Local Attraction

MARK HAMSTRA

Many companies probably would like to be able to say they grew their business by 40% in 2010.

Thanks to a timely and opportunistic merger with a nearby rival, Tops Friendly Markets can make that claim.

From its headquarters in Williamsville, N.Y., Tops was able to acquire most of what was left of the long-struggling Penn Traffic chain out of bankruptcy, and has since been busy converting the stores to Tops' own operating paradigm, which emphasizes strong promotions, variety of selection and local merchandising.

The deal could turn out to be a textbook example of a synergistic acquisition. Tops, with 71 stores concentrated mostly in western New York, and Penn Traffic, with 79 stores located mostly in central New York, had been seen as an ideal match for some time.

“Penn Traffic was a perfect fit for us,” said Frank Curci, president and chief executive officer of Tops Markets, in an interview with SN at the company's newest store this month. “It was a good geographic fit; they are supplied by C&S [Wholesale Grocers], as we are; we are both union; and they had been undermanaged.”

Syracuse, N.Y.-based Penn Traffic, which was going through its third bankruptcy, had become a ghost of its former self. Battered by the perennially weak economy in much of upstate New York, and rudderless with a revolving door in the management ranks, Penn Traffic was bobbing like a shipwreck on the ocean when Tops swept in to rescue the remains of the retail assets for $85 million.

Ten months later, after Tops closed several locations and sold a handful of stores it did not want to Price Chopper and Giant Eagle, it has refurbished and converted to the Tops banner 48 of the 55 stores it retained. Tops is continuing to operate the remaining seven stores under their previous banners while they are undergoing an antirust review with the Federal Trade Commission. The FTC previously had ordered that the stores be sold, and is currently reviewing public comment on the order.

The deal to acquire Penn Traffic capped nearly a decade during which the two chains flirted back and forth but never were able to consummate a merger. Penn Traffic's third bankruptcy presented Tops with the ideal situation to finally pull the trigger.

“We knew no one else wanted to buy the whole chain,” said Curci, who noted that Tops' owners were “very supportive” of the idea of assimilating Penn Traffic's network of stores, which operated under the P&C, Quality Markets and BiLo banners.

“They were very anxious for us to grow and make an acquisition,” he said.

Tops' current owners — private investors led by Morgan Stanley Private Equity — had eyed Penn Traffic once before, when they bought Tops from Ahold in 2007, and Tops had also eyed a potential merger in 2001, while it was still part of Ahold. When Ahold put Tops up for sale in 2006, Penn Traffic was among the companies that looked at buying it, although it was not able to secure the financing.

At the time of its acquisition by Morgan Stanley, Tops was faced with the prospect of spending a year rebuilding its IT systems and other infrastructure after Ahold had migrated most of Tops' support functions to its then-sister chain, Giant of Carlisle, Pa.

“In the beginning, we had looked at buying them with the express idea that they would jump-start our infrastructure,” Curci explained.

As the investors examined Penn Traffic more closely, however, they decided to take a pass.

“We looked at them and thought this was a company that was going to go bankrupt sooner or later,” Curci explained. “And we decided there were parts of the company we didn't want. We didn't want their warehouse, and we thought we could build a more modern IT system.

“So, when they declared bankruptcy a year ago, we were ready,” he said. “We knew the stores, we knew the people, and now, with them in bankruptcy, we didn't have to take the warehouse, we didn't have to take the office, we could renegotiate all of their leases, we didn't have to take the stores that didn't make sense, and we didn't have to take their union contract, because ours was better. All the bad parts of Penn Traffic were cleansed away through the bankruptcy. It was the perfect way for us to buy it.”

Now Tops is in the process of taking the operating philosophy and systems that make its stores successful in the Buffalo, N.Y., market, and apply them to the acquired Penn Traffic locations.

That philosophy was sharpened through the company's release from Ahold, when Tops basically rebuilt itself as a freestanding operator and strengthened its position as a locally oriented food retailer in touch with its western New York customers.

