Last year was a busy one for retail mergers and acquisitions, and 2015 looks like it will follow the same trajectory. BDO USA, LLP recently surveyed 100 CFOs in the retail industry about what they expect the M&A landscape to look like over the next several months, and 59 percent of them said they expect activity to increase. Even after last year's significant uptick in retail M&A, the results of this year's survey marks the most bullish projection in the survey's history.
But why the flurry of activity right now?
There are a number of trends that are shaping the retail industry today, and each is having a strong influence on the approach to strategic M&A. Retail is as competitive as it's ever been due to technological and cultural forces that require retailers to adapt to a whole new ballgame, and M&A is a viable strategy for keeping an edge in a crowded market.
For investors looking to add a new retailer to their portfolios, or those wondering if they should sell one, it's worth investigating what that particular retailer has in its M&A pipeline. A strategic M&A outlook could very well be what separates the relevant from the forgettable in this market.
Blurring the line: online-only and brick-and-mortar
One of the biggest trends in retail has been the rise of the omnichannel brand. Rather than being an exclusively online retailer, or just a brick-and-mortar one, smart brands are looking to be both. Today, consumers want to be able to research products online and then go into a store to sample or buy them. They want to go to the store on a whim, touch and feel a product, and then go home and order it online. They want to use their mobile phones to get targeted, timely deals and place orders directly through the app.
Simply put, retail success will come to the companies that can provide the most seamless shopping experience possible. In terms of M&A, look for e-commerce retailers to start merging with or acquiring brick-and-mortar companies to acquire some physical real estate. On the flip side, we can probably expect to see storefront-heavy retailers getting together with e-commerce businesses to build out their digital HQ.
"Behind the uptick in retail deal flow is one simple truth," Ted Vaughan, partner in the consumer business practice at BDO, said in a release. "Many traditional brick-and-mortar retailers have fewer opportunities for growth, and are turning to M&A to gain market share through consolidation or enter new markets to extend their brand and reach. On the other hand, we're seeing more and more online-only retailers eyeing floor space to demo products and engage with consumers, and acquisitions can be an effective way to do so."
One of the most notable instances of this type of acquisition comes from the Chinese online retail giant, Alibaba. Last year, Alibaba invested $692 million in a traditional department store to give it a ready-made physical presence that would allow it to serve the younger digital crowd as well as those who still do their shopping in stores, Reuters reported.
It is believed that Alibaba made this move in advance of its U.S. IPO to make it more desirable to American investors. The result? At a whopping $25 billion valuation, Alibaba had the largest global IPO in history.
Acquiring new services, products
When it comes to adding new services or products to a business' offerings, it's not always easy or cost-effective for a company to take a DIY approach. Sometimes the best way to stay on the cutting edge is to let an agile upstart develop something new and simply acquire them.
That's exactly what Rite Aid is doing with EnvisionRx, a full-service pharmacy benefit management company. The news source explained that for a hefty $2 billion, Rite Aid will get:
- A fully integrated mail-order and specialty pharmacy service through Orchard Pharmaceutical Services.
- A new, industry-leading claims adjudication software platform from Laker Software.
- A national Medicare Part D prescription drug plan through Envision Insurance Company's EnvisionRx Plus product offering.
Rite Aid could have made attempts to build these products and services themselves. But there's a cost-benefit trade-off: Could the company create similar offerings for less than it would cost to buy EnvisionRx outright? It's doubtful, since what EnvisionRx brings to the table is beyond the scope of Rite Aid's core competencies. By acquiring the benefit management company, Rite Aid added several valuable services to its portfolio without spending years and billions of dollars doing it. Speed, agility and resources are essential in a fast-moving retail world, and staying ahead of the pack means using M&As to bulk up in a hurry. Rite Aid CEO John Standley said it best:
"With the addition of EnvisionRx, we will create a compelling pharmacy offering across retail, specialty and mail-order channels, enabling us to deliver cost-effective solutions to employers and health plans while driving growth and creating long-term value for our shareholders. We also look forward to welcoming EnvisionRx's proven management team and talented associates to Rite Aid," Standley said in a release.
Staying afloat in a highly competitive landscape
Sometimes M&A is simply a survival mechanism. The proposed merger of Staples and Office Depot proves it. The New York Times reported that the merger would create a $36 billion office supply retailer. Naturally, some have raised the specter of reduced competition in this space due to this consolidation, but the retailers and even federal regulators have stated that the merger is unlikely to have much of an impact on competition.
Staples and Office Depot argued that consumers have more choices than ever with Amazon, Walmart and Target all making significant plays in the office supply vertical. This has led to lower prices and brought competition to a fever pitch. The merger, then, is a way to prevent what seems to be an inevitable fate for the struggling retailers. The Times reported that Staples could save up to $1 billion by merging with Office Depot through layoffs and combined purchasing and marketing costs. So while it may not increase market share, it might ensure survival.
"Financially, this transaction makes sense and is necessary for the long-term health of these two companies," David Strasser, an analyst at Janney Capital Markets, wrote in a research note.
Each of these trends will continue to inform M&A strategies going forward. Investors should look at who's merging and buying up new assets - and why - to see who's going to fortify their position, versus those who simply respond to market conditions by clumsily try to build what seems like a viable business extension. A sound M&A strategy will differentiate the winners from the dinosaurs.
