Amazon's Disruptive Force...

...Is Industry & Asset-Class Agnostic

Scott Galloway likes to say that Amazon simply needs to make a simple product announcement and the market capitalization of an entire sector - of dozens of companies - can take a collective multi-billion dollar hit. On a seemingly weekly basis, his point plays out. Upon the announcement of the Whole Foods transaction, all of the major grocers got trounced. Upon news of Amazon building out its delivery infrastructure, United Parcel Service Inc. ($UPS) and FedEx Corporation ($FDX) got hammered. Upon news that Amazon was getting into meal kits, Blue Apron's ($APRN) stock plummeted. This week it was the pharma companies that got battered on the news that Amazon has been approved for wholesale pharmacy licenses in at least 12 states. It was a bloodbath. CVS Health ($CVS) ⬇️ . Walgreens Boots Alliance ($NAS) ⬇️ . Cardinal Health ($CAH) ⬇️ . Amerisource Bergen ($ABC) ⬇️ . Boom. (PETITION NOTE: obviously impervious - for now - are the ad duopolists, Alphabet Inc. ($GOOGL) and Facebook Inc. ($FB), both of which, despite news that Amazon did $1.12b in ad revenue this quarter, had massive bumps on Friday).* Luckily there isn't an ETF tracking doorman and home security services because if there were, that, too, would be down this week. 

What Galloway has never noted - to our knowledge, anyway - is the effect that Amazon's announcements have on the leveraged loan and bond markets. Remember that Sycamore Partners' purchase of Staples from earlier this year? You know...that measly $6.9b leveraged buyout? Yeah, well, that buyout was financed on the back of $1b of 8.5% unsecured notes (issued at par) and a $2.9b term loan.Ah...leverage. Anyway, investors who expected that the value of that paper would remain at par for longer than, say, 2 months, received an unpleasant surprise this week when Amazon announced its "Business Prime Shipping" segment. According to LCD News, the term loan and the notes traded down "sharply" on the news - each dropping several points. Looks like the "Amazon Effect" is biting investors in a variety of asset classes.

One last point: this is awesome. Maybe the future of malls really is inversely correlated to the future of (livable) warehouses. 

*Nevermind that Amazon's operating income declined 40% due to a 35% rise in operating expenses. Why, you ask, are operating expenses up? How else could Amazon be poised to have half of e-commerce sales this year?
 

Brief (and Limited) Reality Check

There's a lot of bluster in the restructuring community about Amazon, e-commerce and the death of brick-and-mortar retail. It's hard not to be sanguine about the future of retail when the bankruptcy roll is littered with names like General Wireless Operations, hhgregg Inc., Gander Mountain Co., Gordmans Stores Inc., and Vanity Shop of Grand Forks Inc. - and those are just the filings that have occurred in March.

In the interest of completeness, though, there is SOME nuance here and that nuance largely depends on socioeconomic and geographic considerations. This Washington Post story features interesting data about the adoption of e-commerce and while it has grown in nearly every state, there are some states that have been very slow to adopt it, e.g., Idaho, South Dakota, Colorado, Arkansas and Arizona. The macro trend remains the obvious, of course, but we thought this was worth noting. Sometimes it's erroneous to paint with too broad a brush.

A Look Forward

Right before the holidays, Benedict Evans of the venture capital firm Andreesen Horowitz released a fascinating presentation called "Mobile is Eating the World." It's a long presentation - roughly 31 minutes - but well worth reviewing if you have the time. We here at PETITION think there are a lot of nuggets within it relevant to the restructuring industry. After all, technological advancement and disruption help create the industry's client pipeline. Here is a brief summary with some editorial mixed in:

Overview

• We are halfway to connecting everybody. There are 5.5 billion people over 14 years old, close to 5 billion people with mobile phones, and about 2.5 billion smartphones. The latter number is quickly headed to 5 billion.
• Mobile has accelerated past the PC, which is now flat-lining at around 1.5 billion units.
• Each new technology follows an S-curve (creation-to-deployment) and is then passed by a new technology. Mobile is transitioning now from creation to deployment. 
• With this transition comes a new kind of scale. Google, Apple, Facebook and Amazon ("GAFA") have 3x the scale ($450b annual revenue) that Microsoft and Intel had in their heyday ($150b annual revenue). Microsoft saw 14x growth when it was dominating tech in the 90s and subject to mass regulatory scrutiny; GAFA's growth is 10x that now. 
• In 1995, Microsoft was not even the biggest company on the stock exchange. Now Microsoft and GAFA are the top five companies on the exchange. 
• This size drives more capex: $1b of capex in 2000 vs. $30b of capex in 2015. Tech has so much more scale now: GAFA are giants of the ENTIRE economy, not just tech. 
• Which has implications: Apple is the 10th largest retailer in the world with $53b in revenue across e-commerce and 500 stores. Netflix has the fourth largest entertainment production budget in the world. Amazon has the sixth - even though its content is just a feature to drive its core product: Prime. These "tech" companies, therefore, are fundamentally impinging upon other industries. Another example: Google, Amazon and Apple are now making custom chips for their own products rather than sourcing externally from the likes of Intel. 