Wegmans and Wal-Mart

While many operators might not enjoy having as their primary competitors Wegmans Food Markets and Wal-Mart Stores, Curci sees those two titans of food retailing as leaving the competitive field wide open for an operator that can provide all the amenities the larger rivals do not.

“Our thesis when we purchased this chain [from Ahold] was that we could do a better job from a local standpoint,” Curci said. “We believe the best supermarkets are locally run, and we've found that to be true.”

By focusing on being a traditional high-low supermarket operator with broad variety and convenient locations, Tops sees itself continuing to grow in its marketing areas through both new locations and by driving sales and traffic at the acquired Penn Traffic stores.

“In western New York, people love their traditions, and people love their food,” Curci said. “We felt we could serve that need better, and we think we have.”

The region, he explained, “is a very stable marketplace.”

“Wegmans and Wal-Mart are both very well-defined and very good at what they do,” Curci said. “We knew our place in the market was to be different from those two.”

One of the key ways Tops seeks to differentiate itself is through its promotional positioning as a high-low operator.

“People in western New York love a deal,” he said, citing a list of promotional strategies the company uses — including 10 for $10, five for $10, buy-one, get-one free offers, and others. “We have sharpened that a lot as part of our stewardship of this business.”

When Tops was part of Ahold, he explained, the chain was much less promotional.

In addition to its promotional stance, Curci sees other advantages Tops can leverage, including the format flexibility it has that allows it to operate in smaller markets that neither Wal-Mart nor Wegmans would be interested in.

“We try to fit the store to the neighborhood,” Curci explained, noting that Tops now has stores ranging from 10,000 square feet up to 100,000 square feet and more. “We have more variety in store size than our competitors.”

With the acquisition of Penn Traffic, Tops picked up several smaller sites and some expertise in running such locations.

The average size of a classic Tops store was about 60,000 square feet, vs. the 30,000- to 32,000-square-foot average of the Penn Traffic locations.

“We can fit in places where others cannot,” he said. “Convenience plays a big role for us.”

That is especially important in upstate New York, he said, where frequent winter snowstorms tend to keep drivers close to home.

Outside the network of stores acquired in the Penn Traffic acquisition, Tops' newest location is a 38,000-square-foot store in Spencerport, N.Y., that incorporates many of the elements of Tops' market-specific strategy.

“We think there are opportunities like this across our marketplace where we can build stores where Wal-Mart won't go, and where Wegmans won't go,” Curci said.

Product variety is another aspect of Tops' offering that Curci said helps differentiate the banner from its rivals. While Tops features a range of private-label products sourced through its Topco membership, it also seeks to emphasize a broad selection of branded product, and especially local favorites.

Even in the Spencerport location, which is about 20,000 square feet smaller than the average Tops prototype, the company has managed to fit in most of its traditional product selection.

Tops also has two exclusive partnerships with local suppliers — Buffalo chicken wings from the Anchor Bar, the local establishment known for the invention of the spicy recipe, and Tim Hortons, the Canadian coffee and doughnut shop that is ubiquitous in the Buffalo market.

In fact, Tops now has a hot coffee program from Tim Hortons — named after a hockey star — in all of its locations. In many of the stores, it also has a more extensive Tim Hortons offering that includes baked goods and a seating area.

Curci said Tops previously had a more generic coffee program, but with Tim Hortons, the chain is seeking to do “something that was meaningful to our customer base,” he explained.

Both Tim Hortons and the Anchor Bar products are part of a competitive prepared-food set that also emphasizes other local favorites, including store-made pizza, and an EDLP program in rotisserie chicken.

“Western New York loves pizza,” Curci noted.

Tops has been seeking to capitalize on that and make itself the destination of choice for pizza in the region by grouping all its pizzas — hot, take-and-bake and frozen — together in its ad fliers.

