Conditions Ripe for More Mergers and Acquisitions

ELLIOT ZWIEBACH

For supermarket retailers considering buying or selling stores, the time to strike may be now, according to industry observers.

“If a company is losing shareholder value every day — because its competitive position, capital structure and EBITDA are all deteriorating — it should consider selling before the situation gets any worse,” Scott Moses, managing director for Sagent Advisors, a New York-based boutique investment banking firm, told SN.

“Some companies may get a reprieve from the improved credit market, where larger transactions are available today at lower interest rates and with a higher probability of success. Unfortunately, there will inevitably be others who will not be so fortunate,” he explained.

“Perhaps the most important evaluation senior managements and their advisors should make — whether they are buyers or sellers — is a realistic assessment of whether they are going to grow shareholder value or watch it deteriorate further.”

Moses, who oversees food, drug and specialty retail investment banking for Sagent, served as financial advisor to Sprouts Farmers Market, Phoenix, in its pending merger with Henry's Farmers Market and also to Haggen Inc., Bellingham, Wash., in its pending acquisition by Comvest Group, West Palm Beach, Fla.

He also served as advisor to Pro's Ranch Markets, Ontario, Calif., in the 2010 sale of its four California stores to Vallarta Supermarkets, Sylmar, Calif.

“Given the continued challenges of a difficult economic backdrop — from high unemployment and under-employment to decreased discretionary income and a weak housing market, as well as the ever-strengthening non-union alternative formats that are constantly encroaching on grocery market share — there remains a wide spectrum of capacity among regional grocers to compete and generate shareholder value, particularly those with less scale and access to capital,” Moses added.

David Schoeder, principal at The Food Partners, a Washington D.C.-based investment banking firm, also said he believes the time is right for buyers and sellers to get together.

“The number of retail grocery acquisition opportunities continues to exceed the number of transactions consummated,” he said, “and with underperforming retailers deteriorating at an accelerating rate, this is a great time to make an acquisition, particularly given the economic climate,” he said.

“Valuation multiples are constant, and access to capital is excellent for strategic buyers with a track record, and the cost of debt capital is low, which has increased interest in locking in current rates to make acquisitions,” he noted. “In addition, pricing continues to improve as competition between banks increases, with absolute interest rates at a historic low.”

NO MEGA-MERGERS

Deborah Weinswig, an analyst with Citigroup Global Markets, said the era of mega-mergers is “in the distant past as there is a thinning pool of distressed supermarkets.”

“However, opportunities still exist for smaller acquisitions in strategic regions that will allow retailers with capital to service new markets.”

Those opportunities are enhanced by easing credit markets, which help facilitate deal-making, she said — noting that merger and acquisition activity increased 30% in the first half of 2010 after declining from 2008 to 2009.

According to Weinswig, Kroger Co., Cincinnati, is likely to continue to review potential acquisition candidates while maintaining its “tuck-in” strategy, which focuses on existing markets.

Most industry speculation for some sort of significant transaction involves Minneapolis-based Supervalu, Weinswig pointed out. If Supervalu were to be acquired by an investor, its significant debt load would probably force the buyer to sell off the company's most valuable assets — Save-A-Lot and the supply business — “so it could use the proceeds to pay down debt and put Supervalu in a better position to improve the operations of its traditional food retail business,” she noted.

To Schoeder, retailers generally fall into two groups — those who want to grow and those who want to exit “rather than go another round.”

“For companies that want to grow and remain viable, there's more recognition that the world is not going to get much better and that, just to stay even over the next 10 years, most will have to double their size,” he explained.

Strategic buyers are more focused on in-market acquisitions, while larger transactions involving regional players are generally on hold as buyers have adopted a “pick-of-the-litter” strategy, Schoeder noted.

He said he expects further consolidation among supermarket companies whose annual sales volumes exceed $1 billion, “as both buyers and sellers will be under pressure to eliminate duplicative overhead.

“That will mean acquisition opportunities for independents will continue as acquiring companies prune stores,” he said.

Supermarkets with annual sales between $300 million and $1 billion — the so-called “super independents” — are likely to continue to grow over the next decade “primarily through acquisitions that leverage both their brand and their niche,” Schoeder said.

Supermarkets with annual sales ranging from $150 million to $300 million will continue to grow “if they establish and maintain continuity of management and ownership,” he noted, “though family-owned companies that do not have succession plans in place will be at high risk for consolidation.”

Companies with sales below $150 million “will need to grow over the next 20 years or eliminate overhead by accessing a virtual chain like IGA or Piggly Wiggly,” Schoeder said. “These are the companies that will most likely need to double in size to maintain their competitive position,” he pointed out.

Schoeder's company, The Food Partners, has worked with Central Grocers, Joliet, Ill., on its 2008 merger with Central Grocers Midwest and its acquisition last year of Strack & Van Till; Associated Wholesalers Inc., Robesonia, Pa., on its 2006 merger with White Rose Food; and Safeway on its 2001 acquisition of Genuardi's.

PRIVATE EQUITY INTEREST

According to Moses, the private-equity community continues to be very interested in the grocery industry.

“Private equity interest in the food retail sector remains strong, given nearly a half-trillion dollars of ‘dry powder’ — available capital — and the improving credit market, plus the increasing supply of acquisition candidates,” he explained.

In contrast, strategic buyers “are being very cautious in making acquisitions, given the fragile economic environment,” he added. “As a result, they may not be as willing to pay quite as much or do transactions quite as large as private investors are or to utilize debt to the same degree.”

Moses said public companies are generally trading for multiples between 5 and 6.5 times EBITDA, “though multiples are lower for companies that have been under-performing,” he noted.

The vast majority of strategic acquisitions of conventional food retailers have occurred at transaction multiples in excess of 6 times EBITDA, he pointed out, while private equity transactions generally occur “at valuations below typical strategic transactions.“

Earlier in his career, when Moses was with JPMorgan, he served as financial adviser to Ahold USA in its sale of U.S. Foodservice and to A&P in its acquisition of Pathmark, both in 2007, and to the consortium that included Supervalu, CVS and Cerberus Capital Management in its 2006 buyout of Boise, Idaho-based Albertsons.