Food for Thought: Amazon Should Acquire Dollar General $AMZN $DG

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Picture this: A long established direct to consumer business has committed to opening a significant amount of brick-and-mortar stores in 2021. Amidst the 2020 online fulfillment craze this company is rapidly expanding its physical footprint.

2020 had us believe “brick-and-mortar retail is a thing of the past.” But we fail to realize is this monumental statement can be true and false at the same time.

What gives? At a certain scale, DTC businesses realized the cost of a retail location is actually a cheap way to acquire incremental customers (especially in high-traffic locations). Here’s a great discussion on Warby Parker doing this, for example .

The same is true for the largest e-tailer, Amazon.

This post will dive into Amazon’s foray into brick-and-mortar and why it’s obvious that it will expand its footprint (hint, it compliments a significant driver of its moat, Prime).

Bear with me on some historical points in this post: It’s important to understand the history. And then we’ll all better understand why Dollar General is an attractive target for Amazon to gain retail footprint AND its logistics expertise.

The Importance of Prime

Doubted at First – Now the Moat

Amazon’s online retail business truly started to gain steam when it launched Prime 2-day free shipping. At the time, people forget many said something like:

“the cost of business just keeps rising, this won’t be that attractive to many customers… will they ever generate profits?”

I took these comments straight from a sell-side report at the time. But Amazon realized this would be attractive.

The annual Prime Membership fee + low prices + free shipping = a very sticky business. Amazon was able to use the membership fee to subsidize the growth and chose to scale much faster than Costco (I’ve discussed their similarities in a prior post).

Last Mile Delivery

Amazon found something consumers want (cheap, near instant gratification with little work) and now has over 200 million paid prime members.

So they’ve decided, “hey, this is driving a moat and causing customers to pick us over others – let’s turn it up a notch.” Now big cities are seeing 1-day delivery or even 2-hour delivery in some cases.

Amazon also has been aggressive investing in a last mile delivery service of their own.

This is from a Fedex deck put out in late 2019

Fedex used this graph to explain why Amazon wasn’t that meaningful to them, and why they are ending a contract with Amazon. All it told me was that Amazon is aggressively investing to control delivery, gain scale, and dominate the customer (as an aside, is this an under discussed AWS-like business for Amazon? I.e. something they first use for their benefit, but then farm out for others in third-party fulfillment. Yes.)

Amazon Embraces B&M: The Whole Foods Acquisition

Turning back to the original point of this post: everyone understands the Whole Foods acquisition expanded Amazon’s brick-and-mortar footprint.

Recall this article titled, “Amazon buying Whole Foods puts it right next to one-third of America’s richest households.” I highly recommend you to read it.

Amazon’s expanded touch points and categories allowed the stores to serve as delivery locations (Prime Fresh) and also are stores where customers can conduct returns.

Similarly, Amazon Go is another retail concept Amazon is experimenting with. Just walk in the store with the app open, grab what you want, and walk out. A true CONVENIENCE store. The goal is no line hassles. In fact, a new article just came out applying this tech to a whole grocery store. Hmm.

So, we’ve established that Amazon:

  • Wants to create as sticky of a customer relationship as possible
  • Wants to get products to customers in a low-cost way
  • Knows supply-chain is key and is investing heavily there
  • Understands retail footprint will be part of the mix

There is still TONS of white space for Amazon

I assume most people reading this post are in a reasonably populated city. Maybe you’ve experienced Amazon’s 1-day delivery, or even 2-hour delivery. Maybe you get Whole Foods delivered.

Congratulations. But you are only part of America. If there’s anything elections have taught us, what you may think is America, ain’t all of America. Okay, I’m slightly kidding there.

If we go back to that Whole Foods analysis that was done that I linked to above – you need to re-read it. The title is misleading. The article actually says, “one-third of Americans with annual incomes over $100,000 live within 3 miles of a Whole Foods.”

What is the median household income in the US again? It’s $68,000. That’s for household. Median individual incomes are about half that.

That means there is actually much more white space for Amazon by going out beyond the Whole Fooders. Clearly, they’ve been focused on high-density population areas with high incomes. But there is a lot of white space out there.

I wish the Census Bureau chart (left) broke down incomes into more brackets, but I compared it with Whole Foods locations from this website (right). Compare dark green spots on chart of the left with dark green dots on chart on the right.