Altogether, the prepared foods and the deli account for about 5% of total sales at Tops.

Tops also emphasizes its service meat department as a distinguishing element, with its “Real meat, real butchers” promotional campaign and through displays of store-cut offerings in the meat cases. The campaign also helps distinguish Tops from its primary competitors in the market.

Gasoline is another point of differentiation for Tops, which operates 36 fuel stations on store parking lots and offers a discount program connecting fuel and groceries. Customers can accumulate 10 cents off per gallon for every $100 spent in stores for a six-week period.

“People like to accumulate them, and then get free gas,” Curci pointed out, noting that some customers spend as much as $3,000 during the time period to earn $3 off per gallon. “It's a big part of our value creation. Stores that have gas stations get more sales increases as more and more people participate.”

Although Wal-Mart offers gas at many of its supercenters and discount stores around the country, it has only a handful of such sites in upstate New York, Curci noted. Wegmans does not offer gas at all.

Wal-Mart is a growing competitor for groceries in the region, however. The company opened six supercenters in Tops' marketing area in the past year, although Curci noted that overall the impact was minimal.

“They certainly capture some customers, but we have had a positive customer count and positive market share growth, all while Wal-Mart is throwing its best punch at us,” he said.

Wegmans, by contrast, has not been expanding in Tops' market area for several years.

Integration

Tops has tackled the conversion of the Penn Traffic stores systematically, beginning with a group of 15 stores in western New York, where the Tops brand is strongest, before moving into the Syracuse market, where Penn Traffic's P&C banner was dominant.

John Persons, senior vice president, operations, said one of the first things Tops did when it acquired the stores was restock the shelves, which had been depleted during Penn Traffic's bankruptcy.

In many of the locations, service meat and seafood departments had been eliminated, but Tops reinstalled them. In addition, Tops installed its “Wall of Values” at the acquired stores, where aggressive product deals and promotions are displayed near the entrance to the stores.

“Once we decided what we were going to keep, we did a resetting, where we took out product that didn't make sense any more, and brought in new product, added some more variety in grocery and produce, and kept all the items that were important to their customers,” Persons explained.

Through a coordinated effort across the organization, Tops was able to stage the first set of grand reopenings by Memorial Day, just four months after the acquisition, and the second set in the Syracuse market a little more than two months after that, around Labor Day. The last group of eight conversions was completed earlier this month.

New TV and print ads featuring Curci as the spokesman for the chain have helped introduce the new Tops stores to the market.

In addition, Tops formed a marketing partnership with Syracuse University athletics, and is even transforming a store near the school to cater specifically to the community. Tops has similar partnerships with other athletic teams in Buffalo, and also is active with local food banks and women's and children's charities across its marketing areas.

The fact that both Tops and Penn Traffic were customers of Keene, N.H.-based C&S Wholesale Grocers also made the transition easier, Curci explained. Tops has had a supply agreement with C&S since its Ahold days, although because of the way the contract was structured, Tops retained ownership of its warehouse, an 900,000-square-foot depot in Lancaster, N.Y.

Since the acquisition, former Penn Traffic stores that have been rebannered have seen 10% to 15% increases in sales volumes, Curci said.

“It's been a great integration, and customers are reacting well,” he said. “They see a store that looks better, with better merchandise, is better stocked, and has happier people working there.”

In January the acquired stores will begin bolstering the same-store sales figures for Tops, which earlier this year began filing some financial information with the Securities and Exchange Commission in connection with a debt offering the company executed.

The filing showed that Tops was generating average weekly sales of about $416,527 in the first quarter of this year, with Penn Traffic's acquired stores included. Same-store sales were down 0.7% in the period, excluding gas.

Tops had total sales in 2009 of about $1.7 billion, and projects that total to be about $2.5 billion in 2010.

In addition to rolling out the Tops programs into the acquired stores, Tops also looked to see what programs Penn Traffic had that had been successful, and has even begun adopting some of them into the original Tops locations.

