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Amazon Third-Party Sellers Are Being Bought Up Rapidly. But There Are Risks.

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In the private equity business, there is a strategy called a “rollup.” That’s where a private equity group buys or forms a company (usually called a “platform” company) which then acquires, or “rolls up,” other companies in the same business. The idea is to put the “rolled up” companies on the “platform” and cut redundant costs, increase efficiencies, develop greater scale and provide more opportunities for the investor to put more money to work. If the strategy works, then the multiple of earnings that the combined company eventually gets sold for is greater than what was paid when the investments were made and everyone makes money.

A giant rollup is what’s happening to third-party sellers on Amazon AMZN right now. Companies that sell primarily unbranded, well-reviewed products on Amazon marketplace are being bought by businesses created just to consolidate those Amazon sellers. (Forbes writer Lauren Debter has a great story about some of the companies involved.) But will it work? There are many compelling aspects to it but there are also risks. As you’d expect, the companies doing the rollups don’t think those risks are substantial but it is not a certainty that what works now will work in the future.

How These Rollups Work

The deals involving Amazon sellers are different than most other rollups in pricing, structure and timing. The cash portion of the purchase price is usually much less than deals in the non-Amazon sellers universe. Josh Silberstein, co-CEO of Thrasio, the largest Amazon seller rollup that has raised over $1 billion in total capital, says the cash-at-closing component of their deals had been 2x EBITDA (earnings before interest, taxes, depreciation and amortization) in the past. Now with the entrance into the market of other rollups, the competition for acquisitions is more robust and 2.7x-2.8x is “more typical.” That price, albeit higher than in the past, is still much less than profitable consumer companies usually sell for. Silberstein says that the revenue of the companies Thrasio buys usually “increase by 156% annually” and the payouts to sellers over time reach 6x EBITDA in total, a much more typical purchase price for consumer-related businesses. My experience with payments over time in mergers and acquisitions is that averages are tricky because company performance varies widely subsequent to an acquisition. To be fair, acquisitions of Amazon sellers is more formulaic and may have a more narrow range of outcomes that could make averages more relevant.

Because each acquisition of an Amazon seller is very similar, they happen much faster than other types of deals. Where a normal acquisition takes 6-12 months, buying an Amazon seller can be done in weeks and sometimes days. And unlike other deals, the management of the company being sold usually doesn’t stay on past a short transition phase.

Ryan Gnesin, CEO of Elevate Brands (formerly Recom Trading LLC), says its acquisitions must have a “review moat,” a high number of five-star reviews and be on the marketplace for a long time. Chris Bell of Perch, which acquired 20 companies in 2020, says criteria like organic ranking, long consumer buying sessions, high conversion of browsers to customers, sales over time with profitable unit economics and low returns are the kind of criteria that are attractive for their acquisitions.

Will It Work?

These rollups are buying companies for 2-3x earnings in cash, that’s a very low price for a profitable, growing consumer-related business. And the growth on Amazon marketplace is huge; in 2019, Amazon marketplace sales were about $200 billion and are estimated to be about $280 billion in 2020.

Sebastian Rymarz of Heyday, which hired its first employee in August 2020 and raised $175 million at about the same time, told me, “Amazon looks at the world in a certain, consistent way. They are customer-focused and have a long-term mentality.” What he means is that as long as Amazon third-party sellers perform, Amazon will support the marketplace and everyone will make money.

The problem is that the history of retail is otherwise. In the past, vendors that became dependent on one retail channel found themselves at the mercy of whoever controlled that channel. Once growth slows, as high growth always must, retailers in the past looked around for where they could get more profitability and they always found the same answer: their vendors. Those retailers said to themselves, “we control the relationship with the consumer and what consumers see, we should be making more money.” In the service of their own increased profitability, they institute fees, or they promote their own private label products to compete with their vendors and sometimes even get an equity interest in their vendor. Retailers in the past didn’t care if they drove their vendors away or put them out of business. The feeling was that there’s always another vendor willing to supply product if you have the biggest order book in the world.

The people who run these rollups think that won’t happen or if it does, it won’t be for a long time. Silberstein of Thrasio cites the need for Amazon to expand into other countries where it is growing but not dominant, like the U.K., Germany, Australia and other countries that will provide plenty of opportunity for future growth. He says Amazon is focused on the best product selection and “their mentality is not: where do we find more profit.” Bell of Perch believes that in 2-3 years, 25-50% of his company’s revenue will be on channels other than Amazon. Rymarz of Heyday says, “if they raise prices on marketplaces with fees, then third party merchants will move to another marketplace. [Amazon] consumers will get less product selection, [lower] quality and [pay] higher prices with less competition. It would be inconsistent with the way [Amazon has] operated for 25 years.”

These are all good arguments. And yet...mentalities do change, high growth can’t go on forever and it must eventually slow down. We have often seen in retail that disruptors themselves get disrupted by change they did not foresee. According to Statista, Amazon’s market share of ecommerce in the U.S. will reach 50% this year and that raises the question of how much more Amazon e-commerce can grow, at least in the U.S. Andrea Leigh of Ideoclick, who advises 350 Amazon sellers and spent over nine years at Amazon leading numerous product categories, talked to me about Amazon squeezing its vendors. “They already do that,” she said, but she said it “looks different” than the way traditional retailers have done it. “I would argue that they’re the king of the game of changing the rules to acquire more profit,” she said. Amazon has ways of motivating third party sellers to advertise on its platform to get traffic, increasing rates on storage fees, penalizing sellers for long-term storage and has numerous other strategies it uses, she explained.

And you have to ask yourself: why are Amazon sellers selling their companies for much less cash in the deal than sellers in other channels? The answer is that there’s more risk in the business and that risk is their vulnerability to control by Amazon. Either that risk is wrong or it’s going to be realized at some point.

It’s possible that the Amazon third party rollups may build huge businesses and sell them for enormous profits. If they get out before the growth slows, there’s no reason why Amazon’s modus operandi should change from what it is today. But if growth slows at Amazon, watch out. It will look for profits from wherever it can and one juicy target will be all those vendors making tons of money selling products to Amazon customers. Slower growth at Amazon will change mentalities very fast and that’s when having a concentration in one channel can be fatal.

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