Whole Foods Sells Equity Stake as Sales Slow

ELLIOT ZWIEBACH

AUSTIN, Texas — Whole Foods Market said last week it sold a 17% equity interest in the company to an investment group “to have adequate liquidity for whatever comes down the pike” — a decision challenged by one participant during a conference call.

“We are in very uncertain economic times, and we're not certain what will happen,” John Mackey, chairman and chief executive officer of Whole Foods, told analysts last week during a call to discuss financial results for the fiscal year and fourth quarter, which ended Sept. 28.

He said the chain raised $425 million from the sale of Series A preferred stock to Green Equity Investors V, a limited partnership affiliated with Leonard Green & Partners, Los Angeles — a deal that equates to an ownership interest of 17% if the preferred stock were converted to common stock.

Mackey said the money would be used to manage the 66 stores in Whole Foods' development pipeline over the next four years and to pay down debt.

One investor challenged that move, noting that Whole Foods has sufficient cash flow to cover its needs. “I can't figure out why you would dilute shareholder value by [close to] 20%, given that you have plenty of cash flow to repurchase shares — though I would never encourage you to do that unless the valuation was so extreme.”

When asked why the company hadn't opted instead to slow its growth rather than give up so much equity, Mackey replied, “We had strong internal debates among the management team and the board of directors about that, and we chose to be as prudent as possible, given the uncertain financial conditions we face.

“Right now Whole Foods is very undervalued, trading at three to four times EBITDA, but that's a temporary phenomenon,” he added. “In terms of buying back stock right now, it's a good suggestion, and I urge you to write to the board sharing your perspective with them.”

Asked what it would take for Whole Foods to stop growing, Mackey said, “We would stop putting up stores if they were not going to be profitable.”

Karen Short, New York-based analyst for FBR Capital Markets, Arlington, Va., said she disagrees with Whole Foods' ongoing new-store development strategy.

“We believe the company should cease opening new stores, given the state of the balance sheet, declining performance and the weak economy,” she said in a report.

The equity investment was “a necessary lifeline because liquidity was tight, but was consistent with management's recent disregard for the shareholder,” she noted. “The investment is dilutive and only acts to facilitate and encourage a continuation of unprofitable growth.”

Net income for the 12-week fourth quarter, adjusted for an extra week a year ago, fell more than 95% to $1.5 million, which the company said included a negative impact from Wild Oats of approximately $25.4 million, including charges for idle properties and asset impairments, plus an increase in the store closure reserve for 40 shuttered Wild Oats units; repatriation of cash from its Canadian subsidiary; lease terminations; and legal costs.

Sales rose 2.6% to $1.8 billion, while comparable-store sales increased 0.4%. Identical-store sales declined 0.5%. Comp and ID sales from the Wild Oats stores that Whole Foods acquired a year ago were included for the last four weeks of the quarter.

Mackey said ID sales in every region decelerated during the quarter, due in part to cannibalization, with “markets that have seen the sharpest real estate downturns, such as Southern California, Las Vegas, Phoenix and Florida, seeing the greatest negative impact.”

“The unrelenting negative economic news appears to be shifting buyer behavior,” he said, noting that Whole Foods' transaction counts were down approximately 1.5% during the quarter, but basket size increased about 2%.

For the year, net income fell 37.3% to $114.5 million, while sales rose 20.7% to $8 billion. The company did not release comps or IDs for the year.

For the first five weeks of the first quarter, through Nov. 2, comps fell 2.1% and ID sales fell 3.3%. Mackey said sales will be going up against tough comparisons in the first half of the fiscal year but should recover against weaker comparisons during the second half.

Whole Foods expects to invest $400 million to $450 million in capital expenditures this year, encompassing 15 stores, four of which have already opened, with one more due in the fourth quarter, four due in the second, and six in the second half of the year.