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SPLURGE 'N MERGE

Consolidation is here to stay -- at least as long as the economy remains healthy, costs can be harnessed and efficiencies can be achieved.That's the assessment of a variety of industry observers, who see the phenomenon of market consolidations through mergers and acquisitions continuing for the future."For supermarket operators, staying independently owned is a short-term pleasure," Jonathan Ziegler,

Consolidation is here to stay -- at least as long as the economy remains healthy, costs can be harnessed and efficiencies can be achieved.

That's the assessment of a variety of industry observers, who see the phenomenon of market consolidations through mergers and acquisitions continuing for the future.

"For supermarket operators, staying independently owned is a short-term pleasure," Jonathan Ziegler, a securities analyst with the San Francisco office of Salomon Smith Barney, New York, told SN. "The pressure to merge will become more intense as time moves on."

Asked how long the consolidation ball will keep rolling, Ziegler replied, "It's got a long way to go. We're not even in the third inning yet."

Debra Levin, an analyst with Morgan Stanley Dean Witter, New York, said she also expects consolidation to continue indefinitely.

"There are still a lot of potential buyers out there, and given the fragmented nature of the industry -- with the top five supermarket chains comprising only about 22% of the total grocery industry -- there's certainly plenty of opportunity for consolidation," she said.

Phillip St. Georges, managing director of retail ventures for KPMG Peat Marwick, Washington, D.C., also said the industry is "really ripe for consolidation because of its huge size and fragmented nature."

According to Harvey Gutman, senior vice president, store development, for Pathmark Stores, Carteret, N.J., "The supermarket industry is no different than other retail sectors that have seen consolidation. Consolidation is almost a requisite for attaining growth in a stable industry like supermarketing."

Observers told SN they see consolidation continuing because of activity at all levels of the food industry:

Among larger chains, which view consolidation as a way to obtain critical mass quickly and efficiently.

Among smaller chains, which seek to grow their businesses by selling to companies with deeper pockets or to sell while prices are high.

Among wholesalers, which see consolidation as a way to cut costs through distribution synergies.

Among independents, which see consolidation among larger players as an opportunity to grow by buying units divested by the consolidating companies.

In interviews with SN, a host of observers addressed the subject of consolidation from a variety of angles, including which companies are the most likely consolidators; whether companies that consolidate outside their markets will lose touch with local consumers; whether Wal-Mart will edge itself into the consolidation picture; to what extent consolidation depends on a rising bull market and strong economy, and whether the industry will end up with only a handful of companies.

Jim Wisner, vice president of Willard Bishop Consulting, Barrington, Ill., said the most desirable candidates for consolidation are midsized regional chains with annual volumes of anywhere from $600 million to $2 billion.

The long-term success of today's consolidations may depend on how well companies are able to maintain the ability to localize the businesses they acquire, Wisner added. "Many regional chains have built their businesses by keeping in touch with the needs and desires of their customers in a particular marketplace, and the question is, will that ability evaporate through consolidation?

"Retailers are certainly able to address that issue from a technological standpoint, but the question remains whether they can do it from a more personal standpoint."

Ron Pearson, chairman, president and chief executive officer of Hy-Vee, Des Moines, Iowa, expressed doubts about the wisdom of some consolidations. "We believe the ability to get customers in the front door is what we need to concentrate on. You still have to operate good supermarkets for customers every day, and you can't consolidate that." Sam Duncan, president of Ralphs Grocery Co., Compton, Calif., said he expects the approach used by Fred Meyer, Inc., Portland, Ore., and Richfood Holdings, Richmond, Va., could ultimately resolve the issue of geography, "with a handful of holding companies controlling the majority of supermarkets across the U.S. and letting each operate in its own area -- especially if they can leverage their buying power to pass savings onto consumers."

With the incentive to expand quickly into new markets, larger chains will continue to actively pursue consolidation through acquisitions and mergers with regional operators, observers said. "It's hard to enter new markets one store at a time. It's much easier to find partners to leverage off critical mass," George Golleher, chief executive officer of Ralphs, told SN.

