AMZN - Ocado: Rumored Deal Would Make A Lot Of Sense For Amazon

2023-06-22 16:51:40 ET

Summary

• Ocado's AI and robotics expertise make it an attractive acquisition target for Amazon, which could help develop the technology grow.
• The Ocado Smart Platform has potential for significant growth and synergies with Amazon Fresh, making it a valuable asset.
• A price-to-sales multiple of around 2.5x is a fair valuation for the potential upside from synergies and the large market they could serve.

Thesis

Today, rumors that Amazon ( AMZN ) or some other tech giant is buying struggling UK online supermarket company Ocado ( OCDGF ) sent its shares up more than 40% at one point. And I think it makes a lot of sense to buy Ocado's expertise in the AI and robotics industry at this price, because it could be worth a lot more with the right execution. Amazon is financially strong enough to fund the growth story of the smart platform, and they also have some of the best AI engineers in the world who can help improve this software even further. Furthermore, Amazon would diversify its business a bit more and could create synergies with Amazon Fresh.

Analysis

Ocado, which operates through two divisions, the online grocery business, which is a joint venture with Marks & Spencer ( MAKSF ) and accounts for about 11% of the UK online grocery market, and its crown jewel, the Ocado Smart Platform, a type of robotic warehouse technology used by Kroger ( KR ) in the US and others worldwide that really has a lot of potential.

Many investors have pinned their hopes on this technology, which promises cheaper and faster deliveries . A robotic arm picks and packs orders, reducing the need for labor and therefore one of the biggest cost items, wages could be reduced by approximately 30%. Another reason why this technology could be important and mission-critical is that many of Ocado's customers have said that they have problems finding enough staff, and the robots could solve this problem. Once a company adopts this technology and sees the benefits, it could be very difficult for them to go back to the old way of working, as the switching costs are likely to be high, and the efficiency would unfortunately be lost.

Last month, Ocado also announced the acquisition of 6 River Systems , a provider of autonomous mobile robot fulfilment solutions, demonstrating its commitment to investing in and growing this business. All in all, I can definitely see why Amazon or other technology heavyweights would be interested in acquiring Ocado.

The human race always will be dependent on the provision of food, and if a company has a way of getting it to them cheaper and faster, it promises an incredibly large addressable market. And AI and robotics are very hot right now, as we saw with the sudden rise in Nvidia ( NVDA ) shares.

Customers

In addition to Kroger, they already work with France's Groupe Casino (CASP.PA), which has more than 11,500 stores worldwide, and Lotte, the largest department store and second-largest hypermarket chain in Korea. Their customers are some of the world's largest in their industry, and their technology adds real value. And because it's not easy to build such technology without the right expertise, I would argue that they have a deep moat and strong barriers to entry. So for a company with enough cash, it makes a lot of sense to buy that expertise and profit from it.

However, Ocado needs access to finance, or it needs to be bought out as it burns cash. Their free cash flow has been negative every year for 10 years . And new CFCs with their technology are capital intensive, so a strong partner with an experienced management team would be the perfect solution for them.

If they are not bought, what happens?

This is a good question as the UK is in a difficult situation with truflation at 13.06% and a cost of living crisis that is having a real negative impact on earnings. Two days before the takeover rumors, JPMorgan ( JPM ) slashed its price target on Ocado to £4 , citing the macro backdrop and falling consumer budgets. And FTSE has reported that it will have to remove Ocado from the FTSE 100 index . So without an acquisition from Amazon or someone else, it looks difficult for Ocado, and they will most likely have to get some funding from somewhere.

A spokesman for Amazon declined to comment on the takeover rumors, and Ocado has also declined to comment . £8, or around $10, currently represents a premium of around 45% to the shares, which are currently trading at $7.

If the takeover rumors turn out to be untrue in the next few days, I expect the shares to fall back to where they were before the rumors, or even lower. However, if the rumors turn out to be true and the shares remain at their current price, this could be an attractive arbitrage opportunity.

However, it should be noted that the CMA previously carried out a long probe into Amazon's investment in Deliveroo before approving it in 2020. So I wouldn't expect a smooth ride, as there are likely to be obstacles, even if both parties want the deal to go through.

What will Kroger do?

Kroger has a 5.771% stake in Ocado with 47,700,000 shares, how will they react, and what will happen to their CFC centers if a competitor takes over Ocado? After all, they're also a big customer, and if a direct competitor were to buy Ocado, there could be tension. But without knowing the details of a deal, we need to wait for an official offer to review the situation.

Valuation

As Ocado has never really been profitable, as evidenced by its net profit over the past few years, it's difficult to say what the fair value of an acquisition is on that basis. What can be said, however, is that there's potential for a new management team to develop the technology in peace and quiet, without the need for funding.

From a price-to-sales ratio perspective, even the £8 price is well below the long-term average as the shares peaked at £29, a multiple of over 10x. And at a ~2.5x price-to-sales multiple for such an exciting technology, plus the 11% share of the UK online grocery market in their other division, I would say that the price is fair on this metric, especially given the upside potential.

Conclusion

The Ocado Smart Platform, described on the Amazon AWS website as combining the latest innovations in AI with machine learning, robotics and IoT, could be the perfect acquisition candidate for Amazon. Amazon Fresh and the Smart Platform would likely have some synergies, and Amazon has enough cash to get them through the tough times and also help them spread their software to more customers.

An approximate price to sales multiple of 2.5x also is a good price to pay for the potential upside from synergies and the development of robotics technology and the really big market it could address.

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