Taking Stock

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Is Cerberus Capital Accelerating Its Interest In Safeway Acquisition? 

I just returned from the FMI Midwinter Conference in Scottsdale, AZ and a lot of the chatter was about Cerberus’ prospective plans to acquire all or most of Safeway and the role that private equity is playing in reshaping the supermarket business. Of course, Safeway’s last minute “no show” at the conference only heightened the speculation that a deal with Cerberus was inching closer.

And some of Safeway’s recent internal moves give even more credence that a deal might be imminent.

Last month, the big Pleasanton, CA chain whacked the four highest paid executives at its eastern division (president Steve Neibergall; VP-merchandising Rick Stein; VP-CFO Glenn Davis; and VP-retail operations Henry Bash). Numerous sources have noted that these changes are only the beginning of further cost-cutting moves. We’re told a corporate restructuring in Pleasanton is coming soon and, at its stores, Safeway has been slashing labor for the better part of the year. Additionally, Safeway is eliminating all corporate charitable events (including the annual Easter Seals fundraiser at its eastern division and its sponsorship of an LPGA golf event held annually in Phoenix). The chain has also recently implemented new vendor practices that have drawn the ire of some of the country’s leading CPG firms.

You’ve got to wonder if these belt-tightening moves are aimed at enhancing Safeway’s market share and consumer image, or if they are primarily a method to improve the bottom line so that potential suitor Cerberus Capital Management will sweeten its offer to possibly acquire most, if not all, of the chain.

I’m betting on the latter.

So, let’s examine these pieces and explore whether these moves make Safeway a better retailer. First of all, we wish new eastern division president Brian Baer the best of luck. We’re told he’s extremely intelligent, has excellent people skills and possesses a strong financial background. He’ll needs to utilize all of his skills, because Safeway’s morale and market share are sliding. But don’t put all the blame on the previous eastern division leadership. The truth be told, despite some of the best locations in the market, Safeway hasn’t stepped up to the plate when it comes to dealing with the realities of new and merging competitors; it simply hasn’t been aggressive enough in terms of localized marketing; its pricing strategy isn’t competitive with most of the retailers in the market and it has cut so much labor in its stores that customer service and training have consistently deteriorated over the past two years; and the division remains in dire need of a broader-based remodeling and new store program – replacing primarily its best stores is only a partial solution. These shortcomings cannot be blamed on local managers – these are strategies developed corporately, and like an increasing number of retailers, are designed to create short-term profits rather than creating a stronger long-term foundation.

As a retired retail executive (who worked for a publicly-traded grocery chain for more than 30 years) has told us: “It’s OK to sell less stuff as long as we hit our earnings objective and placate Wall Street.”

And perhaps Baer (who only has been involved in retail operations/division leadership positions for a couple of years) and Brad Spooner (a good guy who’s never been involved in merchandising) will rise to the occasion and provide the spark that Safeway needs. But it ain’t gonna happen if the corporate poobahs in Pleasanton continue to operate one of the most centralized, process-oriented systems (with a distinct West Coast slant) in the entire food and drug industry.

As for Cerberus, there’s no guarantee that an acquisition will take place. However, if you gave me $20 and ask me to bet it, I’d go directly to that window and bet it all.

Why? Cerberus has proven its desire to be a bigger factor in the grocery business and with talented industry veteran Bob Miller supervising its retail food growth under its New Albertsons unit, the company will soon operate nearly 1,200 supermarkets nationally. By the way, Miller recently resigned as chairman of sister company Supervalu to “focus on other demands” (Cerberus?). That number has been significantly bolstered over the past year with the acquisition of Supervalu’s five large supermarket divisions and a pending purchase of about 70 United Markets in Texas. Cerberus also came in second to Kroger in the Harris Teeter acquisition derby.

And what a fit Safeway would be. If you excluded Southern California (Vons) and Seattle-Portland because of existing overlap and possibly even excluded Northern California (Safeway’s most profitable division with no overlap) to preserve some continuity for Safeway if it remained a viable regional organization, Cerberus/New Albertsons would get four existing divisions – Eastern, Phoenix, Denver and Texas – that have struggled in recent years under Safeway’s leadership but would be ideal for a private equity investor who would see little overlap while gaining key real estate control and significant cash flow.

