How Amazon Haunted Smart & Final

Frustrated by an inability to rekindle public market interest in its stock following a downturn that coincided with the Amazon-Whole Foods deal of 2017, Smart & Final Stores put itself up for sale last fall, the company revealed in a disclosure to federal securities administrators.

And though the ensuing auction drew responses from dozens of potential financial and strategic acquirers, interest in the business—particularly its namesake food stores—was less than officials had hoped at the outset of the process.

As previously reported, Smart & Final announced April 16 it had agreed to an offer from funds associated with Apollo Global Management to sell itself for $6.50 per share or $1.1 billion. According to a narrative of the merger background filed with the Securities and Exchange Commission, the retailer accepted Apollo’s offer over a competing bid launched jointly by an unnamed strategic buyer and a financial partner. That proposal would have landed the company’s Smart Foodservice restaurant-supply stores in the hands of the strategic buyer and its Smart & Final banner stores with the financial buyer.

Another proposal came from a financial buyer interested only in the foodservice division.

In all, Smart & Final and its advisers contacted 74 parties as part of the auction, with 38 entities signing confidentiality agreements, seven submitting preliminary proposals and four parties submitting final proposals.

In the end, the certainty of Apollo’s cash offer and the swiftness with which the transaction could be completed, helped the board to choose Apollo. That entity, which will take Smart & Final private, launched its tender offer last week.

Amazon was something of a specter in the Smart & Final story. Its merger with Whole Foods in 2017 triggered an industrywide reset of valuations for food retailers that scotched an early Apollo buyout offer in 2018, and concern about Amazon’s potential to bring increased competition to Smart & Final was among several “uncertainties” dogging its business ever since, the company said in a filing.

Smart & Final, based in Commerce, Calif., operates nonmembership warehouse stores under the Smart & Final and Smart & Final Extra banners, as well as a restaurant supply stores known as Smart Foodservice. Sources predicted earlier this year that Smart & Final’s unique formats and combination of assets would make finding a strategic buyer a difficult task.

Kenneth Tuchman, an independent Smart & Final director that was appointed chairman of a board committee to oversee the strategic alternatives process for Smart & Final last summer, said the committee recommended the Apollo offer considering macroeconomic risks in the market and the industry; uncertainty around new competition including Amazon and stubborn food inflation; and a stock market that had “persistently failed to reward the company’s uniqueness.”

Those factors led to softening growth at the company over the past years, Tuchman said.

The Apollo offer had a higher likelihood of consummation than the competing proposals, citing conditionality and timing factors associated with the joint offer. Shareholders of Smart & Final’s majority owner, Ares Capital Management, were also in favor of the Apollo offer, the filing noted.

For Apollo, the acquisition marks the second time it has acquired Smart & Final, having sold it to Ares in 2012.

According to the filing, Apollo approached Smart & Final’s CEO, Dave Hirz, about reinvesting in December 2017 but was rebuffed in early February 2018 in part because the company felt its share values were still feeling the aftereffects of the previous summer’s Amazon deal.

Its stock, however, continued to fall in the months that followed, prompting the board to begin strategic alternative proceedings at a board meeting on July 29.

As part of the process Smart & Final crafted a five-year plan of financial projections it shared with certain interested parties and scheduled “fireside chats” with Hirz.

The five-year plan contemplated companywide sales growing from $4.9 billion in fiscal 2019 to $6.1 billion by fiscal 2023 and adjusted EBITDA from $94 million to $273 million over same period. The company emphasized these projections “were based on numerous variables and assumptions that are inherently uncertain.”

Apollo is expected to split Smart & Final into separate companies. Its $6.50 per share offer represents a premium of approximately 25% over Smart & Final’s average closing share price over the 24 days preceding the announcement of the merger, and 19% over the closing price of $5.48 per share reported the day before.