Now that the credit crunch has knocked the wheels off private equity's shopping cart, industry observers are anticipating that strategic consolidation could make a comeback — at least, once reduced demand brings asking prices down.
Strides made toward reducing debt and strengthening operations in recent years have put large retailers like Kroger and Safeway once again in a position to expand by acquisition, sources said. If large retailers can benefit from current inflation trends — and time will tell whether that will be the case — they could soon be vacuuming up the competitors that cannot, observers added.
“The acquisitions market has really been driven by the private equity guys. Now that they've dropped out, and fewer deals are getting done, you'll see multiples go down to a level where Kroger and Safeway can get back into it,” Neil Stern, senior partner at Chicago-based consulting firm McMillan Doolittle, told SN last week. “Over the last few years, retailers have had a real difficult time competing with private equity, which you could argue was paying irrational prices for deals that were driven by cheap credit.”
Recent remarks from retailers reflect a subdued posture toward dealmaking. While they reported no shortage of potential supermarket sellers, they said asking prices have generally been too high. Consolidation, they argued, is a long-term process they would participate in over time.
“Consolidation is a funny thing. It takes a lot of years,” David Dillon, Kroger's chief executive officer, said in a conference call earlier this month. “And in most industries we've watched, it's not just a linear movement; it's some starts and stops and some diversions and so forth. But I think it's generally continuing.”
In the most recent wave of retail acquisitions, led by financial investors, the quality of the asset was occasionally a secondary consideration. These investors bought with primary intentions of lucrative turnarounds and flips, as real estate plays, or as cash-generation vehicles for investment portfolios.
This buying — which drove up prices — was fueled by easy access to borrowed money, sources said. But that abruptly evaporated last summer in the wake of the subprime mortgage crisis.
“I wouldn't expect any private equity deals, especially big ones,” Andrew Wolf, an analyst for BB&T Capital Markets, Richmond, Va., told SN.
“Financing is hard to come by and synergies nearly nonexistent” for financial buyers, added Karen Short, an analyst for Friedman Billings Ramsey, New York.
Analysts said that large companies are better prepared to weather rough economic conditions due to their size, pricing power and ability to profit on forward buying during inflationary periods.
“Those [supermarket companies] who are bleeding cash are going to have a lot of trouble,” Wolf predicted. “But a company like Kroger is probably better positioned. Their cash flow is much more secure, so in a tight credit market, they are probably advantaged.”
Whether Kroger will have an appetite for weaker competitors remains to be seen, although the company has shown little reluctance to buy up certain struggling competitors in existing markets, as evidenced by its purchase of several Farmer Jack stores in Detroit last year.
But much still comes down to price, said Short, emphasizing that while all deals should be looked at on a case-by-case basis, taking into account market share, competition and other factors, asking prices have generally been too high.
“There's been a disconnect between what sellers are asking for and what a buyer's willing to pay,” said Short. “Food retailers' multiples [share price expressed as a multiple of EBITDA] have all gone down, so making an accretive acquisition on top of that is difficult. If you're only trading at 5.5 times EBITDA, you're clearly not going to be paying 10 times, for example. My sense is, you've still got sellers that think they can get multiples that just aren't reasonable given what's happened in this industry.”
Burt P. Flickinger III, managing partner, Strategic Resources Group, New York, predicted more mergers once the credit crisis passes.
“The last time there was tremendous food and fuel inflation, it triggered a massive wave of mergers and acquisitions in the food retail business because of the tremendous cash flow coming from food retail and the tremendous profits from making money on inventories,” Flickinger told SN.