200 million from a bond sale, some £94.5 million of which is going to be channelled into further robotic developments and expanding capacity at its warehouses.

Morrisons in play?

But Ocado’s not the only option for Amazon if it wants to replicate the Whole Foods gambit outside of the US. Remember that the big asset that the online retailer picks up with that deal is a chain of over 400 stores across the US that become logistics and fulfilment centers in one fell swoop.

Ocado can’t provide that raison d’etre for a takeover, but there is another immediately obvious option.

The only other supermarket to experience a boost from the Amazon Whole Foods news last week was, ironically enough, Morrisons, which is one of Ocado’s handful of clients. This can be attributed to the fact that it also has an existing deal with Amazon Fresh in the UK, but a Morrisons buy-out might make a lot of sense for Amazon. Neil Wilson at ETX Capital noted:

Whole Foods has just nine stores in the UK so the impact on Morrisons should not be too significant, and if anything could support Morrisons if it signals how Amazon might be able to help it grow market share.

Morrison's has struggled with its own online delivery service and digital transformation, but has valuable nationwide real estate that would be fit for purpose for Amazon's needs. It's an intriguing option and one that might make more sense than Ocado in the long term.

My take

I suspect the challenge of getting the Whole Foods relationship to work is going to keep Amazon busy enough for some time to come.

But at some point, it will have to think about the non-US market, starting with the UK where online grocery shopping and delivery is much more established practice. Amazon Fresh will need to up its game and having nine Whole Foods stores isn’t going to make a particularly significant difference.

From the perspective of Amazon, the good news is that it’s…well, Amazon.

From the perspective of the UK grocery industry, the bad news is that it’s…well, Amazon.

Then of course, there’s the rest of Europe - Carrefour in France or Ahold Delhaize in the Netherlands? - and indeed the rest of the world to be taken into account. We all need eat and Amazon’s served notice that it intends to be the one feeding us.