According to Levin, "With low inflation and saturated markets, internally generated growth can be difficult to achieve. Growth through acquisition can be less risky because the supermarket industry is so competitive."

Looking at the major chains, Chuck Cerankosky, an analyst with McDonald & Co., Cleveland, said Safeway, Pleasanton, Calif., is probably ready to do another sizable transaction, "though it's not in any rush to do so"; Kroger Co., Cincinnati, has expressed an interest in making acquisitions, "though they are being fairly patient about it"; American Stores Co., Salt Lake City, has been more interested lately in buying up drug-store properties; Netherlands-based Ahold is likely to continue to make acquisitions, "and A&P could return to the acquisition table."

Albertson's, Boise, Idaho, is also pursuing growth through acquisition, especially as a way to enter new markets, Ziegler pointed out. However, unlike Safeway, which is seeking large companies with strong operating cash flows -- like its April, 1997, purchase of Vons Cos. -- Albertson's "is taking the piranha approach, taking small bites to grow," Ziegler said, citing the chain's acquisitions of Seessel's in Memphis, Smitty's in Springfield, Mo., and three Super One Foods stores in Des Moines.

Adding a new element to the consolidation mix is the possible entry of Wal-Mart Stores, Bentonville, Ark., into the acquisition picture. After adding supercenters at a rate of more than 100 per year, primarily by converting existing discount stores, "Wal-Mart will eventually run out of locations to convert, and it may begin looking for acquisitions in the supermarket industry," Ziegler said.

"And as Wal-Mart gets into a smaller store format -- stores in the 40,000-square-foot range -- a likely acquisition candidate would be Food Lion, whose everyday-low-price operating style, efficient distribution and right-sized stores could fit nicely with Wal-Mart's requirements."

Observers also said they expect more consolidations within markets. "The U.S. supermarket industry has been over-stored for years, and a lot of companies find it cheaper to purchase buildings than to have a competitor move in right next door," Hy-Vee's Pearson said.

"The advantages of consolidation are the synergies that result, and sometimes you need those synergies just to cover the premium acquisition prices," Pearson added.

For medium-sized regional operators, the choice is to grow or be swallowed up by one of the larger retailers, observers said.

According to Levin, "I think smaller chains will increasingly consider being purchased by entities with deeper pockets in order to better weather the competitive environment and realize their investment as well."

Wisner said smaller operators may opt to sell while the selling is good. "People who are thinking about selling sometime in the future may look around and decide they don't want to get blocked out if stock valuations flatten out and they miss the chance to make a profitable deal, and that attitude will continue to drive consolidation for awhile," he explained.

Robert E. Stauth, chairman and chief executive officer of Fleming Cos., Oklahoma City, expressed a similar viewpoint. "When a retail or wholesale executive takes a strategic look at his company and where it's likely to be in 10 or 15 years, he may not be sure he can sustain his current levels of operation, and he may consider the fact that he can get 8-10 times operating cash flow for his company right now, which may prompt him to sell.

"However, a lot of regional chains are still family-owned businesses with good succession plans, and they are not for sale."

According to St. Georges, consolidation among family-owned independents is "the story beneath the story -- deals that often operate below the radar screen and that don't get the publicity the biggest deals get. But those companies are accelerating their rate of consolidation as well -- companies like Schwegmann's, Seessel's and Jitney-Jungle. (See Chart, Page 20.)

"While companies like Albertson's and Ahold are consolidating as part of a growth strategy, these smaller operators are seeking buyers because they see that acquisition prices are the highest they've ever been and they want to get their share."

They are also finding it harder to keep up with the pace and cost of technology and the intensely competitive nature of today's grocery business, St. Georges added. Cerankosky said some independents will prosper despite consolidation. "There will always be a number of strong regional chains who are unique players in some markets, and the independent channel will still be around," he said.

According to Stauth, even if the industry were to consolidate down to a handful of chains, "there will always be a niche market for good independents."

