ALBERTSONS PURCHASING NEW ENGLAND PRESENCE 2004-04-05 (1)

ELLIOT ZWIEBACH

BOISE, Idaho -- The pending acquisition of Shaw's Supermarkets and Star Markets by Albertsons here will expand the chain's national footprint into New England, although financing the deal could create a drain on the chain's resources, industry analysts told SN last week.

The deal could also lay the groundwork for further acquisitions by Albertsons in the Northeast, possibly encompassing Pathmark Stores, analysts said -- a development that could bring Delhaize or Kroger Co. into the picture in a possible bidding war for Pathmark, they pointed out.

Albertsons announced a definitive agreement 10 days ago to acquire Shaw's and Star Markets' 202 stores from J Sainsbury, London, for just under $2.5 billion -- a cost of approximately $12.3 million per store.

The deal, which is expected to close before the end of July, will boost Albertsons' store count to a total of about 2,500 stores and add Shaw's $4.6 billion in sales to its total volume, boosting annual volume close to $41 billion -- still No. 2 behind conventional leader Kroger's $53.8 billion.

Analysts said Sainsbury's decision to sell its U.S. holdings apparently came about very quickly following a change in top management at the London-based company -- "probably in less than a month, because Sainsbury was a very motivated seller," Gary Giblen, senior vice president and director of research for C L King Associates, New York, told SN.

"Until recently, Sainsbury had been very vocal about how it planned to aggressively expand Shaw's and use it as a growth engine for the company," Giblen said. "Apparently, though, the company's turnaround in the United Kingdom was faltering -- with Wal-Mart coming into its own, Wm. Morrison buying Safeway and Tesco continuing to be strong -- and Sainsbury's new CEO was under pressure to focus the company's financial and management resources there."

Edouard Aubin, an analyst with Deutsche Bank Securities, New York, offered a similar assessment. "Albertsons paid a minimal acquisition premium, considering Shaw's profitability, market position and quality of management. This was made possible because Albertsons was likely one of the only bidders, and Sainsbury, facing a price war in the U.K., was desperate to shed the assets."

Sainsbury said it would return about one-third of the proceeds from the sale to shareholders and use the rest to develop its core retail business in the U.K.

According to Giblen, there had been widespread speculation that Sainsbury might eventually try to acquire Pathmark, "so there's now some logic to speculation that Albertsons might go after Pathmark at some point to fill the gap in its Northeast geography between [its Acme stores in] Philadelphia and New England."

The pending deal would move Albertsons into all six New England states -- Massachusetts, Connecticut, Maine, Vermont, New Hampshire and Rhode Island.

Analysts told SN they don't expect the deal to have much impact on competition in New England.

"Industry consolidation is generally a positive in mature industries," Mark Wiltamuth, an analyst with Morgan Stanley, New York, explained, "but because Albertsons does not have a presence near the New England market, we do not expect this deal to significantly alter the cost structure or local market competitive positioning for either Shaw's or Albertsons."

The lack of an Albertsons' presence near New England also means the deal is unlikely to result in significant cost-savings synergies, Wiltamuth added. "Accordingly, aside from some opportunities for management consolidation, we expect much of the Shaw's distribution infrastructure to remain in place," he said.

Giblen said he believes Albertsons can learn a lot from Shaw's about private label -- given the strong emphasis on private label emanating from Sainsbury -- loyalty card expertise, urban stores and tailored marketing, with its strong focus on prepared foods geared to different ethnic mixes.

Mark Husson, an analyst with Merrill Lynch, New York, said he doesn't see the potential for a lot of synergies for Albertsons, "except for some reverse synergies from Shaw's, such as strong fresh execution and strong private brand."

Aubin also said he sees minimal synergies, "given that Shaw's is geographically distinct from Albertsons' operations and that Albertsons will not be in a position to leverage its supply chain." Shaw's currently buys groceries from C&S Wholesale Grocers, Brattleboro, Vt.

In addition, Aubin said procurement synergies are likely to be minimal, given Albertsons' lack of centralized procurement, with less than 50% of national brands purchased on a national basis by Albertsons, compared with over 75% at both Kroger and Safeway.

However, Albertsons should benefit simply from operating in New England, Aubin said, "[because it is] one of the most benign competitive environments in the U.S.," due to a high degree of financial leverage by the parent companies of Shaw's two primary competitors -- Ahold, which owns Stop & Shop, and Delhaize, which owns Hannaford Bros. -- and a limited Wal-Mart Stores supercenter presence there.

The peak earnings potential for Albertsons may be short-lived, Aubin added, as the competitive environment "should only intensify in the coming years."

Wiltamuth also said the presence of only 21 Wal-Mart supercenters in New England will afford some competitive advantages for Albertsons-owned Shaw's. "While we expect Wal-Mart to eventually work its way up the I-95 corridor and possibly [construct] a Maine distribution center, these markets are not feeling much Wal-Mart pressure for now, and we believe Shaw's offers strategic real estate in a high-cost real-estate market," Wiltamuth said.

