WFM swept up in AMZN current

Since last November's presidential election, CEOs of the nation’s largest companies have sounded more confident than in recent years, expressing optimism in surveys about the economy and their own businesses, anticipating fewer regulations and lower taxes under President Trump and a Republican-controlled Congress.   Investors, likewise, appear buoyant, bidding up shares as reflected in the almost 14% rise in the S&P 500 index since Mr. Trump's election November 8th.

On June 12, NYT's Dealbook observed, however, that this confidence runs counter to Wall Street's "one barometer that is considered the ultimate truth serum when it comes to reflecting C.E.O. confidence: merger and acquisition activity."  Corporate chiefs tend to do deals when they are confident about their own business and the trends in the economy, and are reluctant when apprehensive about the future and consequently focus internally.  (Other observers dispute that such activity is necessarily a manifestation of corporate confidence, but that's an argument for another day.)  The article even posited that the prospect of an early morning Twitter tirade from Mr. Trump may be holding back deal making.  Year-to-date, the number of deals and their aggregate value are at the lowest level since 2013.  Total deal making in the United States in the first quarter was off nearly 40 percent from its peak during the same period in 2015, according to S&P Global Market Intelligence.

Later that week, Amazon (AMZN), not afraid to swim against the current, announced plans to acquire Whole Foods Market (WFM) at $42 a share, a 27% premium to the previous day's closing price.  The $13.7 billion outlay would make the deal the largest to date for the massive online retailer.  The announcement sent the grocery sector into a tailspin, with Kroger (KR), Target (TGT) and Wal-Mart (WMT) shares sinking.  Bulk retailer Costco (COST), behind the curve developing a digital platform endured a "vertiginous" 12.7% drop in the week after the deal's announcement.  Since "grocery stores are in [Warren Buffett and Charlie Munger's] blood", their Berkshire Hathaway (BRK.A), with big stakes in Wal-Mart, Costco and food producer Kraft Heinz (KHC), could also be adversely impacted.  Comparing it to Buy-N-Large, the satirical megacorporation depicted on Pixar's Wall-E, one columnist is not standing idly by as "Amazon eats the world."

Leaving aside for the moment the riptide caused by Amazon's latest bold move, the question at hand is how does Whole Foods - and its co-founder and CEO John Mackey - find itself it this situation.

Last September, Neuberger Berman, an investment firm with $267 billion of assets under management, broke with its longstanding buy-and-hold philosophy and sent a letter to the WFM board of directors raising issues with the company's performance.  Since peaking at $57.20 on Feb. 2, 2015, Whole Foods shares had been on a protracted slide hitting a new low of $28 on Sep. 13, 2016, a decline of 51%.  The S&P 500 Index was up 5.25% and the S&P Retail Select Industry Index (of which WFM is a top-10 component by index weight) down 8.4% over the same period.  At the time, Neuberger Berman was in the process of amassing a stake in WFM, which amounted to 2.4% of the company's common by yearend, according to its 13-F filing with the SEC.

On November 2, WFM disclosed Walter Robb's resignation as co-CEO effective December 31st, leaving Mr. Mackey as the sole CEO after six years sharing the role.  Mr. Robb was thought to be Mr. Mackey's heir apparent.  The company entered into a Separation, Advisory, and Noncompetition Agreement with the former providing for, among other things, $10 million in severance and, perhaps more lucrative, a lifetime 30% discount on purchases made at Whole Foods stores.  The company also announced that Glenda Flanagan, Executive Vice President and Chief Financial Officer, intended to retire from her role, effective as of September 24, 2017 (i.e., the end of the Company’s 2017 fiscal year).  Mr. Mackey pledged to increase margins and revamp operations but the changes apparently were not enough for Neuberger Berman, which continued its behind-the-scenes campaign to spur changes at Whole Foods and to drum up support among activist hedge funds.

February's annual shareholders meeting then provided the occasion for shareholders to express mounting dissatisfaction with slowing sales growth and a languishing stock price.  In the weeks before the meeting, WFM lowered financial guidance, dropped previous plans to expand to 1,200 stores in the U.S., and announced the closure of nine stores and the company's last two remaining commissary kitchens and the termination of two leases.  Whole Foods also announced teaming up with dunnhumby, the consumer data subsidiary of Tesco (TSCDY), aiming to make up ground with rivals already using such information to boost merchandising to loyal customers.  Proxy adviser Glass Lewis, meantime, had raised concerns over WFM's board independence, board attendance and executive pay and opposed the severance package for Walter Robb.