On a different level, Safeway is also an ideal candidate to be targeted by Cerberus. That’s because recently retired CEO Steve Burd practically invented the book on how to trim fat and create efficiencies in the supermarket business. And his successor, former CFO and president Robert Edwards, seems to be taking the knife sharpening to an even higher level, showing no hesitancy to create more shareholder value by selling Safeway’s Canadian operations at a premium price to another PE firm – Empire Co. – and withdrawing from Chicago (Dominick’s) despite the fact that only 15 of its 72 stores were able to be sold before that division was shuttered on December 28. With little excess fat remaining at Safeway and a very vanilla merchandising and marketing approach, the retailer is easily the best large chain turnkey opportunity for Wall Street investment firm to pursue.

And while cost cutting and seeking greater efficiencies are noble efforts in the “seeking greater shareholder value” objective, there’s a point when the belt gets too tight and restricts normal breathing. And, if you listen to a number of senior managers at the top consumer packaged goods firms in the U. S., Safeway’s recent tack of trying to extract additional vendor funding for 2013 is heavy-handed, unfair and perhaps even illegal.

We first started hearing about Safeway’s attempt to receive additional funding from several suppliers in late November. During the course of the next 30 days, more complaints came our way and I did some additional digging, too, noting the vitriol that was displayed by key executives at these large national manufacturers.

So here’s a collective summary of the events, according to senior executives at 10 of the biggest CPG companies that do business with Safeway.

The specific tack, according to the vendors I spoke with, involves an approximately 30 minute meeting with a Safeway executive and a consultant who offer a PowerPoint presentation detailing Safeway’s current performance with the vendor and claiming that the vendor has underfunded Safeway based on its analysis. The PowerPoint lasts for about 25 minutes. At the end of the presentation, vendors are given a bill (seven or eight figures, representing an increase of 25-40 percent over previous mutually agreed upon funding levels for 2013). Vendors told us that there was no right to redress at the meeting and that any follow up questions should be made in writing (several vendors submitted questions and said that their inquiries were not adequately answered). The term “resetting the economics” was mentioned by several of our vendor sources as a phrase that Safeway used at the meeting to seemingly justify its new vendor initiative.

Of the 10 major CPG vendors who I spoke with, all said the data that Safeway presented was either erroneous or ambiguous.

Also noted was that the Safeway executive at the meetings said that 2014 budgets would not be discussed until the 2013 bill was settled (vendors said that the payment window was only about two weeks from the time of the original meeting). Several vendors also noted potential Sarbanes-Oxley implications since contracts had been mutually agreed to and signed many months ago.

Vendors believe that Safeway is trying to strong arm its leading suppliers (I’m told the “hit list” includes the chain’s top 100 vendors), an approach that none of those vendors claim that Safeway has ever deployed, which they regard as heavy-handed and unfair.

“It’s a money grab, pure and simple,” said one senior VP at a leading CPG company. “ ‘Pay us the ransom money now or there will be repercussions later’ was clearly my take away from the meeting. No follow up questions were allowed. The data they presented was in my opinion subjective and open to interpretation and the whole episode reeked of corporate thuggery.”

Another senior executive a major manufacturer noted: “We were caught completely off guard by Safeway, of all retailers, using this strong-armed approach. But that’s only part of the issue. The amounts they are seeking are astronomical – way out of line. To me, it seems like this was a consultant-driven initiative. Maybe Safeway needs to be reminded that they are a significantly smaller company than they were a year ago with the sale of its Canadian operations and its withdrawal from Chicago. I can tell you our company is not going to acquiesce to their demands and if it comes down to it, we’ll move on and restructure our programs with our more productive customers.”

When presented with this overview, Safeway spokesman Brian Dowling responded: “We routinely meet with our vendor partners to discuss a range of mutual issues focused on how we can better serve customers.”