Kroger Pays Premium For Harris Teeter

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In one of the largest supermarket deals of the past five years, The Kroger Co. has agreed to acquire Harris Teeter Supermarkets, the large Cincinnati based chain announced earlier this month. Officially, the two retailers have entered an agreement under which Kroger will purchase all outstanding shares of Harris Teeter for $49.38 per share in cash, or approximately $2.5 billion.

The transaction price represents a premium of 33.7 percent to the Harris Teeter closing share price on January 18, 2013, the day of the first media report that Harris Teeter was evaluating strategic alternatives. The terms of the agreement were approved by the boards of directors of both companies.

According to Kroger the acquisition of Harris Teeter brings “an exceptional brand and complementary base of 212 stores in attractive southeastern and mid-Atlantic markets and in Washington, DC. The stores are located primarily in high-growth markets, vacation destinations and university communities in North Carolina, Virginia, South Carolina, Maryland, Tennessee, Delaware, Florida, Georgia and the District of Columbia. Harris Teeter also operates distribution centers for grocery, frozen and perishable foods in Greensboro, NC and Indian Trail, NC and a dairy facility in High Point, NC. Harris Teeter had revenues of approximately $4.5 billion for fiscal year 2012.

Kroger gave no timeline for potential closure of the deal, noting that it filed the necessary paperwork with the SEC and FTC on July 9 and will wait for their approval. Of the 212 stores there is some store overlap, particularly in the Raleigh-Durham, NC, Charlottesville, VA markets and the Tidewater area of Virginia.

Together the company will operate 2,631 supermarkets and employ over 368,300 associates across 34 states and the District of Columbia. Following closing, Harris Teeter will continue to operate its stores as a subsidiary of The Kroger Co. and will continue to be led by key members of Harris Teeter’s senior management team. There are no plans to close stores, and associates will continue to have employment opportunities with both companies. Kroger headquarters will remain in Cincinnati, and Harris Teeter will keep its headquarters in Matthews, NC.

“We are excited to welcome Harris Teeter to the Kroger family,” said David B. Dillon, Kroger’s chairman and chief executive officer. “Harris Teeter is an exceptional company with a great brand, friendly and talented associates, and attractive store formats in vibrant markets run by a first-class management team. They share our customer-centric approach to everything we do – from store format and merchandising to innovative loyalty programs. This is a financially and strategically compelling transaction and a unique opportunity for our shareholders and associates. We look forward to bringing together the best of Kroger and Harris Teeter while continuing to operate and grow the Harris Teeter brands. Together, we can continue to deepen our connections with customers across all of our markets.”

Thomas W. Dickson, chairman of the board and chief executive officer of Harris Teeter stated, “Harris Teeter has a long track record of creating shareholder value and this merger is the culmination of those efforts over many years. We are excited about becoming part of The Kroger Co., one of the best food retailers in the U.S. while maintaining the Harris Teeter banner, our management teams, our new store growth plan, our distribution and manufacturing facilities in North Carolina as well as our headquarters in Matthews, NC. As part of Kroger, Harris Teeter will be well equipped to continue to provide our customers outstanding quality and customer service as well as excellent value in an increasingly competitive market.”

In a conference call with financial analysts following the acquisition announcement Kroger CFO Michael 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.”

Kroger said it will finance the transaction with debt. Kroger also intends to assume Harris Teeter’s outstanding debt of approximately $100 million. Consistent with Kroger’s and Harris Teeter’s shared long-term commitment to returning cash to shareholders, Kroger intends to continue its quarterly dividend and share repurchase program while managing free cash flow to reduce the leverage taken on from this merger. Although the ratio will increase at the time the merger closes, Kroger expects to allocate some free cash flow to debt reduction to re-establish and maintain its 2.00 – 2.20 net debt to EBITDA ratio over the next 18-24 months. Kroger is committed to maintaining its current investment grade credit rating.

Including the effect of allocating some free cash flow to debt reduction, Kroger expects net accretion to earnings per diluted share in the range of $0.06 – $0.09 in the first full year after the merger, excluding transition and transaction expenses. Kroger expects to maintain its current 8-11 percent long-term net earnings per share growth rate off of this higher earnings base.

Kroger expects to achieve annual cost savings of approximately $40 to $50 million over the next three to four years. Much of the savings is expected to come from the benefits of Kroger’s scale. Kroger has a strong history of achieving synergy goals. Being patient in achieving those goals reduces the risk of the transaction and sets the stage for sustainable growth.