Taking Stock

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Harris Teeter Holders To Meet Oct. 3; Filings Show Only Two Bids Made

Although the Federal Trade Commission (FTC) has not yet ruled on which Harris Teeter or Kroger stores are candidates for divestment that it has scheduled an October 3 meeting at the company’s headquarters in Matthews, NC for shareholders to approve the all-cash deal.

In a filing with the Securities and Exchange Commission (SEC) on August 27, Harris Teeter chairman Tad Dickson urged shareholders to approve the acquisition in which they will receive $49.38 per share. Dickson also asks that stakeholders approve deal related compensation for certain senior officers of Harris Teeter including Dickson and HT president Fred Morganthall.

Despite four separate lawsuits contesting the deal (a frivolous, but usually common endeavor with these types of transactions), I’ll be shocked if the acquisition is not strongly approved by Teeter’s shareholders.

A fascinating sidebar to the story is the recounting of how the whole sales undertaking started (read the filing at the end of this column). In a separate August 2 SEC filing, Harris Teeter detailed the background of the process. The following is a lengthy, but important excerpt from that filing.

So, while 19 companies “kicked the tires,” only two – Kroger and Party P (believed to be Cerberus Capital Management) – actually made bids.

I also found it interesting (but not surprising) that HT’s board opted for the presumably more stable long-term partner in Kroger rather than Cerberus, which offered more in cash ($52 per share) but for only 40 million of the retailer’s outstanding common stock shares. Cerberus’ cash portion of that offer was about $2.1 billion. Kroger ultimately paid $2.44 billion in cash.

Some other interesting footnotes from the deal include the compensation that Harris Teeter’s four key executives will receive if the deal is approved by shareholders. Chairman Dickson will receive $262,500 as an incentive bonus at the close of the transaction. Others receiving compensation for successfully executing the sale will be president Morganthall ($188,125), CFO Woodlief ($175,000) and executive VP Rod Antolock ($156,725).

Additionally, J.P. Morgan examined the financial results of 11 high-profile publicly-traded retailers as a comparison to HT’s performance. Those retailers were divided into three groups: large national peers – Kroger, Safeway and Supervalu; multi-national peers – Ahold and Delhaize; regional peers – Ingles Markets, Roundy’s and Weis Markets; and natural high-growth peers – Fairway, The Fresh Market and Whole Foods.

J.P. Morgan also examined the enterprise value of 19 food retailers that were sold during the past 12 years to better determine a range of earnings multiples that Harris Teeter might fetch. Those retailers that were evaluated were:  Cerberus’ 30 percent stake in Supervalu; Cerberus’ acquisition of New Albertsons from Supervalu (2013); Winn-Dixie’s 2011 purchase of Bi-Lo; BJ’s/Leonard Green (2011); Yucaipa Cos.’ 37 percent stake in A&P and Pathmark (2009); Leonard Green’s 17 percent stake in Whole Foods; A&P’s purchase of Pathmark (2007); Wild Oats/Whole Foods (2007); Smart & Final/Apollo (2007); Marsh Supermarkets/Sun Capital (2006); Foodarama ShopRite/management-led buyout (2006); Albertsons/Supervalu (2006); Piggly Wiggly Midwest/Certified Grocers (2005); Yucaipa’s 40 percent stake  in Pathmark (2005); Bi-Lo-Bruno’s/Lone Star Funds (2004); Shaw’s-Star Markets/Albertsons (2004); Roundy’s/Willis Stein (2002); Copps/Roundy’s (2001); and Dick’s Supermarkets/Piggly Wiggly Midwest (2001).

In the filing, Harris Teeter, while noting the difficulty in making growth projections, offered this future analysis: store counts will respectively grow to 220, 228, 236, 245 and 255 for fiscal years 2013, 2014, 2015, 2016 and 2017 (it currently operates 212 units); the company will achieve comparable store sales growth of 2.6 percent for fiscal 2013 and 3 percent thereafter; gross margins will improve by 15 basis points from fiscal 2013 to fiscal 2014 and thereafter remain relatively flat; increased sales, general and administrative (SG&A) expenses leverage such that SG&A expenses, including fixed costs, will increase more slowly than the increase in revenue; and capital expenditure plus purchases of other investments (primarily land for future development)  would be offset by proceeds from the sale of property, plant and equipment and other investments and ranged from $171 million to $208 million per year between fiscal 2014 and 2017.

My guess is that senior management might stick around longer than the traditional one-year transition period. Keeping the local flavor of its acquisitions, allowing those managers to have regional flexibility while also still integrating many backroom functions which can maximize Kroger’s efficiencies and clout, are primary reasons why the Cincinnati-based retailer has been more successful with acquisitions than its “ large national peers.”

And while the FTC will almost certainly mandate some store closures/sales due to market overlap (Raleigh-Durham, Hampton Roads and Charlottesville, VA), this is a relatively clean deal and a tremendous opportunity for the nation’s largest pure play supermarket chain to make its imprint on the Baltimore-Washington market and perhaps as a steppingstone further north.