Taking Stock

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Cerberus/New Albertsons Poised To Become Nation’s Second Largest Supermarket Chain 

OK, most of us now recognize that Cerberus Capital Management’s pursuit of Safeway has been one of the worst kept secrets in recent memory. Now that both sides have agreed to the $9.2 billion deal, the heavy lifting will begin in about eight or nine months.

And there will indeed be some heavy lifting, because this is one of the biggest private equity acquisitions in the history of the retail food business.

The obvious “to be determined” questions are: 1) Considering that there are store overlap issues in several key markets, which stores will have to be closed or sold and who might acquire those overlapping locations? 2) How much will Cerberus/New Albertsons/AB Acquisition rearrange the deck chairs in terms of corporate and divisional personnel? 3) How much will the new organization invest in cap-ex, especially in building new stores or significantly remodeling many older stores that resemble “Lifestyles (of the 1990s)” and 4) As a private equity firm, how long will Cerberus stay in the game?

Although I’d never make it as a professional gambler, let me take a very subjective stab at answering those questions and add a few more opinions and observations of my own.

As for store overlap issues, the big conflict regions are Southern California (Vons, Albertsons) and the Pacific Northwest (Safeway, Albertsons). However, there are geographic store overlaps in Phoenix, Denver and even in parts of Texas (a Safeway train wreck with its Randalls and Tom Thumb stores). It’s anybody’s guess who will end up with these potentially divested locations, but Kroger (which contrary to published reports did not make a bid for the entire company, we learned) seemingly would be interested in some fill-in locations (however, it too would have even more potential overlap issues in many of the markets where both Safeway and Albertsons operate stores). With the glut of retail location in most markets, don’t be shocked if any of the closed locations remain dark.

Regarding personnel changes, expect a further streamlining, perhaps not as deep at the divisional level although there will be local shifts, too. In fact, Safeway CEO Robert Edwards, who will become chief executive of the new organization, has quietly made significant moves involving senior staffers over the past several months. With industry icon Bob Miller to serve as executive chairman and de facto Cerberus tactician Justin Dye, currently chief strategy officer at New Albertsons (and another key Cerberus link), look for at least several former Albertson veterans to hold key posts at the new “Safeway unit” for the soon-to-be 2,400 store supermarket chain. And don’t be shocked if the smallish current New Albertsons headquarters in Boise, ID ultimately shifts to Safeway’s larger corporate offices in Pleasanton, CA.

Cap-ex increases? Accelerated new store pipeline? I wouldn’t make that bet. First, that’s not the M.O. of private equity. Monetizing real estate assets and exploiting the advantages that supermarket cash flow brings to the table are the main reasons this deal is happening and are part of a bigger end game which I will reveal at the end of this piece. If you view the 877 store acquisition by Cerberus/New Albertsons from Supervalu just about a year ago, there are several changes that have been implemented that are worth noting. New Albertsons has done a fine job of reinstilling pride in the associates at store level, it has lowered retails, and it has restored more of a “local” presence to its divisional operations (Safeway’s issues in those areas need far less radical surgery). New Albertsons also brought in new leadership, primarily comprised of “Miller’s posse,” executives who once toiled for the original Albertsons organization in the 1970s and ‘80s and have brought supermarket professionalism to Acme Markets, Shaw’s, Jewel-Osco and Albertsons. But new stores, no. In those past 12 months, I can’t recall one new supermarket opening under the New Albertsons regime and there hasn’t even been very much major remodeling of stores in need. To be fair, at least at Acme and Shaw’s, the stores look more refreshed and there have been limited improvements to the physical plants. So, while I expect Safeway to continue with its half-dozen or so new store projects, don’t look for a lot of cap-ex devoted to expanding the current real estate pipeline.

For those keeping score, here’s a consolidated recap of the deal.

