Four reasons Walmart wants to buy smart TV maker Vizio

Walmart is doing some shopping of its own.

The retail giant announced last week that it plans to buy smart TV maker Vizio in a $2.3 billion deal. If the acquisition goes through, the discounter will own a consumer electronics company that already sells many flat-screen TVs and soundbars through Walmart's website and stores.

Yet the heart of the acquisition is the value of getting in front of millions of people while they stream their favorite TV shows and movies, and being able to link that leisure time to the Walmart purchases they make later.

"It's not really about the televisions," Jefferies retail analyst Corey Tarlowe said. "It's about advertising."

Here's a closer look at the major reasons Walmart wants to buy Vizio.

When shoppers think of Vizio, they likely envision store aisles filled with giant TVs. But the growing, and increasingly lucrative, part of the company's business is a little harder to see.

In the past few years, the company, based in Irvine, California, has reinvented itself to become more of a software company. Its TVs come with the SmartCast operating system, which allows viewers to pull up and watch streaming apps, such as Netflix and Hulu, without a "plug-in" device such as an Amazon Fire TV stick or Apple TV. It also allows Vizio to sell ads.

Vizio can make money from advertising in three ways using the SmartCast system, said Dan Day, an equity research analyst who covers digital advertising for B. Riley Securities. It can sell ads on SmartCast's home screen. It can sell them in WatchFree+, Vizio's own free, ad-supported streaming app. And it gets a small inventory of ads that it can sell as part of agreements with third-party streaming companies.

Vizio's SmartCast system has 18 million active accounts, according to Walmart.

As Vizio's owner, not only could Walmart set the price of Vizio TVs on its website and in stores, but it could also expand how many people use SmartCast by adding it to the big-box retailer's own brand of TVs, Jefferies' Tarlowe said. Some of Walmart's rivals, such as Amazon, Best Buy and Target, that carry Vizio TVs could continue to sell Vizio products after the deal, but some retail analysts have raised questions about whether they may downplay their competitor's items.

Walmart's in-house TV brand, Onn, currently has a licensing deal with smart TV competitor Roku. The TVs are loaded with Roku's operating system, which supports the rival company's advertising revenue.

Tarlowe and other analysts are betting that once that contract ends, SmartCast will become the operating system on Walmart's private label TVs — putting ads in front of millions more eyeballs.

Vizio knows what customers watch. Walmart knows what they buy.

With the acquisition, the two companies can combine that data to make advertisements more personalized and effective.

Vizio TVs include automatic content recognition technology, which allows the company to understand a customer's streaming preferences, said Kirby Grines, founder of 43Twenty, a digital marketing company that works with tech companies in the video space.

If Vizio knows that a viewer plays Xbox for two hours a day or streams a lot of children's shows, the company can then decide whether to show an ad for a certain snack or a brand of diapers.

"You'll know where to insert advertisements for more reach," Grines said.

Walmart, on the other hand, knows what its shoppers buy in store and online — and has more granular data about customer preferences as it expands Walmart+, its subscription service and answer to Amazon's Prime.

With the Vizio deal, Walmart can use its shopping insights to give customers more relevant ads, and it will know if they lead to a purchase, said Michael Morton, an analyst who covers Amazon and other internet companies at MoffettNathanson.

He described that as the "holy grail" for brands.

"I'm sure you've heard that joke: '50% of my advertising spend is wasted. I just don't know what 50% it is,'" he said. "That's not the case for these retail media networks. The vendors can measure all of it."

When running a store, Walmart has to keep the lights on, pay employee wages and buy items to stock shelves. With its online business, it has to pick, pack and ship orders.

Advertising, on the other hand, costs a lot less, Morton said.

"It's incredibly profitable," he said, especially when comparing the costs of packing and shipping an online order with the costs of tacking a product placement ad onto a webpage.

Operating margin, which measures how much a company makes from each dollar of sales after subtracting costs, is 65% or higher for advertising, according to an estimate by Jefferies' Tarlowe. That compares with the roughly 4% operating margin Walmart reported in the most recent fiscal year.

Walmart is trying to grow profits faster than sales by using automation and leaning into higher-margin businesses. Tarlowe compared it to building out two separate income statements — one for its legacy retail operations and a second for its newer businesses such as Walmart+, fulfillment services for its third-party marketplace and more.

By combining the two, Walmart becomes a higher-margin company overall.

Plus, Walmart sees how much money its competitor, Amazon, makes from advertising — and wants to run the same play.

Sales in Amazon's advertising unit grew 27% year over year to nearly $15 billion in its most recently reported fiscal quarter. It sells ads for its website, such as by putting sponsored products at the top when a customer searches for items.

In January, the company began showing ads on Prime Video content, too — an indicator that it sees streaming as a bigger moneymaking opportunity.

With Vizio, Walmart could fuel an already fast-growing part of its business.

The retailer has offered more advertising opportunities at its big-box stores. Those include third-party ads on self-checkout lane screens and TVs in store aisles, advertising spots on the store radio and demo stations where brands can pay to have customers sample their products.

As Walmart expands its third-party marketplace, sellers can buy sponsored ads that put them toward the top of search rankings or promote their product on other parts of Walmart's homepage.

In the most recent fiscal year, Walmart's global advertising business grew about 28% to reach $3.4 billion. In the most recent quarter, Walmart Connect, the company's U.S. ad segment, grew 22% and its global business grew 33%.

With ownership of Vizio, Walmart has another type of advertisement that it can sell: TV spots on streaming services, which it can potentially bundle with other types of ads.

It also will collect a "gatekeeper fee," since many streaming services share a portion of their advertising revenue with the smart TVs or smart devices that they ride on, 43Twenty's Grines said.

Walmart leaders shared few details on the company's recent earnings call about its plans for Vizio, saying they will wait for the deal to close.

Yet in a CNBC interview, Walmart CFO John David Rainey described advertising as "a very exciting part of our business" and the acquisition as "a way for us to complement what we're already doing organically."

"We think of this as simply an accelerant to what we're already doing," he said.