“We took a little time to find out what was unique about the things they offered, and there were some things they did really well,” Persons explained, citing as examples an in-store fried doughnut program, which Penn Traffic had in several locations. Tops has since added in-store doughnut making to five of its stores, and the company plans to roll it out to additional locations as well.

Other products from Penn Traffic's baking program also were adopted, he said, including some specialty items and holiday offerings.

“Penn Traffic had a more mature service-bakery program than we did,” Persons said, although Tops also has an extensive bakery offering.

In addition, Penn Traffic also had a seafood salad that was very popular among its customers, and that has been brought into the Tops stores, where Persons said it is expected to generate strong sales.

Persons praised the enthusiasm and professionalism of the workers in the acquired stores for helping accelerate the transition. About 3,000 workers joined Tops as part of the acquisition.

“Originally when we took over this company, we thought it was going to take a year and a half to rebrand and remerchandise these stores,” Persons said. “But what we found was that the people who were in the stores were fantastic. They had more capabilities than we originally anticipated, and they were very excited to be part of our organization.

“The reason we were able to crunch that timeline down, and convert 48 stores and bring 55 stores online was the capability of the people in those stores. Even though they had been through a lot at Penn Traffic, they were willing to go the extra mile with us.”

Tops had decided from the start that it would seek to keep the store managers in place through the acquisition, although it has since made some changes.

In addition, the company brought some veteran Tops managers into the Penn Traffic marketing areas, mostly so they could help teach the managers in the acquired stores how Tops operates.

Tops opened a Syracuse office, which supports that market, overseen by Mike Patti, regional vice president. The district managers there are veterans of the Penn Traffic organization, Persons said.

“All the key elements to run an operation, we have still residing in Syracuse,” Persons said. “A lesson we learned from being a part of Ahold was that we wanted to make sure we had a presence in the market.”

Persons said Tops has been bringing the new personnel up to speed through the formalized training program at Tops, called the Tops School of Business. The program, in partnership with local universities, teaches a range of management skills needed for operating a food retailing location and more.

“We are always in the mode of identifying key people within the organization for growth,” he said, noting that Tops is also sponsoring some key employees through MBA programs.

Overall, Curci said Tops has developed a diverse executive team that includes individuals with Tops experience and some from outside the organization.

Curci himself had been president and CEO of Tops from 2000 to 2003, when he left after Ahold's accounting scandal there. He previously had held financial and operating positions with Edwards and Bi-Lo. He returned to Tops in 2007 as a minority investor in the chain as part of the buyout from Ahold.

As Tops redeveloped its executive team in the wake of the Ahold sale, it has brought in several executives who were veterans of other chains, including Giant Eagle, Meijer, Pathmark and Weis Markets, to work alongside longtime veterans like Persons, with 26 years of experience, and Jack Barrett, senior vice president of human resources, with 40 years at Tops.

“The thing I like about our team is that we are all passionate about the business,” Curci said. “To work in this industry you have to love food, and you have to love people.”

Tops has been an attractive destination for executives, he said, because of its independence as a freestanding company that is not part of a larger conglomerate and its entrepreneurial approach to rebuilding the company from scratch after its sale by Ahold.

Now Tops is heading toward what could be an eventual public offering of stock as Morgan Stanley some day seeks to monetize its investment.

“We think the most likely way for Morgan Stanley to exit is through the public equity markets,” Curci said. “There is nothing definitive, and nothing set in concrete, but they would at some point like to cash out of their position, and that could be through an IPO, or it could be through refinancing, or private equity, or it could be something else.”

In the near term, however, Curci said Morgan Stanley has been “thrilled” with the investment.

“We have built a lot of value for them,” he said, “and they know we still have a lot of growth ahead of us. There's a lot of sales we can get from those Penn Traffic stores, and they want us to grow even more than we are today. They are not in any hurry to get out, because we are becoming more valuable every day.”