On April 10, Jana Partners, an $8.5 billion activist investment manager, filed a Form 13-D with the SEC disclosing that it had become WFM's largest shareholder (surpassing Vanguard Group and Blackrock), by acquiring a 9% stake.  Virtually unchanged since its AGM, WFM shares were up 10% for the day.  Jana stated its intention "to have discussions with the Issuer's board of directors and management regarding topics including: (1) addressing the Issuer's chronic underperformance for shareholders, (2) changing the Issuer's board and senior management composition and addressing governance, (3) optimizing the Issuer's real estate and capital allocation strategies, including discussing the Issuer's "365" small store format and opportunities to improve returns on invested capital, (4) pursuing opportunities to improve performance by advancing its brand development and by addressing core operating deficiencies in areas including customer loyalty and analytics, category management and analytics, technology and digital capabilities."

Jana took a stake in Safeway, a national supermarket chain, in 2013 and within six months Cerberus Capital Management bid $8 billion for the company so that it could be combined with Albertson's to create a direct competitor to Kroger.  Accordingly, Jana stated in its filing that it has "substantial experience analyzing and investing in the grocery sector and more broadly across the food and retail sectors, and the other reporting persons collectively possess significant operational, financial and nutritional expertise, including, for some of the other reporting persons, experience creating significant shareholder value in the food and grocery sectors."

In a lengthy Texas Monthly article entitled "THE SHELF LIFE OF JOHN MACKEY", published on June 14, Mr. Mackey said, "[t]here's a narrative about business in America that says, 'Business sucks,'" which conveys "the idea that business is about a bunch of greedy bastards running around exploiting people, screwing their customers, taking advantage of their employees, dumping their toxic waste in the environment, acting like sociopaths."  Whole Foods, conversely, "is really, really trying to do the right thing."

Back in 2013, Mr. Mackey co-wrote a book about conscious capitalism - coining the term - contending that business and capitalism are fundamentally heroic systems.  "In the long arc of history, no human creation has had a greater positive impact on more people more rapidly than free-enterprise capitalism," he writes.  Professor Raj Sisodia, the book's co-author, conducted research that showed that the stock prices of a sample of companies ostensibly exhibiting conscious capitalism outperformed the wider market over fifteen years by more than tenfold.  Perhaps, goes their reasoning, conscious companies make for better investments over the long-run.

Mr. Mackey does not argue that Whole Foods should get a pass from Wall Street because it means well, but that patience is warranted.  In the Texas Monthly interview, Mr. Mackey then proceeded to hone in on WFM's activist investors, i.e., major shareholders: "We need to get better, and we're doing that.  But these guys just want to sell us, because they think they can make forty or fifty percent in a short period of time.  They're greedy bastards, and they're putting a bunch of propaganda out there, trying to destroy my reputation and the reputation of Whole Foods, because it's in their self-interest to do so."  Of course, some media outlets played up Mr. Mackey's colorful characterization of Jana Partners.

"These people, they just want to sell Whole Foods Market and make hundreds of millions of dollars, and they have to know that I'm going to resist that," Mr. Mackey continued.  "That's my baby.  I'm going to protect my kid, and they've got to knock Daddy out if they want to take it over."  However, when this year's proxy was filed in January, Mr. Mackey owned less than a million shares.  All directors and officers as a group owned only 1.30% of the outstanding shares, which would not provide much of a base upon which to build support for keeping the company independent.

On June 16, after a "whirlwind courtship", Amazon said it planned to buy Whole Foods.  It turns out that Mr. Mackey and colleagues visited Amazon's Seattle headquarters late in May for a meeting arranged by mutual acquaintances.  "We just fell in love," Mr. Mackey said.  "It was truly love at first sight."

Don't fight the tape, advises the old trader's adage.  Considering the downward trend in the WFM share price in recent years, not to mention the grocery industry's roiling structural changes driven primarily by technology integration, it's remarkable that the company stayed independent until now, particularly because it has no takeover defenses in place.  Under the circumstances, a company is swimming upstream in trying to ward off activist investors clamoring for change, making it wise - and inevitable - to explore strategic alternatives.

Robert Stead