Pretty clear overlap, and it makes strategic sense for Whole Foods (or Whole Paycheck, as some call it). But if you believed in the Whole Foods acquisition thesis and believe B&M footprint can help Amazon reach the customer, that also means there is tremendous white space for Amazon.

Why? Because that last mile delivery is very expensive. Rural locations do not benefit from the same route density and therefore, shipping to them gets incrementally more expensive. Yes, Amazon has been leaning on the USPS for some of this, but if you want to push the envelope ahead of your competitors, you can’t rely on that forever.

Enter Dollar General as M&A Target

  • Who has over 17,000 stores, with ~75% of US population living with 5 miles of a store, and a goal of 25,000 stores?
  • Who has stores specifically where Amazon is underpenetrated?
  • Who has had a relentless focus on logistics, driving a powerhouse?
  • Who already has a private carrier fleet accounting for 20% of their outbound fleet?
  • Who has already figured out produce and fresh food logistics to rural areas?
  • Who provides low cost products to customers, while also earning a high ROIC?

Let me state these points another way: Dollar General provides low cost products to its customers (in some cases very rural areas), yet also carries ~11.5% EBITDA margins (almost 2x Amazon & Wal-Mart’s margins, despite high margin third-party fulfillment revenue for the behemoths), and has a ROIC in the ~50% range?

That must mean Dollar General benefits from some mix of these things:

  1. customer acquisition cost is low (only game in town)
  2. they are getting paid some premium (perhaps for location)
  3. they have very effective logistics (to keep cost low), and
  4. they utilize assets / working capital effectively to drive high ROIC.

Dollar General: A Logistics Powerhouse

If you’ve followed Dollar General for a while or read my prior discussions on them, you probably know that they are a logistics tour de force. We’ve talked about a couple things already, but here are a couple more to consider:

Relentless Focus on Reducing Stem Miles: This is the distance between a distribution center (DC) and a store. Reducing the distance reduces cost. Dollar General has 17 DCs for non-refrigerated products, 9 cold storage DCs, and 1 DC that serves both. Goldman recently conducted some analysis that showed DG had reduced stem miles by ~10% since 2016, despite store count increasing by >20%.

DG Fresh Valuable to the Everything Store: I’m just going to let DG explain this one from when they launched DG fresh in early 2019.

DCs Are Valuable: Amazon details it has ~295 million sq ft of properties across fulfillment centers, data centers, and other in North America. Dollar General only has ~20 million sq ft, but its likely in the areas that Amazon is not.

Amazon has $1.7 trillion market cap. Dollar General is $50 billion. Hm. Could increase your North American sq footage by 7% by acquiring something 3% your size.

The Math: Can Amazon to Acquire Dollar General?

Dollar Generals’ market cap is around $50BN with a $53BN enterprise value, ex-operating leases. In contrast, Amazon spent $58BN in capex during 2020.

Amazon also exited Q1’21 with ~$73BN in cash and can issue debt at super cheap rates. They have equity currency too if they really wanted. But any way you slice it, I think Amazon would have no problem acquiring DG.

The synergies would be dramatic and the shear amount of positive headlines would probably be nauseating – that’s how good of a deal it seems to me. Cross-selling, mini-DCs, adding Dollar General’s logistics in the mix, etc. etc.

Imagine combining these two powerhouses together. Imagine taking the learnings from Amazon Go and applying it to 17,000 stores as fast as possible. Imagine Amazon actually having this kind of access to the whole country.

How would you answer this question? Do you think Amazon will eventually provide 1-day or faster delivery everywhere in the country?

Most know it’s inevitable, but this deal would hasten the inevitable.

Re-visting my AWS Thesis and Valuation $AMZN

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I published an AWS piece in March 2019 that is counter to what most people are saying. My note could be boiled down to 3 thoughts: AWS is a good business with great tailwinds, but:

  • It’s becoming highly competitive, with Google, Microsoft, Oracle, IBM and others all gunning for a piece of the pie.
  • Pricing, and therefore margins, will likely go down in the future . In fact, AWS proactively lowers pricing for customers. This is not a sign on a good business, but instead a sign of a commodity. You become the low cost producer by having the highest volume, so you need to incent players to stay and leverage your fixed costs.
  • I didn’t think it was being mis-priced in Amazon’s stock. In other words, it wasn’t a hidden gem. You’ll see from this post that I still think that is true.

