A&P, Pathmark Discuss Long-Awaited Merger

JON SPRINGER

MONTVALE, N.J. — A&P here last week said it was in negotiations to purchase Pathmark in a $1.27 billion deal that observers said could unleash millions in cost savings and create market leadership positions in the fragmented New York-to-Philadelphia corridor.

The merger, the companies said, was not complete and would be subject to several conditions, including federal and state antitrust reviews. Each company issued a press release confirming the negotiations after regulators halted trading of their stocks last Tuesday, citing high volume, and in the case of A&P, significant gains while the overall markets were plummeting. Deal speculation reached a frenzy after Pathmark officials canceled a scheduled presentation at an investor conference.

That the companies confirmed a price — $12.50 a share for Pathmark to be paid in cash and stock — convinced many observers a deal was imminent and only details remained. Including the assumption of $618 million in Pathmark debt, the merger values Pathmark at $1.27 billion, or around 9.7 times Pathmark's estimated annual EBITDA of $130 million.

Market observers had been anticipating a merger of the longtime rivals since 2005, when A&P sold its Canadian assets and Pathmark received new investment from Yucaipa Cos., each citing greater scale — and a subsequent return to profitable operations — as a goal. Both companies have since embarked upon strategies to improve their respective operations but which, analysts said, clearly require cost relief and greater scale to be successful.

“This deal has the potential to put A&P into the black for the first time in anyone's memory,” one analyst, who asked not to be identified, told SN.

Analysts said the combination could create synergies of more than $100 million annually, ranging from the paring of duplicate infrastructures to savings on items like advertising, product buying and labor. They also expect at least some store divestitures as the result of antitrust review.

The success of the combination beyond cost savings lies in successful integration of the retailers' respective strengths, observers said. At best, they envision a company with multiple store formats fine-tuned to area demographics and a broad expertise in fresh foods, pharmacy and nonfood. At worst, they see a combination of struggling retailers with disparate skills amounting to more struggles, heavy capital demands and inconsistent execution.

The stock-and-cash nature of the deal indicates that Yucaipa Cos. could maintain an ownership position in the combined companies, giving Ron Burkle's Los Angeles-based group the opportunity to continue participating in an East Coast grocery roll-up, if that remains its goal. Yucaipa purchased 20 million shares of Pathmark two years ago at $7.50 per share, and was granted three- and 10-year warrants to purchase additional 10% stakes at $8.50 and $15 a share, respectively. At the time, Burkle told SN the investment could lead to additional acquisitions.

Analysts estimated regulators would require the companies to shed 25-35 stores to meet antitrust concerns. One observer told SN he expected competitors would fund community groups opposing the merger.

Burt P. Flickinger III, managing director of Strategic Resource Group, New York, told SN that antitrust is a critical area with the potential to scuttle the deal, noting that concerns over forced divestitures unraveled a proposed combination of Ahold and Pathmark in 1999. “The FTC tends to look at past history, and the Ahold deal resulted in smaller market shares than this deal would,” he said.

John Heinbockel, an analyst with Goldman Sachs, New York, in a research note said he would “caution against optimism” regarding the deal, citing risks in banner changes, systems conversions and “a much-needed, stepped-up capital program.”

Multi-Format Approach

MONTVALE, N.J. — The question is no longer if Pathmark and A&P get together, but how.

Some observers pictured the two companies fitting smoothly together as a multi-banner, multi-format operator, with each company providing strengths the other lacks. Others were pessimistic, predicting the combination could be unwieldy and complicated, and might fail to address some fundamental issues.

Karen Short, an analyst with Friedman Billings Ramsey, New York, called A&P and Pathmark “a perfect fit.” She envisions A&P operating upscale, neighborhood-focused stores primarily in suburban settings, with Pathmark providing a high-volume banner for the middle-market and price-conscious shopper, typically in more dense markets and in cities.

“I think it makes a pretty powerful combination because you need two formats to survive today,” Short told SN. “In general terms, you could have A&P migrating to running a neighborhood fresh offering for the higher-income customer and Pathmark, which has great brand equity with the middle-class customer, running stores for that demographic.”

The actual decisions on which formats the company would operate — and which to divest, should it have a say in that matter — would be made on a store-by-store basis, Short said.

While Pathmark runs stores only under its namesake banner, A&P operates under several regional brand names but has moved to common formats for each.

Observers said they expect the various brand names — particularly Pathmark — will endure.

“People have known both of these companies for decades, so I don't see either name going away,” Matthew Casey, president of Clark, N.J.-based real estate firm Matthew P. Casey & Associates, told SN.

Casey, however, said he was not optimistic over the prospects for a combined company, saying that better scale and buying power would not address fundamental flaws plaguing the retailers over the years. A&P, in particular, suffers from poor price perception, leading to its low sales volume, he said.

“This reminds me of the Rickel and Channel home improvement chains that merged. It bought them a few more years of existence, but competition from Home Depot and Lowe's eventually buried them,” Casey said.

In some cases, analysts said, they could see Pathmark stores receiving the same “fresh” makeovers A&P has instituted among its banners, while A&P locations could stand to benefit from Pathmark's strength in pharmacy and HBC. Pathmark has identified a need to drive better performance out of perimeter departments, but is only now implementing programs to do so, sources said. A&P, by contrast, is more settled into its fresh format renovation program, saying it planned for all stores in the chain to eventually receive fresh or discount makeovers.

“This is not a case where one company has a clearly superior operating model, and will impose its model on the other,” said Neil Stern, senior partner with McMillan Doolittle, Chicago. “It can get a little tricky in this case, because there are things that both companies do well and don't do so well. They have to find the best combination.”
— J.S.