Examination Of iRobot Amid The Struggling Amazon Deal (NASDAQ:IRBT)

Introduction: Brief History of the Deal

The internet giant, Amazon (AMZN), has historically pursued a strategy of bolt-on acquisitions – the potential acquisition of iRobot Corporation (NASDAQ:IRBT) being one of them. In 2017, Amazon made the largest acquisition in its history, buying Whole Foods Market for $1.7 billion. Apart from purchasing the high-end grocery chain, Amazon has made acquisitions that bolster its online offerings such as the acquisition of the streaming company Twitch, film and television company Metro-Goldwyn-Mayer Studios (“MGM”), encrypted messaging application Wickr, and more. Among these strategic initiatives, Amazon has also been acquiring companies to expand its at-home Alexa offering by acquiring home-security companies such as Ring and Blink Home (List of all acquisitions). The acquisition of iRobot would further strengthen Amazon’s at-home presence by connecting iRobot’s autonomous vacuum cleaners with the Alexa ecosystem. Furthermore, in the event of a successful acquisition, iRobot would experience a significant share price increase compared to its current levels.

While iRobot’s share price has experienced significant fluctuation due to concerns from regulators, Amazon’s has remained relatively unchanged. This isn’t surprising: the agreed-upon acquisition price for iRobot, $1.4 billion or $51.75 per share, only comprises 0.0008% of Amazon’s current market cap (iRobot News Release).

As noted, iRobot’s share price has fluctuated significantly. In August 2022, Amazon announced an all-cash deal to acquire the company for $61 per share in which traders of iRobot quickly realized the arbitrage. However, the stock slid as a result of uncertainty around whether the U.S. Federal Trade Commission (“FTC”) and the European Commission would approve the deal (Deal History). In 2023, iRobot’s share price has briefly shot upwards during times of optimism. However, this is not such a time. The EU Commission recently informed Amazon that it would block the acquisition of iRobot, however, the final deadline for its official decision is on February 14th (Deal History).

The EU Commission’s Stance on the Deal

On November 27th, 2023 the EU Commission issued a press release detailing its concerns over the potential acquisition. In general, the regulatory body is concerned about unfair, anti-competitive actions that Amazon could pursue when selling iRobot’s products on its website. The EU Commission states the following:

“Amazon may have the ability to foreclose iRobot’s rivals because Amazon’s online marketplace is a particularly important channel to sell RVCs in France, Germany, Italy, and Spain. RVC customers in these countries particularly rely on Amazon both in terms of product discovery as well as for their final purchasing decision.”

Given that Amazon is the primary sales channel for robot vacuum cleaners (“RVCs”), the EU Commission claims that Amazon can prevent rivals to iRobot from competing in the following ways:

“(i) delisting rival RVCs; (ii) reducing visibility of rival RVCs in both non-paid (i.e., organic) and paid results (i.e., advertisements) displayed in Amazon’s marketplace; (iii) limiting access to certain widgets (e.g. ‘other products you may like’) or certain commercially-attractive product labels (e.g. ‘Amazon’s choice’ or ‘Works With Alexa’); and/or (iv) directly or indirectly raising the costs of iRobot’s rivals to advertise and sell their RVCs on Amazon’s marketplace.”

(Quotes cited from EU Commission Statement of Objections)

I believe that the regulatory body’s concerns are legitimate and that its stance against the acquisition is completely warranted. Although this acquisition may seem irrelevant – iRobot has only earned $940 million in revenue “TTM” – the actions taken by the EU Commission and the “FTC” set a precedent for future, larger acquisitions that may also unfairly stunt competitive dynamics.

The Market For Robot Vacuum Cleaners

According to Statista, iRobot retained a 46% market share in 2020, which increased to 57% in 2021 within the RVC market (Statista). Although the company’s market share has been ceded to a multitude of competitors since 2014, the company still maintains a dominant position within its market. This may have further fueled the concern of the regulatory bodies since unfair competitive practices coupled with iRobot’s strong brand image could further stunt innovation and competitive prices for consumers.

When looking into iRobot’s annual report, we can find that Amazon is a strong enabler of the company’s market share. The company states, “For fiscal 2022, 2021 and 2020, we generated 22.6%, 21.8% and 22.7% of total revenue, respectively, from one of our retailers.” (10K 2022). Implicit is that the one retailer is Amazon. This data is in line with the EU Commission’s observation that Amazon’s marketplace is a prominent sales and marketing channel for RVC companies. Furthermore, the acquisition’s impact on the European market may be most destructive – iRobot noted in its annual report:

“floor cleaning robots… have become increasingly popular with European consumers. A number of established companies have developed robots that compete directly with our product offerings, and many of our competitors have significantly more financial and other resources than we possess.”

Given that non-U.S. customers accounted for 48% of the company’s sales in 2022, iRobot is undoubtedly feeling pressure from competitors such as “Samsung, LG, Panasonic, Xiaomi… Electrolux” to name a few (10K 2022).