New Ways to Compete - Artificial Intelligence & Machine Learning

• The scale of 5 billion mobile users and the scale of GAFA are leading to new ways to grow and compete.
• And machine learning is steroids. As just two examples of the rapid progress in machine learning, image recognition has gone from a 28% error rate to 7% and speech recognition from a 26% error rate to 4%. This is all enabled by mass data and more powerful computing power. 
• And so everything in tech is being refocused from mobile to mobile+AI, particularly with the realization that there are cameras everywhere, capturing images that serve as data that are now more intepretable than ever.
• GAFA is rushing to build the engineering and cloud storage systems to enable optimization of this data. 
• Meanwhile, technology design is removing friction, questions and administration which, in turn, changes choices. Think Amazon Echo. So, better design and frictionless decision-making is feeding more and more data.
• All of this gives GAFA the power to (further) change other industries...

Example 1: E-commerce

• Everything the internet did to media will happen to retail, where there'll be a breakup of old bundles and aggregators (albums, magazines, newspaper, store, shopping district, mall). And so now we consume in different ways.
• So far ecommerce mostly just gives consumers stuff we already knew we wanted.
• E-commerce is 10-12% of US retail revenue, with Amazon representing at least 2-6% of that: but it mostly just gives you what you already know you want. Despite this limitation, Amazon is now the fourth largest apparel retailer in the USA: not online, OVERALL. Walmart, Macy's, TJ, Amazon, Gap, Kohls, Target, L Brands, Nordstrom, JC Penney (by '15 revenue). And those reading PETITION regularly know how well some of these names are faring - or NOT. 
• The internet lets you buy, but it doesn't let you shop. No real suggestion or discovery.
• To fill this gap, the first response to this is advertising and marketing which is $1 trillion a year, $500mm is ads (digital and Google ads).
• But now we ask the Amazon Echo to buy more soap and this means we may never make a brand decision again. This disintermediates the ad agency, Walmart and P&G, etc, and changes the whole chain of how something gets to you, the consumer.
• Meanwhile, new businesses can get something to you with way less investment.
• Machine learning can give you "scalable curation" based on the data that you feed it.
• Today you have to go to a store to know what you'd like without seeing it. Now you can use machine learning to give this to you.
• Data is working through retailing: supply chain and logistics moved to advertising and digital metrics and then demand based on data, social, etc. Walmart used logistics to change what retail looked like. Amazon now doing that with AI. $20b retail opportunity potentially disrupted. 

Example 2: Cars

• Cars are becoming like phones with all of the important aspects becoming commoditized and the key being the software.
• Removing the engine and transmission destabilizes the car industry and its suppliers - but it doesn't change how cars are used much.
• Autonomy, however, changes what cars are and changes cities.
• Electric is about the battery cost curve. Complex proprietary gasoline engines and transmissions disappear and replaced by simple commodity batteries and motors, 10x fewer moving parts: all aspects of auto manufacturing and energy use are implicated by this development. 
• Scale, design and brand still matter but the real value moves up the stack into the software and move to autonomy. Leading tech companies now spend as much on capex as car OEMs. 
• Where are we now on the 1-5 autonomy scale: we are at Level 3. Level 5 is 5-10 years away. Batteries and sensors increasingly are commodities. The key is the software and the AI-powered data to feed it.
• Once you have that and take the steering wheel and engine out you have totally new types of vehicles and new uses. Obvious impacts: oil production and safety (1.25mm annual road deaths). Second order effects: what happens to engine servicing industry, machine tooling industry, storage, gas stations, gasoline taxes, municipal parking revenues, police forces? What happens if there's no parking or congestion? What happens to housing, logistics, commercial real estate, trucking, ownership of cars, insurance? 
• And what incumbent companies and municipalities file for bankruptcy as a consequence? This is not science fiction: society will soon need to address these questions...