Does It Make Sense For Amazon To Acquire Target?

There is much market speculation at the moment about Target (NYSE: TGT) potentially being acquired by Amazon (NASDAQ: AMZN). Amazon continues to make headlines as it expands its e-commerce retail business across different verticals from transportation & logistics, to grocery stores & physical stores. Prominent analyst Gene Munster is predicting that Amazon’s next move could be its expansion into the physical retail space with a takeover of Target this year. The analyst also noted that both companies share similar demographics, and with a potential deal, Amazon would benefit from over 1800 Target stores, as it could look to compete with Wal-Mart in the brick-and-mortar space.

While Wal-Mart is the biggest player in the U.S., capturing 8.3% of total U.S. retail sales (as of 2016), Amazon and Target together capture a smaller 3.9% of this highly fragmented market. Given that Wal-Mart still has a larger share than a potential Amazon-Target combination, a potential deal could be approved by regulators – provided it happens. While Wal-Mart is acquiring online startups and exploring cashier-free options to compete in the e-commerce space with Amazon, the internet retailer is taking over physical retail companies such as Whole Foods, in order to better compete with Wal-Mart. Target’s shares rose by nearly 4% on Tuesday, likely in response to these reports.

Grocery Business In Focus

Groceries represent about 20% of Target’s total sales, whereas they account for 56% of Wal-Mart’s total business. Despite Target’s lower grocery share in its total revenues, groceries are important because the retailer continues to witness pressure on its store comparable sales, largely driven by declining traffic and lower average transaction amounts at its brick and mortar stores. In addition, Target also tends to generate stronger overall sales in stores that offer groceries. Consequently, the company plans to make itself a more compelling destination for grocery shopping with several initiatives such as adding organic and gluten-free brands, more local fresh products and better distribution to boost the grocery business. In fact, Target is in a transition phase right now, trying to overhaul its business by renovating stores, supply chain improvements and increased promotions, all at an estimated cost of $7 billion over the next 3 years. If Amazon were to acquire Target, the retailer could also complement the company’s grocery business with Whole Foods. The Amazon-Whole Foods combination could help simplify Target’s re-modeling strategy, as there is a considerable overlap of customers between Amazon Prime subscribers and Target.

Target’s store comparable sales grew positive in Q2 2017, followed by flat sales in Q3, which shows that the company’s strategy of investing in its stores to grow traffic may be working, at least to a degree. Should Amazon actually acquire Target, delivery of groceries would likely become a major offering. Amazon could gain access to a strong brand, a network of upscale stores and also an immediate expansion of its distribution network, which could lead to a rapid expansion of the AmazonFresh delivery service.

Our $59 price estimate for Target’s stock is nearly 10% below the current market price.

See our complete analysis for Target  

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