I’m reposting my initial projections for the company below and we’ll discuss how they’re performing to those expectations. I came up with a value of $165BN.

Maybe I was being a little harsh on the out years, especially for margins. But guess what? AWS was somewhat in-line with this estimate in 2019, with $35BN in sales, $9.2BN in Op Income and $17.4BN in EBITDA.

2020 is supposedly the golden era for AWS with COVID-19. Tons of start-ups are growing rapidly with everyone shifting to the cloud and AWS is the backbone they are built on. As those companies grow, they scale up the resources needed from AWS so AWS makes more money.

YTD 6/30/2020, AWS did $21BN in sales and $6.4BN in EBIT.  If we annualize that, its $42bn in sales and $12.8BN in Op income for ~30.5% EBIT margin. So they are behind on sales actually, but the margin is holding in there. This is from higher utilization needed during the pandemic (which helps fixed cost leverage), but it looks like the company also changed its depreciation schedule, so I would need to see D&A to get a real sense of what true cash margins are (and they don’t disclose D&A by segment outside of the 10-k). They actually called this out as helping the EBIT margins.

For those that may think AWS can keep up its amazing growth, that’s not so. Its clearly decelerating, but it is on big numbers so that is expected. By contrast, Azure grew 50% in this same quarter (though is about half the size of AWS).

So maybe I’m wrong on the AWS valuation. I do think I am probably too punitive on the out years for margins. If I change my margin assumption to ~22% average EBITDA margins for 2024-2028, the value is ~$275BN. This is solid improvement, but seems well captured in Amazon’s $1.6 Trillion market cap.

What is Twitch worth? A look at what you need to believe…

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A good friend of mine came to me full of excitement about the prospect of Amazon’s “hidden gems.” He had heard Amazon owned Twitch and was very excited for what that could mean for the company given the success of Fortnite and other games, which have driven a new era for e-Sports (that is, watching other people play video games). Twitch could also serve as a platform for other content. I decided to take a moment and explore what Twitch might be worth and put into context what that may mean for Amazon’s share price.

Warning: As with any investment analysis, I make a lot of assumptions in this post given I have very limited disclosure from Amazon.

With that warning out of the way, I hope that you can take these assumptions with you and think about “what do I need to believe?” when it comes to Twitch (and Amazon) and determine whether or not the market is pricing this in (as I wrote recently about here). Let’s get started:

Most internet platforms like Facebook, Twitter and YouTube are analyzed by a popular KPI called, Monthly Active Users (or MAU). MAU is important, and different than valuing a company via “eyeballs” as was common in the tech bubble, because MAU measures engagement with the platform and that helps advertisers determine whether placing an ad on the site has impact or not.

According to a very trustworthy source, Wikipedia, Twitch had 100MM MAUs in 2015. I assume that has likely grown significantly since then, given the dawn of Fortnite and internet celebrities like Ninja. I assume 130MM MAUs for 2017, which compares to Twitter’s 328MM.

As for Average Revenue Per User, or ARPU, I think Twitch is still in its infancy stage. I don’t think it is likely capturing as much money as it can right now because (i) it is owned by Amazon which has a long investment horizon and (ii) they likely want to keep engagement up and growing as much as possible in the near term to drive stickiness with the platform. However, I do have it growing substantially over time. In fact, this may be an aggressive assumption given Twitch has a monopoly on this niche for now, and competitors may move in. In addition, advertisers can move elsewhere, such as Instagram, Facebook, Twitter, Youtube, and so on. There is only 1 advertising pie and all these players are competing for the biggest slice.

On the flip side, Twitch should benefit from a “live TV” aspect of its content, much like ESPN which is able to charge a large premium in the broadcast world compared to its peers. As a result, I expect ARPU to ramp up quickly. Twitter’s total advertising revenue / MAU ramped from $2.20 in 2013 to $5.30 in 2017. I have Twitch scaling much quicker than that given what I’ve noted above.