Giblen said it will be hard for Wal-Mart to find supercenter sites in most of the areas in which Shaw's is strong, "particularly in downtown Boston and its close-in suburbs, where Star locations operate on real estate that's pretty much protected from new entries."

Some analysts expressed their most negative concerns about the pending deal in regard to the financing arrangements, which they said could leave Albertsons with an equity overhang.

Albertsons said it plans to finance the acquisition through a combination of cash, debt, stock and assumed capital leases. Eliminating $368 million in capital leases it is assuming from Shaw's and applying the $289 million in cash Albertsons had at the end of the fourth quarter, the company will have to finance up to $1.86 billion, analysts pointed out.

"Shaw's is a positive step for Albertsons strategically, but the financing aspect of the deal presents some risk for equity investors," Wiltamuth said. "With thin free-cash flow after dividends for Albertsons in 2004 and 2005, this could push the company more towards a greater proportion of equity financing.

"Assuming 25% equity financing, Albertsons will need to secure $1.37 billion in debt financing and may need to issue up to 21 million shares, which will add 5.6% to Albertsons' share count."

Husson also expressed concerns about the financial process, "but Albertsons would not be doing this deal if it meant sacrificing the dividend [it pays]," he said.

Giblen said he agreed Albertsons will "for some time be hard-pressed to manage and finance Shaw's while also effecting the significant turnaround needed at its core stores." However, despite his previous skepticism about Albertsons, Giblen said Wall Street may be reacting too negatively. Shaw's has been the most successful food retailer among publicly held companies in the U.S., he pointed out, with comps approaching 1% last year and 3% in 2002, "and I think Albertsons' ability to acquire it is a very visionary move that will pay off in the long run."

After experiencing a 20-week strike in Southern California, Albertsons should find significant labor relief in the New England market, analysts told SN.

According to Aubin, Albertsons should experience lower labor costs at Shaw's, given that Stop & Shop signed "a fairly unfavorable contract" with the United Food and Commercial Workers Union in mid-February "[under which] workers will not have to share the burden of rising health care costs over the next three years," while Shaw's employees share medical costs with the employer.

According to Wiltamuth, only 30% of Shaw's 30,000 employees are unionized, "which effectively reduces Albertsons' risk of encountering a disruptive labor dispute, and it also should give the company more flexibility in reacting to competitive pressure from club stores and eventually Wal-Mart."

Shaw's already signed new labor agreements earlier this year in Connecticut and parts of Massachusetts, with another agreement in Massachusetts and Rhode Island due to expire in July.

Shaw's Acquisition a Perfect Fit

BOISE, Idaho -- Shaw's Supermarkets apparently fits Albertsons to a T.

According to Larry Johnston, chairman, president and chief executive officer of Albertsons, his company spent the last few weeks scrutinizing Shaw's on several counts -- business results, strength in its markets, return on invested capital, best practices, pricing, promotional planning, neighborhood marketing, shrink control, energy management and cultural fit -- "and Shaw's passed with flying colors."

"The quality of Shaw's stores, the talent of its leadership team, the skills and energy of its associates and its customer satisfaction ratings have impressed us," Johnston said.

Paul Gannon, president and CEO of Shaw's, said the pending acquisition "is a win-win for both companies. We believe this exciting new relationship with Albertsons will be beneficial for both companies and allow Shaw's to retain its leadership position in the New England marketplace. Our customers, associates and vendors should be assured we are working toward a seamless transition."

He said the two companies "appear to have a similar approach to how we run the business in terms of excellent customer service and best practices, and we're pleased to join the Albertsons family of stores."

Albertsons said it plans to retain the Shaw's and Star Markets banners on the stores. "Shaw's is an excellent company that we believe will get stronger. We're not going to try to fix something that isn't broken," Johnston said.

"Our goal will be to provide support and resources to the Shaw's leadership team so they can continue to accelerate the company's record of growth. Given our procurement strength, produce expertise and corporate brands, we think we can help them strengthen their operations."

Johnston said Albertsons does not anticipate any regulatory concerns over the pending deal, "and we have no plans currently to close any Shaw's stores."

He said the chain's offices in West Bridgewater, Mass., will remain open. As for possible layoffs, Johnston declined to comment, saying speculation about job cutbacks "is simply that -- speculation."

Johnston said the acquisition is expected to be accretive to Albertsons 2004 earnings guidance of $1.30 to $1.40 per share. He promised more specific guidance "on the positive impact" on earnings once the deal has closed, he added.

Albertsons said it has assigned Larry Wahlstrom, a 33-year company veteran, to lead an integration team composed of personnel from both companies. Wahlstrom spent 16 years heading Albertsons' Osco drug store operations in New England; when those 80 stores were sold in early 2002, Wahlstrom moved to Florida to head Albertsons' division there, and when the Florida operation was folded into a new Eastern division in February, Wahlstrom was named special assistant to Johnston for special projects.