Asked how independents cope with changing ownerships when the chains they compete with are merging, Stauth told SN, "The challenge of changing ownerships is a battle that's being fought among the market-share leaders, and I'm not sure the independent feels threatened by it because a merger means one less competitor in the marketplace. So consolidation probably has less impact on independents than on regional chains."

In addition, when one chain buys another, it's often the independent who benefits, Stauth said, because the acquiring company typically has to sell off a number of stores, "and wherever consolidation happens in the same market, the wholesaler's business grows," he said.

Jeff Noddle, executive vice president of Supervalu, also said consolidations create opportunities for smaller operators, who are able to buy units that the consolidators must sell, noting that Supervalu customers picked up stores when Stop & Shop Cos., Quincy, Mass., and Edwards Super Food Stores, Windsor Locks, Ct., were merged under Ahold's ownership a couple of years ago, and again when Jitney-Jungle Stores of America, Jackson, Miss., acquired Mobile, Ala.-based Delchamps last year.

Wholesalers told SN they expect additional consolidation within the distribution segment of the industry.

Mike Wright, chairman, president and chief executive officer of Supervalu, Minneapolis, said consolidation will continue "as long as bankers have a lot of money to lend at reasonable rates and people are looking to grow their businesses through acquisition." He said he expects consolidation at the distribution level to proceed "at a slower pace than on the retail side," with Supervalu as a consolidator both at the wholesale and retail levels.

Stauth said he expects consolidation to accelerate at the retail level "for sure, and it will probably continue on the food distribution side at the same rate it's been happening."

Consolidations among wholesalers differ from retail consolidations, Stauth pointed out, "because the bigger distributors are already pretty broad in their geography so there have to be synergies to make consolidation work. One reason we bought Scrivner [in 1994] was that it fit us like a glove -- we overlapped in only two or three areas, so it was almost all additive, plus we picked up 17% of sales from retail."

In addition to mergers between wholesalers, Stauth said he expects wholesalers to continue to buy retail companies. "It makes sense to have some control over your future," he explained.

According to several observers, the continued health of the economy will provide a strong spur to ongoing consolidation.

"The economy is in perfect alignment right now, with interest rates and inflation low and stock prices high. And with so many markets overstored, there's a need for the kinds of combinations and rationalizations that we're seeing now," Noddle told SN.

Gutman, of Pathmark, said he believes consolidations will continue "as long as the economy stays healthy and acquisitions continue to be productive."

Wisner said the accelerating pace of consolidations "owes a lot to the opportunity of making deals while interest rates are low. And deals financed with stock, at a time the market is fairly flush, make the value of what companies have to offer a little more attractive."

With so many deals funded with shares of the acquiring company's stock, Cerankosky said, "the strong stock market makes those shares a pretty powerful currency that may allow the buyer to actually pay a higher price than in a cash deal." According to Stauth, "The long-term bull market puts people in a positive mood. When stock prices go up, there's no shortage of money from investment bankers, who are fighting to loan money and get their fees."

Stauth said he doubts the industry will wind up with only a small handful of retail players. "Some have said the industry will consolidate down to five or six chains worldwide that would own virtually all of the retail supermarket business, but I think that's unlikely."

Cerankosky said he does not see consolidation accelerating, "and I don't think we'll end up with a handful of companies controlling 75% of the business."

Pearson said he believes industry consolidation will continue but doubts it will have much impact on Hy-Vee.

"To some people, buying supplies and equipment cheaper is the key to consolidation, but we're a $3 billion company and we are already in the top buying brackets with major vendors," he said.

Pearson said Hy-Vee has acquired 10-12 stores over the past year and a half -- "moreso than in the last few years," he noted -- "but that's not our normal course of business, though we'll acquire rather than build if it fits our needs. But we buy stores only on a selected basis, because we prefer to build brand new stores."

Hy-Vee is not likely to be a consolidator, Pearson said. "We're not looking to expand beyond our seven-state operating area in the Upper Midwest," he explained.