KKR'S TASTE FOR FOOD

ELLIOT ZWIEBACH

NEW YORK -- With its pending acquisition of Bruno's, Birmingham, Ala., Kohlberg Kravis Roberts & Co. here continues to view the food industry as a strong investment.

Since 1981, KKR has invested $300 million worth of equity in the industry, beginning with Fred Meyer Inc., Portland, Ore., in 1981; Safeway, Oakland, Calif., in 1986, and Stop & Shop Cos., Boston, in 1988.

It expects to conclude its merger with Bruno's next month -- with an acquisition of 83% of Bruno's stock -- at a cost of $1.15 billion.

"What attracts us [to the industry] is the consistent cash flow and our own knowledge that's been built up over time," James H. Greene Jr., a general partner in KKR, told SN. "Our philosophy has always been to invest money in good deals and to try to maximize the rate of return." "We look at each deal on a single basis," added Paul Raether, another KKR general partner. "We look at the company as much as the industry." KKR initially owned 100% of each chain's stock but lowered its percentage as each went public. It maintains a 65% interest in Safeway, a 62.5% interest in Stop & Shop and a 38% share of Fred Meyer, where it has lowered its ownership through the chain's public offerings as well as through two offerings of its own. KKR's $300 million investment in the industry represents a very small portion of its total portfolio, Raether said -- less than 4% of the $8 billion-plus in equity investments KKR has made over the past 19 years. Observers told SN it's unlikely Bruno's will be KKR's last supermarket investment. "There's no reason to believe [KKR is] through investing in this business, because it's clear KKR really loves this industry," Jonathan Ziegler, a securities analyst with Salomon Bros. here, told SN. "If other retail companies come up for sale, KKR would probably be interested -- as long as they are good, quality properties." According to Gary Giblen, managing partner at Smith Barney here, "Based on a positive rate of return, KKR has been more successful in its supermarket investments than in any other sector. It's acquiring Bruno's because it feels confident about the supermarket business." In the course of their interview with SN, Greene and Raether shared several thoughts about KKR's plans, including the following: · KKR expects to be more aggressive than Bruno's current owners in building and remodeling stores. · KKR does not rule out a possible acquisition in the Southeast to complement Bruno's. · KKR's search for a new chief executive officer for Bruno's does not involve any executives from the supermarket companies it currently owns. · KKR is noncommittal on its long-range plans for the 35% stake in Vons Cos., Arcadia, Calif., that Safeway owns. · Although most of its investments last between five and eight years, KKR has no immediate plans to get out of its 14-year investment in Fred Meyer, its nine-year investment in Safeway or its seven-year investment in Stop & Shop. KKR made its first foray into the food industry in 1984 when it acquired Malone & Hyde, the Memphis, Tenn.-based wholesaler that was ultimately sold to Fleming Cos., Oklahoma City. Despite its track record of generally getting what it goes after, one supermarket property that got away was Kroger Co., Cincinnati, which opted to do its own financial restructuring in 1988 rather than sell to KKR. According to Greene, KKR's involvement with its supermarket investments are limited to managing the companies at the board-of-directors level. "Both Paul and I and other KKR general partners are directors of the companies we control, and we oversee the management team at each company on behalf of KKR and other shareholders through the director relationship," he explained. Analysts agreed that KKR takes a hands-off policy once it has its people in place. "It tries to bring constructive suggestions to the companies it owns, but it doesn't meddle," Ziegler said. Given its years of experience in the food industry, KKR has the ability to do a good job evaluating each company that comes along to determine its long-term value potential, said Ed Comeau, an analyst with Lehman Bros., New York.

"At this point, KKR brings a lot to the table in terms of its talent pool, so it's able to look at a company more intelligently than it could have even five or 10 years ago. "KKR would certainly prefer to buy good, quality companies at a reasonable price, but if it saw a company it felt it could improve, it would go after that acquisition as well." What attracted KKR to Bruno's, Greene said, was its location in the Southeast -- "an attractive part of the U.S." -- with some premium store locations "and an excellent reputation in its primary markets." KKR approached Bruno's about the possibility of a deal, Raether recalled. "We asked Bob Tobin [Stop & Shop's chief executive officer] if he could arrange a meeting with Ron Bruno [Bruno's CEO], which Bob did late last year. "Jamie [Greene] and I went down to Birmingham last December to see where he stood. At that point the chain was not for sale, and Ron met with us without making any promises. "But he had already asked Bob about KKR and the kinds of things we do once we own a company, and when he met with us, it was to learn more about what we might do with Bruno's. "Then, over the course of the next three or four months, Ron decided working with us was something he wanted to do, and we proceeded with the acquisition."

KKR formed a new entity called Crimson Acquisition Corp. -- a reference to the Crimson Tide, the nickname of the University of Alabama football team -- which would actually merge with Bruno's, with Bruno's emerging as the surviving entity. KKR lowered the price of the deal from $1.2 billion to $1.15 billion after completing its due diligence review, when it raised questions about the method by which Bruno's calculated reserves for self-insured worker's compensation and general liability claims. One industry observer said KKR can do a lot with Bruno's, "because it's the kind of company that needs to do 100 things 1% better, and that's what KKR is capable of doing.