Financials

Poor Post-COVID Performance

One factor that heightens the uncertainty around iRobot’s stock price is the company’s poor financial performance since the pandemic. Following strong upswings in revenue and operating income, iRobot’s quarterly sales have plummeted to 2016 levels. Furthermore, quarterly operating income has now reached historical lows. This operating performance is a reflection of broader macroeconomic trends, however, it also paints the picture of an organization that is unfocused and in distress – most likely due to the insecurity around the Amazon acquisition. Although iRobot continues to expand its product roadmap, the pending acquisition is a significant headwind for updating investors as if the company traded on a stand-alone basis. For example, “In light of the pending transaction with Amazon… iRobot will not hold a financial results conference call, and its practice of providing financial guidance remains suspended.” (iRobot Q3 Results). In the capital market, the inability to communicate with investors and analysts creates information asymmetry and as a result uncertain pricing for the company’s security.

Furthermore, iRobot is currently distressed with a low amount of liquidity. Among the risks mentioned in the company’s 2022 annual report declining operating performance was prominent:

1. “We have incurred substantial operating losses in the past year, expect to continue to incur operating losses for the foreseeable future, and may not achieve a return to profitability in the future.

2. We may not be able to obtain capital when desired on favorable terms, if at all, or without dilution to our stockholders.

3. Significant reductions in consumer demand has caused, and will likely continue to cause, a decrease in revenue from sales of our products and additional costs reducing both gross margin and operating income.

4. We face intense competition from other providers of robots, including diversified technology providers, as well as competition from providers offering alternative products, which could negatively impact our results of operations and cause our market share to decline”

As seen in the graph below, iRobot’s free cash flow fluctuates seasonally while its cash position steadily declines. In July, the company’s cash position reversed its trend as a result of securing a $200 million financing facility. This will help keep the company afloat for the time being, however, the company’s cash-strapped situation offers it little operational flexibility and no room for errors.

Strong Historical Returns Provide Upside Potential

In the case of no acquisition by Amazon, iRobot has some upside potential given that its performance returns to pre-pandemic levels. It is important to remember that iRobot has a strong market share, and relatively high profitability during good times; furthermore, the company’s declining forward P/E ratio reflects a fair adjustment to the company’s valuation.

Prior to the COVID pandemic, iRobot boasted relatively strong profitability due to its high market share and outsourced manufacturing model. According to the company, “Our core competencies are the design, development and marketing of robots. Our manufacturing strategy is to outsource non-core competencies, such as the production of our robots, to third-party entities skilled in manufacturing” (10K 2022). This means that iRobot can sell its products with a low capital intensity and therefore generate high returns on capital as shown in the graphs below.

Below is a presentation of the company’s EV/EBITDA multiple and Forward P/E Ratio. As we can see, iRobot is trading at an excessive EV/EBITDA multiple due to the steep decrease in profits during the year. This points to the fact that iRobot is historically ‘expensive’, however, if the company can regain its previous profitability, then this ratio will decline markedly. When looking at the Forward P/E Ratio, we can see that the market has steadily been pricing in lower growth since 2021. This view has turned out to be correct as profits have now turned into negative territory. While the situation is alarming, the return to GAAP profitability will further reaffirm investors about the company’s potential.

The market trends for RVCs further reaffirm the company’s upside potential. Between 2022 and 2030, one estimate claims that the market will grow from being worth $5.1 billion to $14 billion (15.2% “CAGR”) (Marketreportsworld). Furthermore, iRobot has been successfully growing its engaged community. In the third quarter, the company grew its connected community by 18% “YoY” to a total of 19.3 million (iRobot Q3 Results). Connected customers “opted into communications with us either through our Home App, email or both” which implies that existing customers find value in the product offering and may be interested in purchasing add-on products from iRobot.

Conclusion: Sell iRobot

In conclusion, the potential acquisition of iRobot by Amazon represents a strategic move for the internet giant to strengthen its at-home presence by integrating iRobot’s autonomous vacuum cleaners with the Alexa ecosystem. However, the regulatory hurdles presented by the EU Commission’s objections highlight genuine concerns about anti-competitive actions that could potentially harm iRobot’s rivals.

The EU Commission’s stance is rooted in the belief that Amazon, as a dominant sales channel for robot vacuum cleaners, may employ tactics to foreclose competition, such as delisting rival products and limiting visibility in its marketplace. While iRobot’s market share remains strong, the regulatory scrutiny suggests a broader concern for fair competition and consumer choice.

Additionally, iRobot’s financial performance, impacted by the uncertainties surrounding the acquisition and increasing competitive pressure, has seen a decline post-COVID. The company’s distress is evident in its liquidity challenges and the suspension of financial guidance, creating uncertainty in the capital market. iRobot is currently selling for a 3x discount compared to Amazon’s bid which provides a potential upside to shareholders, especially if the company returns to prior profitability levels; however, the unlikelihood of the deal going through as well as short-term weak stand-alone performance makes iRobot a very risky company to buy into. Hence, I recommend a sell rating for iRobot.