Special situation: Whole Foods (WFM) – “free options” anyone ?
A few days ago, Amazon famously announced to take over Whole Foods Market for 42 USD per share (representing a premium of around 27%).
Markets enthusiastically welcomed this move from Amazon, with the Amazon share jumping almost 4% or ~13 bn USD, which coincidently was almost equal to the deal amount.
Whole Foods itself was “under siege” from activist investor Jana which had built up a 9% stake in the company. Just 2 days before the takeover, Whole Foods CEO called Jana “greedy bastards” indicating that he was not happy having such a shareholder.
Selling out to Amazon seems to be a good deal for him, as Amazon allows successful subsidiaries like Zappos to run their business as they like it and Bezos has proven that he thinks very long-term.
However there are also some unhappy people about this deal. The first unhappy group are the other supermarkets:
While Whole Foods shares are surging because of the 27 percent premium being paid, other grocers are getting crushed. Kroger Co. was down as much as 17 percent, Supervalu Inc. dropped as much as 22 percent and Weis Markets Inc. slumped as much as 9.6 percent.
The stocks of the competitors haven’t recovered much since then because everyone assumes that Amazon clearly will disrupt food retailing next. So theroretically one could argue that it might make sense for Costco, Walmart or someone else to make life more difficult and offer a counter bid.
Another group of unhappy people were the other 6 bidders interested in the company. According to filed documents, Amazon threatened to kill the deal if Whole Foods would try to contact other interested parties.
So it is not really clear if the deal was the best deal for shareholders or if it was just the best deal for the CEO.
My assumptions at the current share price of 41,90 USD:
I think there is very little risk that the Amazon deal will fail. If no higher bid comes up, the deal will go through in the second half of 2017. If I would need to quantify this I would say max. 5% risk of non-completion. My own assumption for an “undisturbed” price would be rather ~34,50 USD/share.
However I do think that there is some likelihood for a better deal. It is hard to say how high the probability is, but with two groups of potentially interested parties (PE & competitors), I think the probability is not zero but rather maybe somewhere between 25-50%. For calculation purposes I use (25%+50%)/2 = 37,5%.
A “normal” take over premium in a competitive process should lead to a higher price. My “gut feeling” assumption in this case would be 5 USD more at 47 USD/share.
When the Amazon deal goes through I will get my 42 USD. The probability then is 100% -5%- 37,5%= 57,5% and I will earn 0,1 USD (before trading costs) in that case.
Update: As a reader pointed out, it would not be unrealistic to assume 1 dividend payments until the end of the year. This would add 0,18 USD or ~40 bps to the expected return and pay for the trading costs…..
So the expected profit based on my assumed probabilities could be calculated the following (based on 41,90):
=5%*(-7,40)+ 37,5%*(5,1) + 57,5%* 0,1 = 1,60 USD or ~ +3,8% for 6 months (or 7,7% annualized).
Alternatively I could invest my existing cash into a USD deposit which would pay my 1,5% annualized or ~0,75% in absolute terms. So on an annualized basis this is a spread of 700 bps which looks attractive to me compared to the risks I take (of course before trading costs etc.).
Looking at the recent price chart it is interesting to see that there seem to have been higher expectations for a higher bid in the beginning when the stock traded up to around 43,80 USD:
For some people this might look like “picking up the nickel in front of the steam roller”. For me it looks like an almost “free option” that someone comes along and puts in a higher bid. As long as I have cash (currently around 13% and still increasing), this is an attractive alternative.
Therefore I have initiated a 3% position at 41,90 USD per share. Again, as in the Actelion case, I fo not hedge the dollar, as I am still within my comfort zone with reagrd to USD exposure.