For now, I don’t think Twitch is a major contributor to EBITDA given investment in R&D, sales staff and general expenses, but with price gains comes scale. For reference on how I derived my assumptions, I looked at Twitter. Twitter in 2015 spent ~36% on R&D, 39% on sales and marketing, and ~12% on G&A (though some of this includes a massive stock based comp expense, at ~30% of sales). This has stepped down to R&D being 22%, Sales being 29%, and G&A being 11.6% (again, these expenses include an 18% of sales expense for stock comp, which is non-cash but is a real expense at the end of the day).

Twitch est

Therefore, you may view my assumptions still as aggressive, but I’m trying to show what you need to believe. Net / net, I have Sales growing at a 127% CAGR from 2017 to 2020 and EBITDA growing at 450% (albeit off of a low base). I’ve also included some multiples so far as a proxy for where the value of Twitch may shake out.

I do not know where Amazon puts Twitch today in its reporting, but I’ll assume it is in the North American Retail business for now, given I don’t have a better idea of where to put it (I know that AWS is distinct from any ad revenues though so I didn’t put it there). here is a snapshot of Amazon today then, including my rough Twitch estimates.

AMZN Today - Segments

Now, for my next assumptions, I am going to go with some street estimates here, but a big assumption on my end is that I do NOT think they are baking in the value of Twitch. That is a big “if”, but given how small Twitch is today relative to the rest of the business, I don’t think it is out of the realm of possibility. Below are the 2020 estimates for AMZN, including my assumptions in value for Twitch.  All in all, it shows pretty strong growth for a company that has already grown massively. AMZN 2020

I took the liberty to assign multiples that you may disagree with, but I have a sensitivity table later that will let you be the judge.

The problem you may be seeing is that the total EV of Amazon of slightly less that $600BN is less than the current ~$890BN. As shown below, my “price target” is well below the current price.


Uh ok… Ok OK I must have done something wrong. My multiples must be WAY off. That’s for you to judge and that is the “art vs. science” part of investing. As we see below, I think I am pretty comfortable given where other Tech titans trade on my multiples, especially when we look out 2.5-3 more years.

AMZN 2020

So what do you need to believe??

Below I show a sensitivity of AMZN’s stock price relative to (a) changes in my EBITDA estimate and (b) estimated changes in the multiple. If you think Amazon is worth 18x EBITDA and will produce $50BN of EBITDA, for example, then today’s price of $1,830 looks OK (if not a little rich given this PT is based on 2020 estimates).

AMZN Sensitivity

Does this seem reasonable to you? It may, or it may not. That’s part of doing the analysis. After all this you may say, “Yes, actually. Amazon is such a dominant force, with a loyal customer base, I think it is worth a high multiple and the street is underestimating it.” On the flip side, you may say to yourself, “Geez, I don’t know. Those are some lofty figures it will need to reach… Maybe I’ll stay on the sidelines for now.”

Both are equally fair.

That’s all for now. Full disclosure: I am long AMZN.

Tax reform’s impact on stocks – the question NOT being asked

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A lot has been written about the Tax Plan passed at the tail end of 2017. I recently wrote a post on, while I think the plan is very beneficial to US equities, some considerations we should have on the rest of our portfolio.

And not to be a debbie downer, but I am here again to discuss some questions that are not being asked here. If you’re buying individual stocks today, I think the main underlying question for investing in that company comes down to one thing: Does this company have a strong competitive advantage?

In highly competitive industries, typically those that compete solely on price or sell commodities and have little differentiation, these tax benefits may soon be competed away.

Consider a distributor, which typically sells many goods and the only value it adds is perhaps customer service. Grainger has been an example of a distributor that has faced headwinds from price competition as customers look to Amazon for cheaper products. Take a look at GWW’s stock chart over 2017 to gain an understanding of this impact (stock was down 3-4% when the S&P was up 20%).

GWW’s stock really started to recover at the end of the year, one from earnings being better than feared on low expectations, but also due to its tax rate which should decline from 38%.

Given GWW’s heightened competition, due you think those savings will be used for buybacks or high return projects, or do you think they’ll be used to compete and maintain market share? Let’s say you think that’s fine if they use it to maintain share, as they’ll be in a better position. Well, do you think Amazon and other competitors won’t also respond?

Also consider the recent hikes in minimum wage from companies and $1,000 bonuses. They are doing that to attract and retain talent, which is simply another form of competition.

Hopefully you can see what I am getting at. Low competitive moat industries likely will compete the savings away. While the tax rate will be low, returns on capital may end up being the same.