"Bruno's has a strong franchise and good stores, but it lacks depth of management because of the plane crash several years ago that killed several member of top management." While several observers have speculated that Delchamps, Mobile, Ala., might make a good strategic acquisition for Bruno's, Greene declined to say if KKR contemplates making any acquisitions in the Southeast to complement the Bruno's operation. "We've always been opportunistic in our investments, and we can't say at this time we have no definite plans to acquire any other companies," Greene said. "We have no definite plans in that area," Raether added, "but even if we were looking at other acquisitions, we wouldn't be in a position to say. But we're not looking now because we want to get this deal done." According to Giblen, "It would make a lot of sense for KKR to get more critical mass in the Southeast. It's a typical strategy in a situation like this to buy one regional chain and then combine it with other operations in the region to form a more powerful entity." Greene and Raether both said Bruno's is in good shape physically and financially. "A substantial number of stores have been remodeled in the last five years, and the company's total debt is roughly $220 million, with equity assets of about $450 million on the balance sheet," Raether pointed out. Greene said KKR does not plan to sell a substantial amount of Bruno's assets "at this time, though in this business there are always stores opening and closing, and that is likely to continue to happen to some extent." According to Greene, "We anticipate investing in [Bruno's] and continuing to open new stores as well as remodeling the current store base, because that's what's necessary to stay competitive, and we want to be competitive." Lack of funds was not the reason Bruno's agreed to be acquired, Raether said. "The company certainly had plenty of financial wherewithal to do what it needed to do," he explained. "However, we may be more aggressive in remodeling existing stores and opening new stores and pushing technology than they were -- but it's all a matter of degree." The KKR executives declined to discuss any specific capital spending plans for Bruno's "because they are still in development," Greene said. "But we have stated publicly that we will bring in a new chief executive officer," Raether said, "so it would be premature for us to disclose plans for the company before he or she has an opportunity to develop a game plan." Besides, Greene added, "we're not in the business of making operating decisions. That's not where our expertise lies. Any thoughts in that direction will be up to the new CEO." The decision for Ron Bruno to step down as chairman and CEO was purely his own, Greene said. "Historically we've always backed existing managements in our acquisitions, but in this case Ron said he did not want to continue with the business, and we didn't have a problem with that." Ron Bruno will remain on the company's board for three years. However, he will remain as CEO only until a successor is found. Asked when a new CEO is likely to be hired, Greene said KKR is still in the process of conducting a search, "and searches take varying amounts of time." Raether said he does not expect the new CEO to be named before the merger is completed in July, "but we hope to select someone within 90 to 120 days." KKR's goal, Raether added, is to find "the best person available" for the job. According to Greene, that person will not come from within the ranks of the supermarket companies it owns. Asked if KKR is looking for someone with operating experience or would prefer a management consultant like Steve Burd was before he was named to head Safeway, Raether replied, "If we could find another Steve Burd, that would be great. Or another grocery store guy like Bob Tobin or Bob Miller [Fred Meyer's CEO] would also be great. "All three are very good, well-qualified executives, and we'd love to find someone in that mold." Asked to assess KKR's supermarket investments, Raether said Fred Meyer "is suffering" because of an 88-day retail clerks' strike last year, "and it's been more difficult to get customers back than management had anticipated. But we're confident the company will do just fine. "Though profits were negatively affected by the strike, and while they continue to be less than we want them to be, we expect things will be fine in the long run." Greene said Safeway is performing very well. "The stock price hit a new high recently, and Steve Burd and his management team are doing a terrific job driving Safeway's growth, and we're obviously very supportive."

He said KKR is excited about Stop & Shop's long-term prospects. "The stock responded well to the news of Stop & Shop's acquisition of Purity, and we think the outlook for Stop & Shop is excellent." KKR's average holding period in most investments is five to eight years, Raether said, "though in the supermarket business we've obviously exceeded that limit in two of the three instances. "But all three have done well and have continued to grow nicely, and we want to hold on to good investment opportunities like those, so there's no real timetable involved." Added Greene, "There's a limit on the time we can hold our investments, given our contractual relationship with each company. That time frame is typically 12 years, although with Fred Meyer the partnership agreement was for a longer period. "But all those agreements are negotiable, so the time frames can be extended if both sides are willing. So far we haven't made any such extensions, but we could." All of KKR's investments are finite, Giblen pointed out. "KKR is in the business of buying and selling businesses for profit, and at some point it will give up its ownership positions. "KKR is a savvy investor, and it won't sell Safeway, for example, when that company has so much momentum. And Safeway won't sell the Vons shares it owns while the stock price is in the low or middle range," Giblen said. According to Ziegler, "Someday KKR will want to take its profits off the table. But in the case of Fred Meyer, the stock is down right now, but there's still a lot of value there, so no sale is imminent. "Safeway is the best performer among KKR's supermarket stocks, so KKR could decide to lighten up there sooner rather than later. "As for Safeway's investment in Vons, KKR wants to have a presence in southern California, and while there are synergies between Safeway and Vons, KKR feels Safeway can make better use of its cash internally right now while getting the benefits of its equity investment in Vons. "But long-term, a company of Vons' size must think about building critical mass, and someday it may have to combine with someone else, and that could be Safeway." Because of Safeway's 35% ownership stake in Vons, there has been speculation for several years that KKR could go after majority control of Vons and merge it with Safeway. Greene said KKR has no plans "at this time" to engineer such a move, although he did not rule out any future moves, including the outright sale of the Vons stock. "Safeway has the flexibility under its 13D filing with the Securities and Exchange Commission to increase its investment in Vons, decrease it or maintain the status quo and do nothing, and we stand by that filing," Greene said.