In June, online retail giant Amazon announced it would buy the Whole Foods Market grocery chain for $13.7 billion. Market watchers speculated on how the acquisition would affect the highly competitive supermarket industry.
A less examined question is worth a deeper look: where does a company come up with $13.7 billion to make this type of large acquisition? In this case, Amazon turned to the capital markets—specifically, they tapped bond markets to borrow the money they needed to buy the Whole Foods chain.
Amazon has deep pockets, with reported cash reserves of $21 billion, but even a retail behemoth with plenty of cash on hand doesn’t just sign over a $13 billion check. They may prefer to hold on to that cash to fund other expansion plans. To effect an acquisition of this size, Amazon turned to the private debt markets, selling some $16 billion of dollars in corporate bonds in August to raise the cash needed for the purchase.
A refresher: Bonds are fixed-income debt securities that allow investors to essentially lend money to the bond issuer, such as a government agency, a corporation or another entity. In return, the issuer agrees to pay the investor a specified rate of interest over the life of the bond and to repay the face value of the bond (the principal) when it reaches maturity — that is, the date the bond comes due. (For more answers to all your questions about how bonds work, check out our Bond Basics primer).
Bloomberg reports on the head-turning deal:
The world’s largest online retailer sold $16 billion of unsecured bonds in seven parts to fund its $13.7 billion acquisition of Whole Foods Market Inc. And in a sign of market interest, the longest portion of the offering, a 40-year security, was sold at a yield of 1.45 percentage points above Treasuries, down from initial talk of 1.6 percentage points to 1.65 percentage points, according to a person with knowledge of the matter.
Amazon is expected to reduce prices at the iconic yet struggling high-end supermarket chain, which is trying to lure more low- and middle-income shoppers. The deal, which rattled the grocery world when announced in June, could intensify a price war in an industry beset by razor-thin margins and persistent deflation.
The debt sale marks Amazon’s first bond-market foray since 2014. The company has more than $21 billion stashed away in cash and other short-term investments that could have been deployed as a bigger allocation in the acquisition financing. But Amazon needs to preserve cash, and now is an opportune time for issuers to take advantage of low interest rates, said Bloomberg Intelligence analyst Jitendra Waral.
“This route is cheaper and gives them flexibility,” Waral said. “The expansion plan Amazon has gotten on with buying Whole Foods is just the beginning, not the end.”
The new bond issue almost triples the Seattle-based tech giant’s amount of debt. That sounds like Amazon is making a big bet that it can make inroads in the grocery industry, an area where the company has sought to become a competitive player. Indeed, merging Amazon’s existing grocery business along with Whole Foods chain of 468 brick and mortar locations will make it the fifth largest grocer in the nation, as the New York Times points out.
Particularly at a time of relatively low interest rates, taking on debt to make an acquisition of this type may be smart play, since the borrowed funds come at a lower price—it’s “cheap money.” Amazon’s wager appears to be that the Whole Foods acquisition will generate sufficient returns to pay back the bondholders plus interest, while generating sizable profits for the retail giant.
Time will tell if that wager pays off. In the meantime, Amazon’s acquisition of Whole Foods is the latest high profile illustration of how the capital markets work to connect investors with investing opportunities, drive innovation in virtually every sector and keep the U.S. economy humming.