Taking Stock

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Kroger Pays Premium For Harris Teeter Acquisition 

At roughly $11.5 million per store and a very healthy multiple of 7.9 percent times earnings, Kroger certainly paid a premium for one of the best run regional chains in the country. For Harris Teeter, which announced last January that it was “exploring” its options, there was little doubt that the timing was ideal to sell – with its operating performance at its peak and a high-level competitor (Publix) with a similar operating style about to establish a beachhead in its Charlotte backyard.

As it turns out, this is a deal that will be good for both parties. For Kroger, the largest pure play supermarket chain in the country (and the best run in its peer group), it marks the first major acquisition made by the Cincinnati based retailer since its $13 billion deal to acquire Fred Meyer in 1999. While there is some store overlap with Harris Teeter in the Raleigh, NC market, in Nashville and in the Charlottesville and Tidewater areas of Virginia, don’t expect too many FTC store conflict issues.

In addressing the financial analysts following the announcement of the proposed deal, Kroger CFO Mike Schlotman added: “This is one of those opportunities when you take a map and put dots on the map where my stores are and take that map and put dots where their stores are – it’s an amazingly great fit. Just like when we merged with Fred Meyer – that was a unique fit. And when you go back to 1983 when we merged with Dillon Stores, it was the exact same thing. I think this is very consistent with what we said we’d look for over time – a great management team, a customer-centric operating model, well-run stores and a contiguous geography where we can leverage a lot of infrastructure.”

At Harris Teeter, at least for the near term, president Fred Morganthall and executive VP Rood Antolock, the main cogs in a skilled and creative management team, will be staying on and that’s a very good thing. And Kroger’s decision to keep its newest prize as a separate operating entity and keeping the Harris Teeter banner in place is also good business. And while there ultimately will be an integration of synergies (Kroger said it can save $40-50 million over the next three to four years by utilizing the big chain’s scale), Kroger has proven it can maintain banner independence and identity as its done with Fry’s, King Soopers, Dillons, Fred Meyer and Ralph’s.

It will be several months before this deal closes and there is one interesting (but unlikely) scenario that could still rear its head. As part of the agreement, although Harris Teeter cannot solicit alternative bids, other companies may still come in with offers, Schlotman admitted during a follow-up conference call after the deal was announced early on July 9 (although there would be significant break-up fees that could affect both parties). This could potentially allow other interested parties such as Ahold and private equity companies Cerberus and Bain Capital to potentially enter or re-enter the derby.

Schlotman noted: “We are excited about entering new markets, which include vibrant and growing major urban centers such as Charlotte and Washington, DC, several other metropolitan areas in the Carolinas, and affluent vacation destinations and university communities. Harris Teeter operates in several markets with populations growing faster than the national average. We see a lot of opportunity to learn from one another, and many ways that our combination will benefit each organization.  We plan to bring to Harris Teeter the things that Kroger does very well, including our purchasing power, information systems, and loyalty programs with the world-class customer insights firm dunnhumbyUSA.  This merger extends Kroger’s footprint into new, growing markets. We also believe the entire Kroger organization will benefit from Harris Teeter’s expertise in operating urban, upscale stores, and gain insights behind their strong customer ratings on people, products and shopping experience. Interestingly, they operate an online ‘click and collect’ system, and we expect to gain insight from Harris Teeter as we continue to study and test this online strategy.”

The tentative agreement also poses some interesting scenarios going forward.

Part of Harris Teeter’s successful growth story over the past decade has been its entry in the Baltimore-Washington market where it now operates 35 stores (and has about a half-dozen new projects under development). Kroger, which used to compete in the DC market (it exited in the early 1960s) I believe would welcome a challenge against market leader Giant/Landover (Ahold USA). Since 2010 when another Ahold USA unit (Giant/Carlisle-Martin’s) acquired 25 Ukrop’s stores in Richmond, Kroger has handled that competitive threat very effectively.

And then there’s the union vs. non-union issue. Kroger’s stores nationally are overwhelmingly unionized (including all stores in the areas where Harris Teeter operates). Harris Teeter is a non-union company. When asked about that structural difference, Schlotman explained: “They (Harris Teeter) have done a great job of exciting their associates every day when they come to work with the package of benefits and pay that they enjoy. And we will certainly take their (Harris Teeter’s management team) guidance on how to maintain that excitement of their associates coming to work the way they always have.”

It’s a great fit for Kroger, which might have been at a financial disadvantage when potentially competing against Ahold. But in the end, they wanted it more and were willing to pay the price to acquire a stellar merchant with the store network and a customer image to help Kroger expand and build market share in new in new territory.