  • Cerberus will pay approximately $9.2 billion ($40.10 per share) to acquire Safeway Stores. The breakdown of the deal includes: $32.50 per share in cash; $3.65 per share of the estimated after-tax net proceeds from sales of primary non-core Safeway assets – Property Development Centers (its shopping centers unit) and Casa Ley (the Mexican supermarket chain of which Safeway holds a 49 percent stake). Shareholders will receive either a cash payout by closing or through Contingent Value Rights post-closing; and $3.95 per share which is the estimated value of its 37.8 million shares of Blackhawk, Safeway’s gift card business (which launched an IPO 11 months ago).
  • AB Acquisition plans to fund the deal in part with debt financing of approximately $7.6 billion, equity contributions from its current investors and their affiliates, partners and co-investors of approximately $1.25 billion, and cash on hand of Safeway.
  • Closing of the deal is estimated in the fourth quarter of this year after regulatory approvals are granted; Safeway’s shareholders will vote on the deal in quarter three.
  • The newly combined organization promises lower prices, better local assortment, an improved shopping experience and a stronger management team.
  • Any new bidders will have a 21-day “go shop” window and additional 15-day negotiation period if bona fide offers are received during the “go shop” period. However, as a deterrent to new bidders entering the process, break up fees of $150-$200 million would be paid to AB acquisition/New Albertsons depending on timing of a successful superior proposal. And if AB Acquisition/New Albertsons fails to close the transaction under certain circumstances, a $400 million reverse break up fee would be awarded to Safeway.
  • The newly expanded company (prior to any potential FTC store divestitures) would operate 2,410 stores (1,075 New Albertsons units and 1,335 Safeway supermarkets) in 34 states and WashingtonDC. Additionally, it would employ 250,000 associates, operate 27 distribution centers and 20 manufacturing plants and operate under the following banners: Safeway, Vons, Pavilions, Randalls, Tom Thumb, Carrs, Albertsons, Acme, Jewel-Osco, Lucky, Shaw’s, Star Market, Super Saver, United Supermarkets, Market Street and Amigos.

A few more thoughts about this whole process: although Kroger apparently attempted to enter the bidding arena at the 11th hour, trade observers have speculated that its interest was primarily to drive up the price of the deal, especially since New Albertsons will soon be Kroger’s primary competitor in many markets. As stated above, Kroger may indeed be interested in specific overlap locations, but Kroger’s corporate grid would have created more overlaps than the New Albertsons-Safeway deal.

And speaking about price, I noticed the hype about the “significant premium” Safeway shareholders would receive based on the closing share price during the past year (a 72 percent gain in value over a year ago; a 56 percent premium over six months ago; and a 17 percent increase since February 18, the day before Safeway revealed its was in sales discussions). Those are nice gains, but we’ve heard from several insiders who believed that Safeway was looking to garner an offer in the $46-$49 per share range.

However, timing is everything. Without another serious bidder, Cerberus held all the leverage. Still, it’s hard to believe that Harris Teeter, a much smaller company with infrastructure assets (real estate control, distribution centers, and manufacturing plants) that can’t match Safeway’s, sold for nearly 25 percent more than the Pleasanton, CA-based chain on a per share basis.

Give former CEO Steve Burd and current CEO Edwards credit – they’ve streamlined Safeway to such a degree over the past two decades that it unintentionally became the optimal poster child for any PE company to desire, especially taking into account the vanilla and centralized way Safeway operates. To a hedge fund or private equity firm, Safeway became the ideal turnkey supermarket chain to target.

And Edwards is certainly a man of his word – since his elevation to chief executive last May, he’s preached “maximum shareholder value.” He’s now achieved his mission, even though the final number may be a little lighter than he and Safeway’s board might have hoped.

Oh, and as for the answer to Question 4: How long will Cerberus/New Albertsons stay in the game? My hunch is no more than three years (although the stores will certainly still exist).

I believe that once Bob Miller (and Robert Edwards) perform their makeover, Cerberus Capital Management will follow in the steps of Bi-Lo Holdings/Lone Star Funds/Southeastern Grocers (Bi-Lo, Winn-Dixie, Sweetbay, etc.), Sterling Investment Partners (Fairway Market) and even Safeway (Blackhawk Network Holdings), and seek to launch a public offering.

That’s where the real treasure trove lies – break up fees, bonus compensation and a potential windfall for the core executives and insiders, which represents hundreds of millions of dollars to be potentially reaped by those inner circle investors.

Because at the end of the day, all of these PE deals are less about selling groceries and enhancing the shopping experience and more about Wall Street leaving an indelible mark on what used to be an exciting and entrepreneurial business.